Consumption taxation through value-added taxes (VAT) is usually considered a relatively efficient way of raising public funds and in the first years of the last decade VAT revenues increased, particularly due to the rise of tax rates. In 2009 the VAT’s revenue decreased but then they rised again and they have been relatively constant ever since.
In the present situation, consumption levels in Portugal need some incentive. The consumers are facing lower income, their purchase power is also decreasing, and consequently the demand side of the Portuguese market is getting suffocated with extremely elevated tax rates, which is also negative to the supply side, once the firms are struggling to be able to buy inputs and sell their outputs.
In Portugal, in 2012, 36% of the tax revenue comes from VAT. It is the type of tax that is more important for the tax revenues.
However, the minimum and medium tax rates do not have a significant weight in the revenues so, if they were reduced or even eliminated that would not be so negative for tax revenues.
Reducing or eliminate these tax rates would have a positive effect on the economy’s growth. Firstly, it would benefit low income families, whose budget constraint is very restrictive these days.
As table 1 from the Economic Bulletin of the Bank of Portugal shows, the low income households consumption the expense lies mainly in food products, result that we can say, it is in accordance with the law of Engel. Food products are essential goods, so if they were cheaper that would increase the consumer’s utility because their choice and opportunities of consumption would increase.
Secondly, this measure would have a positive effect on businesses such as the catering sector, once the inputs used for them would have a lower cost, reducing the production costs. It would be especially positive because the current VAT’s rate applicable in this sector is the standard, 23%.
Once in the tax policy debate the differentiation of VAT is often justified by distributional concerns, Stefan Boeters, Christoph Böhringer, Thiess Büttner & Margit Kraus (2010) investigated the economic effects of VAT reforms in Germany, based on an applied general equilibrium (AGE) approach.
They found that despite the overall welfare effects of pure VAT reforms are very small, a introduction of an harmonized VAT combined with reductions in the marginal income tax rates or social security contributions turns out to yield substantial welfare gains for all households.
On the other hand, they found evidence that supports that reduced VAT rates act as industry-specific subsidies. This indicates that the VAT rate differentiation should be viewed primarily as a subsidy to specific industries rather than an instrument of redistribution.
We cannot compare directly different countries although this work gives some support for us to say that the reduction on VAT tax rate would have a significant positive contribution for the catering sector which would certainly influence the economic growth.
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