Nova workboard

a blog from young economists at Nova SBE

Portuguese VAT reform: a real problem

Going back to 2011, no one has forgotten that Portugal requested financial assistance from the EU, the Eurozone Member States and the IMF. In exchange for financial aid, Portugal has committed to an adjustment program which is composed essentially of fiscal consolidation measures.

One of the measures adopted by the government, despite all the contestation of opposition parties and entrepreneurs, was the increase of VAT in the restaurants sector from 6% to 23% (which is the maximum rate of VAT in our country) since the beginning of 2012.

According to a recent government study, the increase in the VAT rate has fulfilled the objective of fiscal consolidation: the VAT revenue increased by 109% compared to 2011. However, this analysis would be too simplistic and therefore we should look at the other side of the story.

First of all, the VAT revenue increased not only due to the change in VAT rate but also due to other measures adopted to combat tax evasion and to ensure greater efficiency of tax administrations. Additionally, we have to take into account that an increase in the VAT rate may lead to a decrease in the activity of the sector and therefore this effect may partially cancel out the increase in government revenue. Combining these two factors, Paulo D’Anunciação claimed that “less VAT, and less bankruptcies, and equal control would have led to a higher increase in government revenue”.

Another question that might be raised is why the opposition parties and associations of entrepreneurs were against this type of policy. They argued that this policy would lead to the bankruptcy of restaurants and would increase the unemployment. Two years later, the effects of this policy seem to give support to opposition parties. The Business Volume Index decreased by 12,3% compared to 2011; additionally, the number of unemployed workers with origin in this sector increased by around 14% compared to 2011. It is true that both indicators followed a negative trend since 2009, but the current policy has accentuated the crisis in that sector.

Notice that, intuitively, there were losses of welfare for consumers and producers. On the one hand, consumers face higher prices than before; on the other hand, entrepreneurs face a lower demand and some of them were forced to shut down. In other words, the increase in the government revenue had as cost the reduction of consumers’ and producers’ welfare. However, in that study or in the news, there is nothing about the “deadweight loss”. We know that the raise in taxes lead to a higher efficiency loss because it distorts the agents’ behavior. It’s another negative effect of this policy that we should keep in mind.

Besides this, some international studies also defend low VAT rates for some sectors, in particular for those who use low skill workers (e.g. restaurants sector). Among the main reasons is the concern of avoiding a rise in unemployment. Additionally, it is also interesting to see that other countries under financial assistance (Greece, Ireland and Cyprus) apply reduced VAT rates in the restaurants sector, as well as all the countries of the Mediterranean culture.

In conclusion, the government should have adopted alternative measures to get extra revenue (e.g. the other assisted countries were not also forced to implement that measure). The sector of the restaurants sector is a very particular one and an excessive increase of VAT caused destructive effects. This is consistent with one of the conclusions of the last government study: we should go back to the initial tax policy in the restaurants sector.

Filipe Silvério, #617

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Author: studentnovasbe

Master student in Nova Sbe

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