Nova workboard

a blog from young economists at Nova SBE

Too early for lunch?

In Portugal, on January 1 2012, VAT on restaurants, bars and cafes rose to 23%. The Government’s intention was clear: raising fiscal revenue. At the end of the year, results were out: an 109% increase in fiscal revenue from the sector (€521 million for 2012). However, a large share of the additional revenue results from stronger fiscal control.

Now Government is considering cutting the rate back to 13%. This time, the argument is that the decrease in the tax rate will act as a favorable stimulus to the short-term creation of jobs particularly effective for the younger workers who face the highest unemployment rate. Unemployment is indeed a concern in the sector: according to INE, in 2012, the number of unemployed people with origin in the restaurant sector increased by around 7.800, adding to the total observed number in 2011 of 55.565 individuals. In 2013, the figure increased even further, although at a lower rate.

How plausible is this?

When VAT went up, from 13% to 23% (77% increase!), prices were expected to increase similarly. But, checking the CPI for 2012, the true price increase from dec2011 to dec2012 in restaurants, cafes and similar services was only 1,35%.

So, it is reasonable to conclude that the added VAT was paid out of restaurant’s margins and not from consumer’s pockets. As demand for restaurant services is very elastic (meals-out are easily substituted by doing-it-yourself),  restaurants were probably afraid that passing the tax burden to their customers would lead to a very large drop in demanded quantity (already low due to recession and low available income) and absorbed it themselves.

As VAT is an AdValorem tax on the producer, a change in the tax rate causes a pivotal shift in the supply curve. In the left graph, contraction in demand is assumed and, the new tax revenue of 2012 is shown, as well as the maintenance of prices. In right graph, tax revenue for 2013 is given by Q´ (where S’ (VAT=13%) meats D´) times the (equilibrium price-willingness to sell Q´ at S(VAT=0%). The price fall consequent to IVA drop is small – unfortunately no comments can be made on the exact size of final tax revenue impact, as it depends the proportion of Q and P changes .

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There is empirical evidence that VAT changes on restaurant services are only partially reflected on the market price (i.e. in 2009 France restaurant VAT fell from 19,5% to 5,5% but restaurant prices decreased by no more than 1.1%). In Portugal, a Trade Association already stated that prices will not go down -hence there will be no “boost in demand” and restaurants maybe actually gaining profits unfairly, “a rent”, when compared to other firms. Additionally, as restaurants are prone to tax evasion, and in spite of supervision tightening up, they may still be benefiting from a “real VAT” lower than other sectors firms. Furthermore, it does not seem very likely that the tax decrease will allow for any relevant increase in employment of the low-skilled workers of the sector as firms claim they are near the shut-down point. And there may even be the case where each job created will represent an unjustifiably high cost for the public finances (as occurred in France’s VAT cut of 2009 where each job generated came at a cost of €120.000 1). Finally, Government favoring restaurants over similar businesses that use the same workforce, may end up causing distortions in the labor market.  Government may be keen on introducing some alleviating measures, as an answer to political pressures or to sustain the expectations that “the crisis and is almost over”, but isn’t the expected liquid revenue loss of 50 to 100 million€, immediately after the end of the External Assistance Program, a little too much?

1 – Sénate, La TVA à taux réduit dans la restauration: une mesure qui fait ses preuves.

Matilde de Vasconcellos 666

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Author: studentnovasbe

Master student in Nova Sbe

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