Nova workboard

a blog from young economists at Nova SBE

VAT vs IMI – Portuguese Case

In July 2012 and then in May 2013, OECD advised Portugal that it would be better to increase IMI (Property Tax) rather than VAT (Value Added Tax) because it would be a fairer measure and better for the economic growth.

I have decided to analyse this from the consumers’ point of view. In order to do it, I will divide the consumers in three groups: (1) households who are property owners of extremely valuable houses because they have a higher income so they can afford the costs of having such a accommodation, (2) households who are property owners with a medium income and (3) households who are not property owners, i.e., households with low income.

To a simpler and more understandable analysis, we are going to assume (i): that consumers’ utility is measured by the quantity of goods they can afford with their income.

According to INE’s statistics, in the first trimester of 2009, 40,6% of the total number of workers received a net salary of less than 600€ and only 12,4% earned more than 1200€. With all the austerity measures to reduce wages in Portugal since 2009, families’ income may be even less today. Note that we are talking about the total number of workers but we cannot forget that in the second trimester of 2013, the unemployment rate was 16,4%. Nevertheless, according to CENSOS 2011, 73,5% of the total number of housings are inhabited by the owners themselves. Then we can conclude that the majority of Portuguese population is included in group (2).

Besides this, medium-low income families affect a higher proportion of their income on consumption than high income families which means that the majority of Portuguese families will have their welfare affected if their consumption is affected so it would be better for these families if the government amended IMI rather than VAT.

Imagine that the government increases VAT (which higher rate is already 23%). The perception that consumers of groups (2) and (3) have with this policy is that those goods they were used to buy are now more expensive so they will buy less because their purchasing power decreases (income effect) and they will choose cheaper goods (substitution effect). Therefore, their utility will decrease. Note that, in absolute terms, high income families will consume much less than group 2 and 3 but in relative terms, they (group (1)) will be less affected by this decision because consumption is a smaller proportion of their income or wealth so their marginal utility is lower.  This means that groups 1 and 2 will be the most unprivileged parts.

If, otherwise the government increases IMI (which is now 0,8% tops), this will affect groups (1) and (2). But the value of group (1)’s housings are higher, i.e., the incidence base is higher so group (1) will pay more than group (2) in absolute numbers – assuming that accommodation’s value is directly related to family’s income. But, again, in relative terms, IMI has a higher impact in group 2´s income because it is lower. Moreover if IMI increases, the consumption of group (1) will not decrease because the portion affected to consumption will not change and the consumption of group (2) will decrease but not immediately or in a big quantity because, as said, the rate will be appropriate to the value of the house which is assumed to be proportional to income. Finally, the consumption of group (3) will not decrease at all. If we apply our assumption (i) here, we would say that neither utilities of groups (1), (2) or (3) are much affected because the consumption would not decrease exponentially. Although, in fact, the utility of group (2) may decrease because their income will be lower – but not so much as if the policy instrument was the VAT.

Thus, if one talks about aggregate consumers’ welfare, one can say that the impact of a variation in VAT is bigger than the impact of a variation in IMI and as IMI taxes people according to their yield, it is a fairer tax so the system will be fairer as the OECD declared.

Note that, in this case, the decision of increasing IMI does not imply a reduction in VAT because the main goal is to increase government revenues. The only question is finding the most efficient way of doing it minimizing the impact in aggregate households’ utility. As group 1 is the majority of Portuguese people, it is better to amend the IMI because it does not have an immediate impact on consumption and, on the other hand, it does not affect the majority so the aggregate consumer surplus will not change as much as if the government amended VAT. In conclusion, the OECD advice will make consumers better off (in comparison with the measure to amend VAT).

Maria João Azevedo #639 




Author: studentnovasbe

Master student in Nova Sbe

Comments are closed.