Taxes in the Years of Progress

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In recent weeks, the rumor of an increase in VAT for the start of the 2015 school year (from 20% currently to 22%) has frequently come back to the table. The idea is simple: there is a lack of money in the state coffers, and a 2-point increase in VAT would increase public revenue by around 15 billion euros, and therefore bring back the deficit at a level close to 3%. But as a consumer, and assuming this VAT hike takes place, how is your purchasing power going to be impacted?

Are all prices going to increase by around 2%, which would imply a drop in purchasing power of this magnitude if wages do not increase in return?

First of all, it is important to know that there are three main VAT rates: (1) VAT at reduced rate (5.5%), applicable (among others) on  food products, books, subscriptions gas and electricity, the intermediate VAT rate (10%, compared to 7% before January 2014), applicable to catering (immediate consumption), passenger transport or even improvement works housing and the normal VAT rate  (20%,  compared to 19.6% before January 2014), applicable for simplicity on everything else. As a consumer, an increase in the “normal rate” VAT would therefore only have an impact on part of your shopping basket. On average, products at the standard VAT rate represent around 60% of an individual’s consumption: the overall impact on the price of the consumption basket would therefore be, in the event of full VAT passing on in prices, of about 1%. You can get the entire solutions with the calculation of the

  • In this scenario, it is then assumed that companies pass on the entire increase in VAT in prices. If, for example, a company sold a product at 10 euros excluding tax (HT) and therefore 12 euros including all taxes (TTC) when the VAT was 20% (10 * 1.2 = 12 euros), then in the event of an increase VAT at 22%, the company would keep its price excluding VAT constant and the price including VAT would therefore be 10 * 1.22 = 12.20 euros. But in reality, an increase (or a decrease for that matter) of VAT is not fully reflected in prices: this is called the “pass-through” effect.

The Research Paper

The Banque de France published a very comprehensive research paper on this subject in 2013 (source: “What are the effects on inflation of VAT changes in France? “), by empirically studying the direct impact on inflation of the changes in VAT that have taken place since 1995. For example in July 2009, the VAT rate on restaurants fell from 19.6% to 5.5%, which should have mechanically implied a drop in prices of 11.8% in the sector (a meal costing 10 euros HT + VAT = 11.96 euros must in fact cost thereafter, if the drop in VAT is fully reflected in the prices, 10, 55 euros, or a decrease of 11.8%).

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