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IMF advises against anti-inflation VAT rate cuts

Governments would be better to use revenues for more targeted welfare support

The International Monetary Fund last week called for governments to avoid temporary Value Added Tax rate cuts on fuels, electricity or foods as an attempt to reduce the impact of fast-rising inflation. European VAT cuts and in the rest of the world have been rife in as inflation hits forty-year highs.

In its report, the IMF highlights that VAT and similar ad valorem taxes brings in extra revenues given the price elasticity of energy and food spend. Rather than offering tax subsidies to all through VAT cuts, they should instead use the additional taxes to provide targeted welfare support to those less well off.

European VAT inflation cuts have been widespread since the end of 2021 when inflation began to rise.

Environmental issues should be considered

Governments should also consider environmental issues on giving tax subsidies through VAT cuts.

Import tariff cuts on necessities, which are less distortionary, would then be preferable. Externalities that fuel excises address remain valid to mitigate climate change, therefore higher fuel taxes are still needed. Even in the absence of an explicit tax cut, a specific excise tax falls as a share of the consumer price when the pretax price rises.

Examples of recent European VAT rate cuts

  • Finland considers VAT cuts to petrol and food
  • Cyprus has extended cut on domestic electricity to 5% until 31 Aug 2022
  • Luxembourg cuts VAT on diesel till end of 2022
  • Bulgaria cuts VAT on VAT on heating and bread for one year
  • Slovenia considers domestic electricity, fuel and digital newspapers to 5% in September

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