In the debate on tax reforms, it has often been suggested that the burden is shifting from labor to consumption leads to more economic growth and employment. Charges on consumption are less economically disruptive to household behavior than income taxes, according to the economic literature. The question, however, is why that should be the case: if a VAT increase is passed on in prices, the real income will not change when the burden is shifted from labor to VAT. You can visit www.taxfyle.com/tax-bracket-calculator there.
The Right Shift
A shift from the burden on labor to consumption is therefore mainly economically efficient if it leads to a shift in the burden between groups (OECD, 2006). The amount of wage tax mainly affects income from work. The level of VAT, on the other hand, not only causes a change in real labor income, but also a lower real value of social benefits. If these groups are not compensated for the decline in purchasing power, the burdens will shift from mainly active to inactive, which is good for labor participation. This will then increase potential economic growth.
- However, if the inactive are compensated for purchasing power effects, for example through an increase in benefits, the positive economic consequences in the long term are small to nil. If the government does not want to change the differences in purchasing power between different groups too much, the possibilities for achieving more economic growth by shifting the burden on labor to consumption are therefore limited.
Uniform VAT rate without exemption desirable
Regardless of the level of VAT, it is economically desirable to use a uniform VAT rate instead of different rates. In addition to a standard VAT rate, most countries have a reduced rate for, among other things, foodstuffs and an exemption from VAT for sectors such as healthcare and education.
As a result, VAT in most countries is only a fraction of what it could be at a uniform rate without exemptions. An important reason for the reduced rate is to spare lower income groups when purchasing goods and services necessary for their livelihood, because they spend proportionately more on them. However, VAT is an inefficient instrument for this: it leads to red tape and arbitrary choices and in practice it seems that the higher incomes in particular benefit from the lower rates.
Conclusion
It would be much more efficient to regulate such income distribution targets through the income taxes. A uniform rate could therefore yield a considerable welfare gain. The reduced rate is also applied to encourage the use of certain goods and services. Again, however, it is better to stimulate this consumption through direct subsidies instead of a reduced VAT rate.
