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The Intertemporal Substitution and Income Effects of a VAT Rate Increase: Evidence from Japan

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  • David CASHIN
  • UNAYAMA Takashi

Abstract

One of the biggest political issues in Japan is an increase in the rate of value added tax (VAT). In this paper, we evaluate its impact on household expenditure, using Japan's April 1997 VAT rate increase from three to five percent as a case study. A rate increase induces price hikes, and provided this increase in price levels is anticipated, households should engage in intertemporal substitution of purchases. In addition, if households are not compensated for the rate increase, it has the potential to induce an income effect on household consumption. Based on monthly household expenditure data, we find that households spent 30,231 yen more in the quarter prior to the rate increase than they would have in its absence, while the income effect was negligible. Consistent with theoretical predictions, increased outlays on durable and storable non-durable goods and services were responsible for roughly three-quarters of the observed intertemporal substitution effects. Contrary to conventional wisdom, we find that the VAT rate increase had no impact on real household spending following its implementation, once we have accounted for intertemporal substitution, which caused a large transitory disturbance in household expenditures.

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Bibliographic Info

Paper provided by Research Institute of Economy, Trade and Industry (RIETI) in its series Discussion papers with number 11045.

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Length: 44 pages
Date of creation: Apr 2011
Date of revision:
Handle: RePEc:eti:dpaper:11045

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  1. Igal Hendel & Aviv Nevo, 2002. "Sales and Consumer Inventory," NBER Working Papers 9048, National Bureau of Economic Research, Inc.
  2. Karel Mertens & Morten O. Ravn, 2009. "Empirical evidence on the aggregate effects of anticipated and unanticipated US tax policy shocks," Working Paper Research 181, National Bank of Belgium.
  3. Melvin Stephens, Jr. & Takashi Unayama, 2010. "The Consumption Response to Seasonal Income: Evidence from Japanese Public Pension Benefits," NBER Working Papers 16342, National Bureau of Economic Research, Inc.
  4. Summers, Robert & Heston, Alan, 1991. "The Penn World Table (Mark 5): An Expanded Set of International Comparisons, 1950-1988," The Quarterly Journal of Economics, MIT Press, vol. 106(2), pages 327-68, May.
  5. Louis Kaplow, 2006. "Capital Levies and Transition to a Consumption Tax," NBER Working Papers 12259, National Bureau of Economic Research, Inc.
  6. Igal Hendel & Aviv Nevo, 2004. "Intertemporal Substitution and Storable Products," Journal of the European Economic Association, MIT Press, vol. 2(2-3), pages 536-547, 04/05.
  7. Christopher L. House & Matthew D. Shapiro, 2008. "Temporary Investment Tax Incentives: Theory with Evidence from Bonus Depreciation," American Economic Review, American Economic Association, vol. 98(3), pages 737-68, June.
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Cited by:
  1. David CASHIN & UNAYAMA Takashi, 2012. "Short-run Distributional Effects of VAT Rate Change: Evidence from a consumption tax rate increase in Japan," Discussion papers 12029, Research Institute of Economy, Trade and Industry (RIETI).

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