Consumption Tax Cuts in a Recession

Consumption taxes are often used across OECD countries as fiscal stimulus tools during recessions. In this paper, I use an estimated structural life-cycle model featuring multiple consumption categories to assess the e ectiveness of temporary cuts to the Value Added Tax (VAT) rates on non-durable luxuries and durables as stimulus instruments. I find a tax elasticity smaller than 1 for non-durable luxuries and a tax elasticity higher than 10 for durables. I show that the tax cut on non-durables has an intratemporal substitu- tion effect on non-durables and an income e ect on durables and savings, while the tax cut on durables acts through an intertemporal substitution mechanism in the purchase of durables that is stronger for high income, liquidity unconstrained, and younger house- holds. Due to the partial irreversibility feature of durables, this mechanism is dampened if households anticipate higher future aggregate uncertainty.