IDEAS home Printed from https://ideas.repec.org/p/eti/dpaper/11045.html
   My bibliography  Save this paper

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

Author

Listed:
  • David CASHIN
  • Takashi UNAYAMA

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.

Suggested Citation

  • David CASHIN & Takashi UNAYAMA, 2011. "The Intertemporal Substitution and Income Effects of a VAT Rate Increase: Evidence from Japan," Discussion papers 11045, Research Institute of Economy, Trade and Industry (RIETI).
    • Handle: RePEc:eti:dpaper:11045
    as

    Download full text from publisher

    File URL: https://www.rieti.go.jp/jp/publications/dp/11e045.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Igal Hendel & Aviv Nevo, 2006. "Sales and consumer inventory," RAND Journal of Economics, RAND Corporation, vol. 37(3), pages 543-561, September.
    2. repec:dpr:wpaper:0308 is not listed on IDEAS
    3. Louis Kaplow, 2006. "Capital Levies and Transition to a Consumption Tax," NBER Working Papers 12259, National Bureau of Economic Research, Inc.
    4. Karel Mertens & Morten O. Ravn, 2012. "Empirical Evidence on the Aggregate Effects of Anticipated and Unanticipated US Tax Policy Shocks," American Economic Journal: Economic Policy, American Economic Association, vol. 4(2), pages 145-181, May.
    5. Melvin Stephens & Takashi Unayama, 2011. "The Consumption Response to Seasonal Income: Evidence from Japanese Public Pension Benefits," American Economic Journal: Applied Economics, American Economic Association, vol. 3(4), pages 86-118, October.
    6. Igal Hendel & Aviv Nevo, 2006. "Sales and Consumer Inventory," RAND Journal of Economics, The RAND Corporation, vol. 37(3), pages 543-561, Autumn.
    7. 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.
    8. Westin, Richard B, 1975. "Empirical Implications of Infrequent Purchase Behavior in a Stock Adjustment Model," American Economic Review, American Economic Association, vol. 65(3), pages 384-396, June.
    9. Masao Ogaki & Carmen M. Reinhart, 1998. "Measuring Intertemporal Substitution: The Role of Durable Goods," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 1078-1098, October.
    10. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    11. Ishi, Hiromitsu, 2001. "The Japanese Tax System," OUP Catalogue, Oxford University Press, edition 3, number 9780199242566, Decembrie.
    12. Mark Bils & Peter J. Klenow, 1998. "Using Consumer Theory to Test Competing Business Cycle Models," Journal of Political Economy, University of Chicago Press, vol. 106(2), pages 233-261, April.
    13. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 33(1), pages 125-132.
    14. Butler, Monika, 2000. "The political feasibility of pension reform options: the case of Switzerland," Journal of Public Economics, Elsevier, vol. 75(3), pages 389-416, March.
    15. 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.
    16. Robert Summers & Alan Heston, 1991. "The Penn World Table (Mark 5): An Expanded Set of International Comparisons, 1950–1988," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 106(2), pages 327-368.
    17. Watanabe, Katsunori & Watanabe, Takayuki & Watanabe, Tsutomu, 2001. "Tax policy and consumer spending: evidence from Japanese fiscal experiments," Journal of International Economics, Elsevier, vol. 53(2), pages 261-281, April.
    18. 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 737-768, June.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Takeo Hoshi & Takatoshi Ito, 2013. "Is the Sky the Limit? Can Japanese Government Bonds Continue to Defy Gravity?," Asian Economic Policy Review, Japan Center for Economic Research, vol. 8(2), pages 218-247, December.
    2. Alisdair McKay & Johannes F. Wieland, 2021. "Lumpy Durable Consumption Demand and the Limited Ammunition of Monetary Policy," Econometrica, Econometric Society, vol. 89(6), pages 2717-2749, November.
    3. Thomas Crossley & Hamish Low & Cath Sleeman, 2014. "Using a temporary indirect tax cut as a fiscal stimulus: evidence from the UK," IFS Working Papers W14/16, Institute for Fiscal Studies.
    4. David CASHIN & Takashi UNAYAMA, 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).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. David Cashin & Takashi Unayama, 2016. "Measuring Intertemporal Substitution in Consumption: Evidence from a VAT Increase in Japan," The Review of Economics and Statistics, MIT Press, vol. 98(2), pages 285-297, May.
    2. David B. Cashin, 2017. "The Household Expenditure Response to a Consumption Tax Rate Increase," Finance and Economics Discussion Series 2017-035, Board of Governors of the Federal Reserve System (U.S.).
    3. David CASHIN & Takashi UNAYAMA, 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).
    4. David Cashin & Jamie Lenney & Byron Lutz & William Peterman, 2018. "Fiscal policy and aggregate demand in the USA before, during, and following the Great Recession," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 25(6), pages 1519-1558, December.
    5. Metiu, Norbert, 2021. "Anticipation effects of protectionist U.S. trade policies," Journal of International Economics, Elsevier, vol. 133(C).
    6. Domenico Ferraro & Giuseppe Fiori, 2020. "The Aging of the Baby Boomers: Demographics and Propagation of Tax Shocks," American Economic Journal: Macroeconomics, American Economic Association, vol. 12(2), pages 167-193, April.
    7. Emi Nakamura & Jón Steinsson, 2018. "Identification in Macroeconomics," Journal of Economic Perspectives, American Economic Association, vol. 32(3), pages 59-86, Summer.
    8. Karel Mertens & Morten Overgaard Ravn, 2011. "Understanding the Aggregate Effects of Anticipated and Unanticipated Tax Policy Shocks," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(1), pages 27-54, January.
    9. Ruhollah Eskandari & Morteza Zamanian, 2023. "Heterogeneous responses to corporate marginal tax rates: Evidence from small and large firms," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 38(7), pages 1018-1047, November.
    10. Donna, Javier D., 2018. "Measuring Long-Run Price Elasticities in Urban Travel Demand," MPRA Paper 90059, University Library of Munich, Germany.
    11. João F. Gomes & Leonid Kogan & Motohiro Yogo, 2009. "Durability of Output and Expected Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 117(5), pages 941-986.
    12. Victor Aguirregabiria & Allan Collard-Wexler & Stephen P. Ryan, 2021. "Dynamic Games in Empirical Industrial Organization," NBER Working Papers 29291, National Bureau of Economic Research, Inc.
    13. Ramey, V.A., 2016. "Macroeconomic Shocks and Their Propagation," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 71-162, Elsevier.
    14. Fabio Antoniou & Raffaele Fiocco, 2019. "Strategic inventories under limited commitment," RAND Journal of Economics, RAND Corporation, vol. 50(3), pages 695-729, September.
    15. Scott R. Baker & Stephanie Johnson & Lorenz Kueng, 2021. "Shopping for Lower Sales Tax Rates," American Economic Journal: Macroeconomics, American Economic Association, vol. 13(3), pages 209-250, July.
    16. Sims, Eric & Wolff, Jonathan, 2018. "The state-dependent effects of tax shocks," European Economic Review, Elsevier, vol. 107(C), pages 57-85.
    17. Bayer, Christian & Born, Benjamin & Luetticke, Ralph, 2023. "The liquidity channel of fiscal policy," Journal of Monetary Economics, Elsevier, vol. 134(C), pages 86-117.
    18. Erhan Artuç & Germán Bet & Irene Brambilla & Guido Porto, 2013. "Trade Shocks and Factor Adjustment Frictions: Implications for Investment and Labor," IIE, Working Papers 101, IIE, Universidad Nacional de La Plata.
    19. Karel Mertens & Morten Overgaard Ravn, 2011. "Understanding the Aggregate Effects of Anticipated and Unanticipated Tax Policy Shocks," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(1), pages 27-54, January.
    20. Nathan Marwell & Leslie McGranahan, 2010. "The effect of sales tax holidays on household consumption patterns," Working Paper Series WP-2010-06, Federal Reserve Bank of Chicago.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eti:dpaper:11045. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: TANIMOTO, Toko (email available below). General contact details of provider: https://edirc.repec.org/data/rietijp.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.