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More haircut after VAT cut? On the efficiency of service sector consumption taxes

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  • Kosonen, Tuomas

Abstract

Consumption tax rates targeted at specific sectors are often reformed without empirical knowledge about the efficiency of these policies. This paper sheds light on the efficiency issue, the potential for welfare improving reform, by studying the incidence of value added taxes (VAT) on prices and quantities of barber services traded. I also study the incidence on the profits made by the targeted firms. I utilize a VAT reform targeted at a specific service sector which creates a natural experiment set up. VAT for hairdressing services in Finland was reduced from 22% to 8%, whereas the normal tax treatment still applied to beauty salons and other labor intensive services. The choice of the treatment and control groups was exogenous to circumstances in Finland, since these groups were selected in a more wider European setting. The results suggest that hairdressers cut their prices only by half of what complete pass-through would have implied, and that there was hardly any adjustment in the equilibrium quantity due to the reform. Instead of lowering prices, most hairdressers were able to increase their profits. There is important heterogeneity in the results according to firm size.

Suggested Citation

  • Kosonen, Tuomas, 2013. "More haircut after VAT cut? On the efficiency of service sector consumption taxes," Working Papers 49, VATT Institute for Economic Research.
  • Handle: RePEc:fer:wpaper:49
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    File URL: https://www.doria.fi/handle/10024/148788
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    References listed on IDEAS

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    Cited by:

    1. Simon Voigts, 2016. "VAT multipliers and pass-through dynamics," SFB 649 Discussion Papers SFB649DP2016-026, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    2. Dora Benedek & Ruud A. de Mooij & Michael Keen & Philippe Wingender, 2015. "Estimating VAT Pass Through," CESifo Working Paper Series 5531, CESifo Group Munich.
    3. Li Liu & Benjamin Lockwood, 2015. "VAT Notches," CESifo Working Paper Series 5371, CESifo Group Munich.

    More about this item

    Keywords

    VAT reform; efficiency; tax incidence; Taxation; Verotus; Taxation and Social Transfers; Julkisen talouden rahoitus ja tulonsiirrot;

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