VAT multipliers and pass-through dynamics

To quantify fiscal multipliers in Eurozone countries, ECB, European Commission and IMF draw heavily on large-scale DSGE models. In these models, the value added tax (VAT) is implemented as consumption tax, implying essentially full contemporaneous pass-through of changes in the tax liability to consumers. However, empirical evidence suggests that VAT pass-through in Europe occurs only gradually. To investigate how realistic pass-through dynamics affect VAT multipliers, a DSGE model is augmented by a retail sector, which allows to replicate empirical pass- through estimates. The resulting short-run multipliers are dramatically smaller than those from a consumption tax, suggesting systematic over- estimation in institutional research.