A Lower VAT Rate on Electricity in Portugal: Towards a Cleaner Environment, Better Economic Performance, and Less Inequality

This article determines the budgetary, economic, distributional and environmental impact of permanently increasing the value-added tax on electricity in Portugal. The analysis is carried out in the context of a new multi-sector and multi-household dynamic general equilibrium model. Simulation results suggest that a permanent increase from 6% to 23% in the statutory VAT on electricity improves the public budget as well as the environment, but both gains have detrimental economic and distributional effects. As the economy in Portugal begins to recover in the aftermath of the Great Financial Crisis, and the public budgetary situation becomes less constraining, pressure is mounting for this VAT increase on electricity to be reversed. This mixed bag of results is an important element for the debate. Reverting to a tax of 6% on electricity is desirable, as it would improve economic performance and have positive distributional effects. The question, then, is how to compensate for the loss of tax revenue and, at the same time, protect the environment. To offset the adverse budgetary and environmental effects of a lower VAT, we propose to increase the tax on petroleum products. This proves to be a dominant strategy from all relevant perspectives – economic, distributional, and environmental.