In today’s post we present simple back-of-the-envelope estimates from Codera’s CPI forecast model to look at the impact of the 1% point increase in Value Added Tax (VAT) in April 2018 on inflation.
As a demonstration, we make a simplifying assumption that Codera’s model forecast errors over the subsequent year were caused by the 1% point VAT increase. We find a weighted passthrough estimate of around 20% of the VAT change across the components of the CPI.
To more precisely estimate the pass-through of the VAT change one would want to explicitly control for the supply and demand factors that affected different categories and announced administered price changes. Nonetheless, the estimates show that the inflationary impact of the tax change is likely to have been less than one-for-one. There are many possible explanations, including that that firms tend to adjust their markups in response to avoid loosing market share, demand for many goods and services are elastic (i.e. consumer demand is responsive to price changes), consumers substitute to cheaper or lower inflation goods or services or supply and demand dynamics over the subsequent months dominate the impact of the VAT change.
