The Pass-Through of a Large and Permanent VAT Reduction on Food to Consumer Prices: Evidence from Romania

Sammanfattning

We analyze a large and permanent VAT rate reduction implemented in Romania in 2015 for foods and non-alcoholic beverages, which its PM argued would "almost entirely be reflected in lower prices, not in higher profits for some retailers". Using the SDID method introduced by Arkhangelsky et al. (2021), we create a Romanian Doppelgänger to analyze the food price effects of the VAT cut using monthly food price data from EU member states. Our results reveal prices falling by 9.14%, suggesting that 75.77% of the reduction in VAT passed through to consumers. We argue that this incomplete shift in consumer prices was caused primarily by two factors, the relative elasticity of demand and imperfect competition. In the case of the prior, retail sales volumes for food increased by 11.4% in the month following the cut and remained high, thus putting upward pressure on prices. As for the latter, retailers report increasing profits after the cut, pointing towards it allowing them to raise margins. In contrast to prior papers finding complete price shifts, we note an absence of price monitoring made visible to consumers, in combination with doubts over the Competition Council's authority to intervene and enforce sanctions against unjust price setting. Finally, we find large variations in pass-through between product groups, but fail to identify a pattern pointing towards underlying mechanisms explaining this result.