Can VAT Cuts Dampen the Effects of Food Price Inflation?

This paper shows that governments can use VAT cuts and tax incidence mandates to mitigate the effects of inflation on purchasing power. To do so, we use high-frequency retail scanner data from Argentina, along with a temporary 21 percentage point VAT cut on essential food whose pass-through to prices was encouraged by the government to be 100% for the VAT cut and mandated to be no more than 33% for some products after the VAT increase. We implement a difference-in-differences approach comparing goods that are subject to the VAT cut and/or to the pass-through mandates to those that are not. First, we find that ≈ 60% of the VAT cut is passed through to prices, in contrast to recent empirical findings that the pass-through of VAT cuts tends to be very limited. Second, we show that the tax incidence mandates were successful at ensuring gradual price increases when the VAT cut was repealed. Third, we assess the distributional effects of this policy. While its goal was to guarantee access to necessities for low income households in a period of high inflation, we find that the pass-through rate of the VAT cut in chain supermarkets was double that of independent supermarkets where, we show, low-income households are more likely to shop at. Therefore, while the government was successful at engineering a price decrease using the VAT cut, it partially failed to reach the target population.

Youssef Benzarti, Santiago Garriga and Dario Tortarolo