Economic Consequences of Increased Value Added Tax on Food

While there might be effectiveness gains from introducing a single rate value added tax VAT, differentiation of the rates might address well some social equity issues. In the Czech Republic, value added tax has traditionally followed this social perspective, however, in connection to the reduction of the budget deficit and preparation of the pension reform, the value added tax system has been subject to reform. After the initial proposals of unifying both VAT rates to the current standard level of 20%, the government has approved a compromised version, with the single rate of 17.5%. This paper addresses the effects of increased VAT rate for food on the Czech economy. First a simple approach deploying directly own price elasticities is applied and later deeper investigations are made using the Czech national CGE model. Both direct and indirect effects are assessed. The direct effects are associated with the reduced consumer utility and weakened competitiveness of the food industry. The indirect effects reveal further repercussions translated to the sector of agriculture. It is showed that overall economic effects are small, and in terms of GDP positive.