Increase of the Value Added Tax (VAT): Budget- and Welfare-Effects for Consumers

On January 1(st) 2007 the Federal Republic of Germany increased the value added tax (VAT) from 1.6 % up to 19 %. The reduced VAT for food of 7 % has been is kept but it is often debated. The issue in debate is whether distributional effects between different groups of households occur if the VAT of food is increased up to 19 %. The objective of this analysis is to quantify the welfare effects of an increase of the VAT for different German household groups. Furthermore budget effects are calculated, which look upon household expenditures before and after the VAT increase. The methodical basis of this analysis is the Almost Ideal Demand System (AIDS) estimated with cross sectional data of 11,831 German households. Two aspects have to be taken into account with the use of cross-sectional data: insufficient price information and zero expenditures. To derive quality adjusted prices an approach of Cox/Wohlgenannt (1986) is applied. To take censoring of the dependent variables into account a procedure of Shonkwiler/Yen (1999) was employed. The results show that low income households and households with children will have comparatively high welfare losses.