The pass-through of temporary VAT rate cuts: evidence from German supermarket retail

One could object that, even without pass-through, a VAT rate cut may boost economic activity because it allows firms to secure jobs or maintain investment. But a general VAT rate cut helps firms in proportion to their sales. The economic consequences of the COVID-19 pandemic for firms were very heterogeneous. A general VAT cut would channel most of the help to the winners of the crisis, like digital companies or supermarkets, which were exempt from lockdowns. This suggests that, to help firms affected by the crisis, other instruments targeting the most affected sectors and companies would be more effective.

Austria as well as Germany introduced a sector specific VAT cut for hotels and restaurants. In Germany this was on top of the general VAT cut. This will be explained in greater detail in Sect. 2.

Among other things, we investigate whether the pass-through varies across products taxed at the regular VAt rate vs. products taxed at the reduced VAT rate and private label vs. brand products. This cannot be done using CPI data.

Benzarti et al. (2020) show that the pass-through of a VAT rate hike for hairdressing services in Finland was inversely related to hairdressers’ profit margins, suggesting that high cost markups may buffer tax shocks. There is also evidence that the pass-through of excise taxes on alcohol (Hindriks & Serse, 2019) cigarettes (Harding et al., 2012), and fuel (Doyle Jr. & Samphantharak, 2008) is related to the intensity of spatial competition between retailers.

A detailed timeline of the main COVID-related events and policy measures taken in Germany and Austria can be found in Tables 4 and 5 of Appendix B.

Detailed accounts of the stimulus measures are provided by Dorn et al. (2020) for Germany and Baumgartner et al. (2020) for Austria. See also the IMF database on fiscal policy responses to COVID 19: https://​www.​imf.​org/​en/​Topics/​imf-and-covid19/​Policy-Responses-to-COVID-19#A.

These programs allow employers to reduce their employees’ working hours without laying them off. Employees in Germany receive a share of the net loss in income incurred of at least 60 and 67%, respectively, in the case of an employee without children and with at least one child. These allowance rates increase over time to 80 and 87%, respectively, after a period of six months. Austria has a very similar program that grants allowances of at least 80% of the previous net salary and up to 90% for smaller salaries under the current legislation until the end of March 2021.

Before the reduction, the VAT rate for restaurants was 19% in Germany and 20% (for food) and 10% (for drinks), respectively, in Austria.

Source: The Nielsen Company.

We started collecting price data from REWE for a different purpose, which is why our sample period begins long before the announcement of the temporary VAT reduction.

For example, in the Billa online shop, ‘tea, coffee, and cocoa’ is a sub-category of ’beverages.’ In the REWE online shop, ‘tea, coffee, and cocoa’ is a main category. The opposite is true for ‘bread and baked goods.’ In other cases, the collection of goods belonging to the same sub-category or sub-subcategory differs between the online shops.

COICOP is published by the UN Department of Economic and Social Affairs and serves as the international reference classification of household expenditure. It is an integral part of the System of National Accounts and used for many statistical purposes such as, for instance, the establishment of weights for the computation of consumer price indexes and the calculation of purchasing power parities.

The fact that the number of REWE products still exceeds the number of Billa products is due to the larger number of brands and product varieties offered by REWE. For example, the REWE online shop features 185 types of flour, 416 types of bread, and 462 types of cereals. At Billa, there are 22 types of flour, 106 types of bread, and 99 types of cereals.

For the USA, Agrawal and Shybalkina (2023) show that this shift to online shopping led to a redistribution of sales tax revenue from urban centers to rural areas.

Unfortunately, data on the online share of grocery spending for Austria are not available for earlier years.

The REWE (Billa) price index represents a weighted average of the price indexes of the single REWE (Billa) products. In both cases we use the CPI weights for Germany.

Austria only reduced the VAT rate for hotels, restaurants, and certain cultural institutions like theaters, museums or natural parks. Germany also provided a targeted VAT cut for food served in restaurants and hotels, where the reduced rather than the standard rate was applied as from July 1, 2020. This was in addition to the general VAT cut which is the focus of our analysis.

We use the COICOP weights used to calculate the Consumer Price Index for Germany to compute weighted averages. The weights can be found here: https://​www.​destatis.​de/​DE/​Themen/​Wirtschaft/​Preise/​Verbraucherpreis​index/​FAQ/​anteil-gueter-warenkorb.​html.

We compute average weekly price indexes because prices hardly vary within a week.

For example, a price reduction of 1.26% in response to the tax cut for goods subject to the standard VAT rate would imply a pass-through of 50%.

The fixed effects refer to specific products, not product categories or classes. Our baseline specification thus includes roughly 68,000 product-fixed effects.

Clustering standard errors at the product class level would be justified in case similar products are exposed to similar shocks. This assumption is plausible if price developments are mainly driven by production conditions or demand-side factors.

Table 6 of Appendix B shows the estimates in table format.

This result is the opposite of what Benzarti et al. (2020) find. The authors exploit a VAT rate reduction for hairdressing services in Finland that was communicated to be permanent, but eventually repealed five years later. Their findings suggest that the price change in response to the VAT rate hike was two times larger than the price change following the VAT rate cut.

https://​www.​businessinsider.​de/​wirtschaft/​mehrwertsteuer-supermarkt-branche-aldi-lidl-misstrauen-b/​.

Note that we compute White-robust standard errors instead of clustering standard errors at the 4-digit product class level since the number of clusters would be very small. I.e., the product group ‘food and non-alcoholic beverages’ comprises 22 4-digit product classes, the product group ‘alcoholic beverages and tobacco’ seven 4-digit product classes, and the product group ‘cosmetic and hygiene products’ five 4-digit product classes.

From a theoretical perspective, the implications of market structures for tax incidence are generally ambiguous and often depend on the curvature of demand and cost functions as well as the particular market setting. For instance, more market power in oligopolistic markets may lead to more or less shifting of a consumption tax (Weyl & Fabinger, 2013). In an earlier version of this paper (Fuest et al., 2021), we analyze consumption tax incidence in a love of variety model and show that tax shifting to consumers may be higher or lower in product groups with more varieties, depending on the properties of marginal cost and demand functions.

Based on data from Spanish gas stations, Bajo-Buenestado and Borrella-Mas (2022) find that the pass-through of a tax on prices is significantly higher for vertically integrated gas stations.

There is disagreement in the literature about whether retail stores should be viewed as two-sided markets. In Armstrong (2006)’s opinion, the answer is yes. His opinion is based on the notion that retail stores share features of platforms as they allow an exchange between producers and their customers. Rysman (2009), however, views retail stores as one-sided markets, arguing that “the retailer takes possession of the product and sells the product as it wishes, and the wholesaler has no concern for how many units the retailer is able to sell” (p. 126). In our view, Armstrong’s characterization provides an accurate description of the relationship between independent suppliers featuring their own brands, supermarkets, and customers, whereas Rysman’s characterization best describes the situation in which supermarkets are responsible for the pricing and branding of a product.

A theoretical model which generates this prediction for non-tax cost shocks is developed by Hong and Li (2017).

While REWE and EDEKA are ‘conventional’ supermarket chains, LIDL and ALDI are discounters. Together, these four chains represent about 70% of the supermarket retail market in Germany.