It is widely reported that the German parliament is debating the news that Ireland is planning to raise the top VAT rate by 2%. Of course, all else equal, an increase in any tax rate has a negative impact. However, it is important to appreciate that an increase in VAT that avoids an increase in labour taxes is, in relative terms, an employment-friendly policy and is also part of the mix that can engineer a “fiscal devaluation” that can partially replicate the impact of a “currency devaluation” .
A VAT increase is especially effective if it is understood to be permanent (no point in delaying consumption until the tax increase is reversed). Even better, a widening of the VAT base can further assist in raising revenue, alleviating pressure on other parts of the tax base.
In terms of income distribution, the regressive impact of a VAT increase has to be calculated in the context of the overall package of taxes and transfers, since it is important to work out the net impact of all policy changes taken together, rather than on a “one at a time” basis.