More Haircut after VAT Cut? On the Efficiency of Service Sector Consumption Taxes

Government Institute for Economic Research Working Papers No. 49

47 Pages Posted: 10 Oct 2013

See all articles by Tuomas Kosonen

Tuomas Kosonen

University of Helsinki - Department of Political and Economic Studies

Date Written: September 26, 2013

Abstract

Consumption tax rates targeted at specific sectors are often reformed without empirical knowledge about the efficiency of these policies. This paper sheds light on the efficiency issue, the potential for welfare improving reform, by studying the incidence of value added taxes (VAT) on prices and quantities of barber services traded. I also study the incidence on the profits made by the targeted firms. I utilize a VAT reform targeted at a specific service sector which creates a natural experiment set up. VAT for hairdressing services in Finland was reduced from 22% to 8%, whereas the normal tax treatment still applied to beauty salons and other labor intensive services. The choice of the treatment and control groups was exogenous to circumstances in Finland, since these groups were selected in a more wider European setting. The results suggest that hairdressers cut their prices only by half of what complete pass-through would have implied, and that there was hardly any adjustment in the equilibrium quantity due to the reform. Instead of lowering prices, most hairdressers were able to increase their profits. There is important heterogeneity in the results according to firm size.

Keywords: VAT reform, efficiency, tax incidence

JEL Classification: H22, H21, H25

Suggested Citation

Kosonen, Tuomas, More Haircut after VAT Cut? On the Efficiency of Service Sector Consumption Taxes (September 26, 2013). Government Institute for Economic Research Working Papers No. 49, Available at SSRN: https://ssrn.com/abstract=2334084 or http://dx.doi.org/10.2139/ssrn.2334084

Tuomas Kosonen (Contact Author)

University of Helsinki - Department of Political and Economic Studies ( email )

P.O. Box 54
FIN-00014 Helsinki
Finland

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