Monetary Union Index of Consumer Prices

The role of indirect taxes in euro area inflation and its outlook

Retrieved on: 
Friday, September 25, 2020
Price indices, Economy, Macroeconomics, Economy of the European Union, Harmonised Index of Consumer Prices, Tax, Currency, Value-added tax, Euro, Inflation, Monetary Union Index of Consumer Prices, Euro convergence criteria

Changes in indirect tax rates can have a visible impact on consumer prices.

Key Points: 
  • Changes in indirect tax rates can have a visible impact on consumer prices.
  • This assumes the full and immediate pass-through of changes in indirect taxes to consumer prices and therefore, on balance, tends to overstate the effects of tax changes.
  • [1] Based on this measure, the contribution from changes in indirect taxes to euro area HICP inflation has been, on average, 0.2 percentage points, but was much stronger during periods when tax rates increased, such as in 2007 and between 2011 and 2014 (see Chart A).
  • Chart A HICP and HICP at constant tax rates (annual percentage changes; percentage point contributions)
  • However, in response to the coronavirus (COVID-19) pandemic, several euro area countries have reduced indirect tax rates on a scale not seen before in the euro area.
  • In addition to temporary reductions in broad-based value added taxes (VAT) in Germany and Ireland, many other euro area countries have recently introduced targeted reductions in indirect taxes (see Chart B).
  • [2] Assuming full and immediate pass-through, Eurostats HICP at constant tax rates implies that the reduction in VAT in Germany would have a downward impact on euro area HICP inflation in July 2020 of around 0.6 percentage points.
  • [3] Chart B Impact of changes in indirect taxes on HICP inflation (percentage point contributions based on difference between HICP and HICP at constant tax rates)
  • The actual impact of the recent reductions in indirect taxes on inflation is surrounded by considerable uncertainty.
  • First, historically there are few examples of cuts in indirect tax rates in euro area countries that could shed light on the likely degree of pass-through.
  • Lastly, the lions share of the current reduction in indirect taxes results from the VAT rate cut in Germany, which is only temporary (and very rare in euro area countries), and might thus generate unusual anticipation effects.
  • [6],[7] The pass-through of recent reductions in indirect taxes is likely to vary across sectors and to be overall incomplete.
  • The reductions in indirect tax rates in euro area countries shape the inflation profile for 2020 and 2021 in the September 2020 ECB staff projections.
  • Understanding the impact of indirect taxes on the inflation profile and outlook is relevant for the communication of monetary policy.
  • Chart C Impact of changes in indirect taxes on HICPX inflation projections (annual percentage changes; percentage point contributions)