The inadequate arguments against the abolition of VAT for establishments

Let us begin with an important clarification. The purpose of this article is to refute some of the main arguments against the planned reduction of VAT from 20% to 9% specifically for the restaurant sector, which was announced by Prime Minister Borissov this week. The purpose is not to defend proposed VAT cuts for other sectors and especially for specific goods. Let it be clear that in principle, removing VAT for everyone is a measure that has larger-scale positive economic effects. That is, it is better to remove VAT for everyone than for just one sector. We have discussed the topic of removing VAT for individual sectors and types of goods in depth in this material, refer to it for more information.

However, this does not make the removal of VAT for the restaurant sector a bad measure, and certainly not in the way that many economists have been arguing over the past two days. Many economically inadequate arguments against the proposed measure are being circulated in the media, which, however, are widely heard. The purpose of this article is to specifically refute these arguments. The proposals to remove VAT for other sectors and especially for specific goods, which then came from the DPS, are a separate topic.

1. "Why are we cutting taxes for one of the "greyest" sectors in the country?"

In fact, we are looking for a sector to be lightened, and tax cuts are one of the best ways to achieve this. The factors that lead to the formation of a gray sector are numerous, but the most significant are always the level of corruption and the tax and regulatory burden. If the tax and regulatory burden is unbearable for business, there is an incentive to go "gray", i.e. to look for a way to pay less tax and comply with fewer regulations. The presence of corruption, in turn, provides an opportunity to satisfy this desire.

The accusations against the restaurant industry that there is too large a "gray" sector are irrelevant in this case, because the presence of a gray sector is a problem of public, not private institutions. Gray sectors arise due to a failure in government policy or the current work of institutions. If we are going to complain about the gray sector - we should look for the solution in these areas. And cutting taxes is actually one method to achieve a decrease in the gray sector, because with a lower tax burden, businesses have less incentive to work "in the gray". The logic is elementary.

Research in the field shows that the largest gray sectors are in countries where the quality of institutions is low, corruption is high and the administrative burden is too great. The restaurant sector is not to blame for this. No one in the private sector is to blame! In any case, removing VAT for a given sector cannot be a reason for an increase in the gray sector, so it is strange that this topic is even raised. It has absolutely no relevance to the current case except as an attempt to tarnish the reputation of the sector.

2. "Prices won't fall, businesses will reap the profits!"

Another strange argument against the measure, not least because it is planned with the explicit aim of supporting business in the crisis situation. A possible price reduction would be a nice secondary development, of course, but it is clearly not a priority in this case. Interestingly, however, the same economists who propagate this statement are generally of the opinion that the burden of VAT is borne by consumers. Especially puzzling, because this means that the burden of VAT is only transmitted in one direction – upwards, but not vice versa, when the tax is removed.

Apart from the obvious contradiction in such a thesis, its logic is categorically false, economically speaking. In a sector in which the level of competition is generally high, and demand is elastic, that is, sensitive to prices (partly precisely because of the high competition), a possible decrease in VAT is also reflected in lower prices than they would otherwise be. The restaurant industry is such a sector, because it has both large restaurant chains and many small, local establishments. The demand for restaurant services is elastic due to the great variety. Accordingly, a decrease in VAT would most likely have a positive impact on prices, probably especially on smaller restaurants, which, since they do not enjoy the prestige and quality of the large ones, have to compete on price.

This does not mean that if VAT is abolished for the sector next month, prices will also fall immediately. In view of the crisis, it is difficult to predict the direction of price movements, but abolishing VAT would certainly be a measure that stimulates their reduction. Having more free financial resources (because they pay less taxes), more establishments (especially small ones) will survive in the crisis conditions, which would maintain a higher level of competition. Namely, competition is what stimulates a drop in prices. Moreover, in crisis conditions, the consumption of such services always falls, which usually pushes prices down for most establishments (except perhaps the most expensive ones).

3. "This is not an anti-crisis measure!"

This is the most puzzling argument of all and is often thrown around without serious consideration. First, the best "anti-crisis" measures are precisely tax cuts. This is something we mentioned 2 months ago in our article with proposals for measures to stimulate the economy in the context of the Covid-19 pandemic. Tax cuts bring tangible positive results for businesses much faster in periods of severe decline in revenues than subsidies through state-guaranteed loans or direct transfers, such as the 60/40 measure. The NSSI's data on the implementation of this measure shows that its coverage is tragic so far, not to mention that the largest amounts have been paid to government-connected individuals, which raises suspicions of abuse. All risks that we warned about.

On the other hand, the removal of a tax such as VAT, be it for a specific sector, is far easier to administer. There is no need for the administration to assess whether a given enterprise meets the requirements, there is no purely technological delay in completing the entire administrative procedure according to the relevant protocol. Figuratively speaking, today it is decided - taxes are removed - and tomorrow they are removed. This way, all businesses in the sector feel the benefits in the same short period of time (provided, of course, that the reform is decided to be introduced as soon as possible). There is no way that there can be any abuse of the measure, because it is applied equally to everyone. The assessment is elementary, because the entire sector was closed for nearly 2 months, it is fair for the entire sector to receive relief.

4. "The budget will collapse! Revenues will collapse!"

First, state revenues this year will collapse anyway. Second, and we have already explained this, the fact that the treasury will lose revenue is NEVER an adequate argument against cutting a tax. The main consideration should be what is the expected effect on business, consumers and the economic situation of the country as a whole. In the current situation, in which establishments are among the hardest hit sectors, removing VAT would certainly have a positive effect. This will help them recover from the crisis faster, because their net income will now be higher. This accordingly means fewer bankruptcies, fewer layoffs and, as we have already mentioned, more competition. In other words, more employment and lower prices than we would have otherwise.

Whether this improved economic situation will have to be paid for with lower revenues for the treasury is not as certain as it seems at first glance. In the short term, perhaps, but in the longer term this loss can be compensated precisely by maintaining a higher level of economic activity and employment, especially in crisis conditions. Higher activity and employment mean more taxes, that is, more revenues. In fact, it is with this consideration that the Greek government introduced a package of tax cuts this year, calculating that the initial loss to the budget will be compensated over time by higher economic activity.

5. "Social policy should not be done through taxes/taxes should not be changed!"

These are the two favorite mantras of Finance Minister Vladislav Goranov. Most shocking is the outrageous arrogance of the claim about social policy. Think about it. In order to perceive tax cuts as "social policy" because they aim to achieve or achieve higher disposable income (purchasing power), you have to consider that in principle all income of people and businesses belongs to the state. Only in this paradigm can there be any logic in the claim that giving people a larger share of their income to keep is "social policy."

As for tax changes, Goranov's dogmatism on the subject has always been puzzling. Over the past five years, there have been many opportunities to cut taxes in view of the serious budget surpluses that have accumulated every year. Instead, the tax burden has actually increased, mainly through social security claims. When we are in a crisis, cutting taxes is one of the most effective measures to stimulate the recovery of economic activity, as we have explained before and explained once again in this article. So if Goranov's dogma was puzzling in the past, now it is downright harmful to the economic health of the country.

It's actually a good idea to cut more taxes.

Two months ago, we proposed two tax-cutting measures – abolishing corporate tax and raising the threshold for VAT registration. Eliminating corporate tax would stimulate investment because it is applied to the retained earnings of companies, which is the profit that is either retained or reinvested, and not pocketed by the owners. It is strange why the accumulation of such profit is punished, and it is even stranger that the tax on it is twice as high as the profit that IS distributed and collected by the owners.

Raising the VAT registration threshold would seriously help the smallest businesses in the country, which are among the hardest hit by the crisis, as they have less capacity to withstand a longer period of weak demand than their larger competitors. We are glad that some party formations, such as VMRO, have already proposed such a measure. Alas, it does not yet seem to be supported by the majority in parliament.

Finally, it should be noted that in order to achieve the maximum effect of the VAT reduction for the restaurant sector, the measure should enter into force as soon as possible. If we wait until the beginning of 2021, this may be too late, given the anti-crisis objectives of the proposal. This will not make the VAT reduction pointless, there will still be a positive effect, but the anti-crisis effectiveness of the measure would certainly be lost to a large extent.

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