Austrian Central Bank Assesses Impact of VAT Reduction on Food Prices

The Austrian National Bank (OeNB) has released a detailed analysis evaluating the potential effects of lowering the value-added tax (VAT) on food items from 10 percent to 5 percent. According to the findings, such a reduction could temporarily decrease the national inflation rate by approximately 0.5 percentage points. However, the OeNB emphasizes that the overall impact remains uncertain due to several influencing factors.

One of the key considerations is the manner in which retailers might pass on the tax reduction to consumers. The central bank notes that while the theoretical model suggests consumers would benefit from lower prices, in practice, there is no guarantee that the entire tax reduction would be reflected in retail prices. This could diminish the anticipated effect on inflation and the cost of living.

On the fiscal side, reducing the VAT rate on food products would result in significant revenue losses for the government. The OeNB estimates a potential shortfall of EUR1.2 billion, which represents around 0.2 percent of Austria's gross domestic product (GDP). To compensate for this budgetary gap, the central bank suggests an increase in the standard VAT rate from 20 percent to 21 percent might be necessary. Such a move could offset the loss in revenue but could also have broader economic implications, including the possibility of higher prices for non-food goods and services.

The analysis further explores how different households would be affected by this policy change. Lower-income households, which typically allocate a larger share of their spending to food, would experience a relatively greater benefit from the VAT reduction. However, the overall distributional effects are expected to be moderate, as the financial relief would be spread across all consumers.

The OeNB identifies three main outcomes to consider if the VAT on food is reduced. First, while the overall inflation rate may remain relatively stable, supermarket prices for food could decrease, whereas prices in sectors unaffected by the reduction--such as home furnishings--might rise if the standard VAT rate is increased. Second, the government would need to address the fiscal impact through countermeasures to maintain budget balance. Third, the effects on household budgets would vary, but the differences are expected to be minor in aggregate terms.

International comparisons reveal diverse approaches to VAT on food. Malta, for instance, exempts certain food products from VAT entirely, while countries like Denmark and Estonia do not offer reduced VAT rates on food. Germany and Italy apply lower rates, ranging from 4 to 10 percent, compared to Austria's current 10 percent.

In response to the OeNB's analysis, the advocacy group foodwatch Austria has proposed a more targeted VAT reform. Their suggestion includes eliminating VAT on fresh produce, legumes, and minimally processed foods, while introducing a tax on sugary beverages to compensate for lost revenue. This approach aims to simultaneously ease the cost burden on consumers and support public health objectives without undermining state finances.

The ongoing debate highlights the complexity of implementing fiscal measures that balance consumer relief, inflation control, and budgetary stability. The Austrian government is expected to consider these findings and recommendations in its future tax policy discussions.