Government has the ability to make life cheaper for people; the question is – will it use it?

The topic that the food VAT should be reduced pops up from time to time and then recedes again, as the arguments of businessmen meet with the resistance of the Ministry of Finance in protecting the state budget. At the moment, the new government and the Saeima, discussing the next year’s state budget project, have the opportunity to change the current arrangement.

It should be noted that now might be the right time to reduce the rate, because the food price race is significantly ahead of the overall inflation rate in the rapidly growing price. The population would benefit, for whom the payment of daily necessities would become easier, but the potential losses of the state would be less felt. As prices rise, the financial base from which VAT is collected has grown significantly.

Helps in price reduction

In Latvia, it is very common to hear the opinion that even if the VAT rate for food were reduced, producers and traders would use it for additional profit. This cannot be completely denied, but at the same time, statistical data also confirm that the reduction of the VAT rate for vegetables, fruits and berries characteristic of Latvia from January 1, 2018 had a price-lowering effect. For example, the average retail price of a kilogram of cabbage in December 2017 was EUR 0.41, according to the data of the Central Statistics Office (CSB). In January 2018, their price had decreased to an average of 0.36 euros per kilogram, and two and three months later to 0.34 euros/kg. In May, prices started to rise, rising to an average of 0.60 euros/kg. However, as we know, as summer approaches, local vegetable stocks are exhausted and we have to switch to imported products.

It should be added here that in the autumn months, when the new harvest should be, cabbage cost an average of 0.49-0.52 euros/kg. However, it should be remembered that the summer of 2018 was very hot and dry both in Latvia and in Europe as a whole, therefore there was a substantial deficit in the market and vegetable prices rose rapidly. Thus, the determining factor was the meteorological factor and not the appetite of traders. We can almost certainly say that if the VAT rate had not been reduced, expensive vegetables would cost even more.

Promotes economic development

In Latvia, it is very often heard that not only the less wealthy, but also the rich households will benefit from the reduced VAT on food. Of course, the wealthy will also eat cheaper, but the question has never been heard as to whether this is considered a bad thing at all. Even if a person with a larger hand pays less for food, the national economy and budget will not be harmed. If only because there are always far fewer households that are truly wealthy than those that are cash-strapped.

Much more important than abstract “fairness” is the fact that the country has a more orderly economic environment, and local producers and traders gain from it and can sell more. At least that’s what local producers recognized after the VAT reduction for fruits and vegetables characteristic of Latvia, besides, business in this segment is also on a more legal basis, for example, VAT payers in this sphere have increased. In addition, it was recognized that local companies’ sales opportunities and revenues are increasing and they can also pay higher wages to employees. Therefore, the VAT reduction for food is not only perceived as a social, but also an economic development element. Thus, the overall economic activity in the country would also increase and in the long term the state budget would be a winner. Regarding the reduced VAT rate for food, one should calculate not only the losses that could be brought by the reduction of a specific tax in a specific segment, but also look at the opportunities that would be provided by additional revenues in other areas.

The positive example of Poland

If the VAT rate on food were reduced from the current 21% to, say, 5%, household savings could be estimated at tens of euros per month, which could be spent in other areas where the full 21% VAT rate could be paid. This would be particularly applicable to the less wealthy part of society, which would definitely not deposit this money in a bank account, but would be able to purchase goods and services, which was much more difficult to do until then. This is obviously very well understood in most other European countries, so there such a reduced VAT rate is not considered some kind of household luxury, but an everyday norm. For example, when the war in Ukraine started, Poland lowered its already reduced 5% VAT rate on food products to 0%. The end result was that, according to prominent food market experts, the organization of bus trips for the purchase of food products began from Latvia to Poland. Therefore, in this case, not only the collection of the increased VAT tax is taken away from the state budget, but producers and traders also lose revenue. For example, in December of last year, the volume of food retail sales fell by 5.8% compared to the corresponding month in 2021, according to the information compiled by CSB. Among other things, this may indicate that due to the rising cost of living, residents have to save on food as well.

On the other hand, as far as Poland is concerned, businessmen there are probably using the opportunity to make money by raising prices. However, one important nuance must be understood here: companies – manufacturers and traders – also need to earn money, because only by earning more, it is possible to continue investing in development and pay higher wages. Of course, inflation in the food segment is also high in Poland and reached 21.5% last December compared to the same month in 2021, according to “tradingeconomics.com” data. However, the prices of food products in Latvia had increased by an average of 29% in annual terms.

Benefits work too late

Not only the rate of inflation is important, but also the final price paid for a particular food product. The lower the VAT rate for a particular product, the more likely it will cost less. This is very important precisely in such times, when the general cost of living is rapidly increasing. What is important is how much is paid for a particular product in the end. From the consumer’s point of view, a statistical inflation figure is not as important as the price of a packet of milk, but how many goods of a specific nature can be bought at a given income level. The lower the rate, the less the price of the product increases in actual monetary terms. A reduced VAT rate does not curb long-term inflation, but rather makes it possible for the price of a product to grow more slowly in real money terms. This is a very important factor for the less wealthy, whose financial capacity often depends on various benefits.

The factor to be taken into account here, especially in times of rising prices like now, is that most of the various benefits, in the case of their increase, have a delayed compensatory nature in preserving the purchasing power of the population. Namely, price increases are immediate, but changes in benefits occur relatively more slowly in terms of time. The same with pension indexation. Therefore, it is likely that a much greater benefit to the population would occur if more favorable conditions were created for cheaper goods, instead of trying to compensate for the cost of living with delayed increases in benefits.