Économie et Statistique n° 413 Differing Price Adjustments to Rises and Falls in VAT Rates - The Regressive Nature of Indirect Taxes - Accounting Methodology for Assessing the Cost of Capital for French Companies (1984-2002)
Differing Price Adjustments to Rises and Falls in VAT Rates: An Empirical Analysis Based on the 1995 and 2000 French Reforms
Price adjustments in response to varying levels of indirect taxation depend on the nature of market competition, but also on whether the tax in question rises or falls. A first asymmetric effect is linked to production adjustment costs or credit constraints, which result in asymmetrical supply flexibility, giving rise in turn to asymmetrical price adjustments because it is more expensive to increase than to cut production. The quantity exchanged increases less after a fall in indirect taxation than after a rise, so prices adjust more strongly upwards than downwards. In principle, therefore, prices in competitive markets should shift further upwards than downwards. The second effect is linked to consumer demand: consumers react in a more pronounced way to higher price variations both because they are more obvious and because of the costs involved in changing their consumer habits. Consequently, oligopolistic companies, which can influence prices, reduce price rises in order to minimise falls in consumption and accentuate price cuts to create a promotional effect. In imperfectly competitive markets, the latter effect tends to offset the former. The fact that companies in competitive markets increase their prices more than companies in oligopolies is no paradox if we remember that perfect competition reduces prices in the first place, thus ruling out large reductions. Conversely, oligopolistic companies use their profit margins to finance promotional effects by minimising price rises and increasing reductions. However, these two theoretical effects, tested and validated using French data from the analysis of the 1995 and 2000 reforms of the top VAT rate, are short-term effects: the adjustment costs are temporary and the promotional effects evaporate over time.