Cutting VAT rate on food products in a high-inflation environment. Does it work out?

In February 2022, the Polish government reduced the VAT rate on basic food products from 5% to 0% in order to curb elevated inflation. Using multiple state-of-the-art robust estimators within a dynamic difference-in-differences approach, we estimated that the VAT rate reduction initially contributed to an average 2.1–2.8% decrease in the prices of affected products. Therefore, the immediate pass-through of the tax reduction in retail food prices was limited (only 44.0–58.2%), resulting in a 0.3–0.4 percentage point decrease in headline inflation. The effect of the VAT rate cut reached its peak within 5 months, achieving an almost full pass-through of approximately 94.6%, which led to a reduction in headline inflation by about 0.7 percentage points. We argue that the high effectiveness of the VAT reduction in Poland would not have been possible without the active role of the Office of Competition and Consumer Protection. Lowering VAT rate limited the budgetary revenues by only 0.3% GDP (value equivalent to 0.5% of private consumption), which means that it was a relatively cost-effective tool in providing relief to households in a high-inflation environment, especially for poorer consumers with a higher share of food in total expenditures.