Price Effects of VAT Introduction in Croatia

The value added tax (VAT) will be introduced in Croatia on January 1, 1998. As a single rate tax of 22% with the very narrow scope of exemptions it will replace the current retail sales tax on goods and services. The nature of the price effects caused by the introduction of VAT is an issue with which all countries that currently apply VAT were faced both during preparations for its introduction and during the period immediately following. The requirement to study the possible price effects of VAT introduction is particularly important in a country such as Croatia, where memories of inflation and hyperinflation are still fresh, and inflationary expectations are still present. Depending on the degree of cascading prior to the wholesale stage (which we were not able to capture) it is possible to conclude that there is certain amount of room for the aggregate price increase. Taking into account that in the first months of VAT introduction there will be some difficulties, and assuming that prices will not display perfect downward rigidity, the forecast shows that the aggregate rise of prices (measured by the retail price index) could be a maximum of 3.27 % (optimistic scenario) or a maximum of 5.2% (pessimistic scenario) - both on the assumption of zero cascading before the wholesale stage.