Lowering VAT: viral measure or vital measure? The case of the French restaurant industry.

Reducing VAT has become a viral topic in the national “Great Debate” launched by the French government. Whether it is geared towards reducing inequalities in the trolley, transportation, or housing, VAT seems to be firmly in the public eye. Providing relief to the poorest households is clearly at the heart of the matter, yet a reduction in VAT may not always have the desired effect. According to Alain Trannoy, a cut in VAT for the French restaurant sector provides ample proof of this. Is a reduction in VAT necessarily the best remedy?

Amid the Great Debate on January 27th 2019, the Minister of the Economy Bruno Le Maire, declared himself "open to all suggestions" concerning VAT rates. One of the proposals emerging from the discussion was the lowering of the VAT rate on essential commodities, most commonly food and hygiene products, from 5.5% to 0%. This is one of several different VAT regimes in France. 

Before being passed on to customers, any VAT cut might be absorbed and as such, its potential impact on living standards is hard to predict. A reduction in VAT from 19.6% in 2008 to 5.5% in 2009 for the restaurant sector can serve as an example, where the hoped-for impact for customers was partially picked up by restaurant owners, and not passed on. 

A cry for help from the restaurant industry

A cut in VAT rates can be obtained for a number of reasons, and in the restaurant industry it was bosses who led the fight for a reduction. In return, they1 committed to sharing profits three ways: one third for customers (through lowered prices), a third for employment, and a further third for future investment.2 

Thanks to this lifeline – also a masterstroke - the industry was able to overcome the crisis that it had been suffering since 2008, which had engendered a loss to the state of 2.6 billion euros in tax revenues.3 With turnovers coming in 10% lower than those of 1995, traditional restaurants were surely heading for disaster. Their direct competitors - fast-food outlets – were being taxed at a much lower rate of 5.5%, and turnovers reached unprecedented heights of 30% in the same period. Between the two options, customers often make a swift choice, as the offerings of fast-food outlets are viewed as equivalent to restaurants. This is the ‘edge effect,’ generated by consumer-switching behaviour.

• 12/3 are representatives of a professional union.
• 2More precisely, the new rates were designed to impact 7 out of 10 products and generate 40,000 additional jobs over two years with a boost in salaries, plus one billion euros' worth of investment
• 3It is worth remembering that the state surrendered 3.3bn euros in tax revenue in the years 2010 and 2011 (CPO report), but that this coincided with a withdrawal of a 600-million-euro funding package designed to support employment in the hospitality industry, which had been in place since 2004.

Photo by Andrew Weibert on Unsplash

A savoury dish for consumers and restaurant employees

Did the reduction indeed benefit consumers and restaurant staff, as restaurant managers had pledged? Benzarti and Carloni studied the distribution of the profits obtained, over an 18-month period, and according to them the reality was very different. Restaurant owners recouped 46% of the total profits from the VAT reform, while only 24% of savings were passed onto the customer. Rather than playing with prices, restaurant managers prefer to work on building customer loyalty by improving the quality of their offerings. This tendency puts suppliers at a distinct advantage. 

Consumers appear to benefit in equal measure to restaurant staff, as lowering VAT has not proved to be an effective tool for job creation. The results are self-evident: only 18% of profits gained from the VAT cut are passed on to staff in the form of salary raises or increased recruitment.

Consumers doubly impacted

Given the limited success of this solution, would it be advisable then to revert to initial rates? For Alain Trannoy, this could be a damaging climbdown. Even if the VAT cut was only of small benefit to consumers, a sudden rise would nevertheless have a major impact. This happened when the government backtracked by increasing VAT rates to 7% in 2012 and subsequently to 10% in 2014, which upset the balance, and created an unfavourable conditions for the consumer. In the medium term, there was an increase in prices in comparison to the initial situation in 2009.4 According to Benzarti and Carloni, the first increase was passed on to consumers to the tune of 50%!

Reverting to initial levels would be an inconceivable idea, especially in the current context. With an increase in hires of 3.1%, the hospitality and restaurant industries are the leading generators of jobs, while many workers live under threat of unemployment. Slowing down the industry’s momentum is, therefore, an unappealing prospect.

• 4The relative reasoning with regard to the price index

A tax instrument with disparate objectives

Tinkering with VAT rates can be dangerous. The repercussions it may have on consumers are not guaranteed, nor are they in tune with the intended objectives. As a fiscal instrument, VAT may be used to reduce inequalities, and to revive competitivity, boost the prospects of a business, or encourage investment. 

Yet, utilising one tool to target several disparate objectives may be the perfect way to miss them all. A VAT cut on basic necessities would aim to relieve the burden on lower-income households. But would this objective, promoted by the Great Debate, be sufficient to ensure that such a reform bears fruit? Several obstacles have already come up, such as the European law which implements VAT regimes and prohibits member states from reducing the rate to zero. 

Lowering VAT is very well, but for whose benefit? Aside from consumers, there are intermediaries, supermarkets, and producers who could also exploit any reduction for their own gain. The consequences of a cut could be many and various. It is therefore best to proceed with caution and try to pre-empt the consequences.