Frequent Discounts and Loss of VAT for the State Budget of the Czech Republic: Scenario Estimations for Milk

Abstract

Frequent price discounts have become one of the features of retail chains in the Czech Republic. Discounts are most often provided for products popular with customers. One of the products that is subject to frequent discounts is milk. Several expert opinions estimate that up to 50% of milk is sold with frequent price discounts. Price pressure on farmers and food producers owing to frequent price promotions is supported by the purchasing power of retailers and, in extreme cases, leads to sub-cost purchasing prices. These facts set up the framework to assess the impact of frequent price discounts on policymaking, including tax administration. One of the effects of selling goods at discounts is lower VAT collection from shops, and thus lower revenue to the state budget. This paper attempts to estimate one of the potential impacts of frequent price discounts, namely the loss of VAT for the state budget due to low retail prices of milk. Theoretical estimation of the effect of frequent price discounts on VAT can help to assess policy that touches on mark-ups in specific markets, such as food. The estimation is based on data obtained from Czech Statistical Office, FADN, and Orbis databases and employs Monte Carlo simulation to capture the stochastic element of retail markups. Sub-cost prices of producers of milk have a more significant negative effect on VAT revenue than prices of other supply chain participants. The theoretical effect on VAT revenue is estimated to be in the range from a negative effect of 14.9 billion CZK to a positive effect of 7.4 billion CZK. Values of zero VAT effect points (mark-ups of producers, dairies, and retailers) are shown, as well as the critical value of price elasticity of demand (−0.1715), at which the effect of frequent price discounts on VAT revenue is zero.