Incidence of Consumption Taxes on Workers, Firm Owners and Consumers: Evidence from a VAT Reform in France

Abstract

This paper estimates the share of consumption tax changes falling on workers, firm owners and consumers by analyzing the value-added tax (VAT) cut applied to French sit-down restaurants -- a drop from 19.6 percent to 5.5 percent -- in July 2009. Theoretically, we extend the standard partial equilibrium model of consumption tax incidence defined in Fullerton and Metcalf (2002) to include consumption substitutability between the taxed good and an untaxed good, and markets for production inputs, which we allow to vary with the tax. Empirically, we use firm-level data and a difference-in-differences strategy to show that the reform increased restaurant profits and the cost of employees, and aggregate price data to estimate the decrease in prices produced by the reform. We compare sit-down restaurants to (a) non-restaurant market services and (b) non-restaurant small firms, and find that prices decreased by around 2 percent, the cost per employee increased by 3.9 percent and the return to capital increased by around 10 percent. Using these reduced-form estimates we conduct a welfare analysis and find that (1) the effect on consumers was limited, (2) employees shared around 20 percent of the benefit eighteen months after the reform, and 29 percent thirty months after the reform, and (3) the reform mostly benefited capital owners, who received around 50 percent of the tax cut, both in the short-run and in the long-run.