A lower VAT rate on electricity in Portugal

In late 2011, Portugal increased the statutory VAT rate on electricity from 6% to 23% as part of the austerity plan under the country’s international bailout. Naturally, this austerity measure met with widespread concern for its potentially negative effects on both economic performance and social justice. Seven years after its introduction, the country is facing a brighter economic outlook and a more positive outlook for its public finances. Nevertheless, there is no sign that authorities plan to reinstate the reduced VAT rate. Accordingly, evaluating the effects of this measure on the public purse – by any reckoning the rationale for its introduction – and to attempt to measure the possible detrimental effects on economic performance, inequality, and the environment is a pertinent policy question.

This article focuses on the budgetary, economic, distributional and environmental effects of a permanent increase of the VAT tax on electricity in Portugal. We conduct this analysis with a new multi-sector and multi-household dynamic general equilibrium model of the Portuguese economy. Simulation results suggest that a permanent increase in the VAT rate on electricity has positive budgetary effects and positive, albeit rather small, environmental effects, but both come at the cost of detrimental economic and distributional effects. Accordingly, we find that reverting to a VAT rate of 6% would not only improve economic performance but would also have positive distributional effects, and only marginally affect the environment. We also find that replacing the increase in VAT on electricity revenues with an equivalent increase in the general VAT revenues or the tax on petroleum products would have favorable economic, distributional and environmental effects, while still keeping significant budgetary advantages.

Click here to go to the paper by Alfredo Marvão Pereira and Rui Manuel Pereira.