Coming back in Albania, based in the facts from the EU countries we should say that consumption will not be very sensitive to short-term fluctuations in income, because many consumers will add to or draw down their savings to smooth their consumption, and others may be able to repay or add to their debts in order to do so.

1. Reductionof VAT for Albania shouldhappen now
Despite commonmisconception,the EuropeanUniondoesindeedallow memberstatestodecide
theirownratesof VATon a numberof categoriesof goodsand services.
In 2009 the EU amendedthisDirectiveto allow all memberstatestopermanentlyreduce VATto5%
on the renovationof private dwellings,excludingmaterials.Therefore EUrulesare nota barrierto
the UK governmentchoosingtoapplyareducedrate of VATon thistype of work.
But, since the new VATlawwasintroducedinAlbaniain2015, the discussionof the economic
operatorsfromtourismsectorand alsofor otherutilitiesthatare usedfromthe broad base of
consumersare askingforthe reductionof VATstandartrate.
But ispossible forthe Albaniangovernmenttomake andmanage an reductionof VATrate forsome
of the mostimportantbasicneeds?
In thisregardwe want to explore the effectsof atemporarycut inVAT,identifyingthreepossible
effects:
- an income effectaspeople benefitfromalowercostof livingduringthe periodof the
reduction,
- a substitutioneffectaspeople bringtheirconsumptionforwardand
- an arbitrage effectaspeople buynon-perishable goodsbefore the endof the periodof low
VATfor consumptionafterthe VAT rate as beenraised.
International evidence suggestsaclearoverall impactonconsumption,althoughthe nature of the
patterndependsonthe wayinwhichthe data are analysed.However,the keypolicyissueisthe
impactof the VATchange onoutputand to examine thatasimulationmodelof the whole economy
isneeded.
The reductioninVATfrom 20% to 15% islikelytoresultinconsumptionbeingaugmentedby1-2per
centsby the year 2017, if the changeswill take place inthe midof the year.HoweverGDPis likelyto
be raisedby less1 percent relative towhatwouldhave happenedwithoutthe VATincrease.After
the temporaryreductionisoverbothconsumptionandGDPare depressedasa resultof the policy.
Is thispolitical decisionsoharmful forthe economyandstate budget?
Let’ssee some evidencesof consumptiontrendsfromEUcountriesandafterto make a logical
commentbasedonthese facts.
Householdsaccountfor60 % of all VAT liabilityacrossthe EU-27 countries.The average EU-27
householdfacesaVATbill thatamountsto 11 % of theirtotal expenditure.Thisratioishighestin
Romaniaand Hungary(17.8 % and 17.5 %),followedbyLatvia(15.3 %),Lithuania(14.7 %) and
Slovakia(13.7 %).HouseholdsinLuxembourg(6.2%),Cyprus(6.8 %),Spain(7.2 %),the Netherlands
(7.7 %) andthe UnitedKingdom(8.0%) face the lowestVATbill asaproportionof expenditure.
In mostcountries,the largestpartof private households’VATbill relatestogoodsandservices
belongingtothe category“Transport”:Expenditure onthe purchase anduse of vehiclesishighand

2. usuallytaxedatthe standardrate. Inthose countrieswhere foodistaxedatthe standardrate, VAT
paidon foodand non-alcoholicbeveragesissubstantial.
Expenditure onhousingandenergyisusuallytaxedfarbelowthe standardrate.However,as
expenditure onhousingisanimportantpartof total expenditure,VATpaymentsrelatingtothese
categoriesare highinmany countries.
In all countries,high-incomehouseholdspaymore VATthanlow-incomehouseholdsinabsolute
terms.The largestgap isin Luxembourg,wherethe highestincome quintile paysseventimesmore
VATthan the lowestincome quintileandthe smallestgapinthe CzechRepublic,Austriaandthe
Netherlands.
Lookingat VATbillsasa proportionof total expenditure,seemsthatHungarytobe the onlycountry
witha regressive system(low-incomehouseholdsface ahigherVATburdenasa fractionof total
expenditure thanhigh-income households).
The VAT systemin11 countries(Spain,Romania,Bulgaria,Lithuania,Slovakia,Estonia,Greece,
Austria,the CzechRepublic,CyprusandLatvia) isapproximatelyproportional:thatis,all income
quintilespayroughlythe same share of theirexpenditureinVAT.
On the otherhand, a progressive systeminthe UnitedKingdom, Luxembourg,Italy,Belgium,Poland,
Malta, Slovenia,Finland,Ireland,Denmark,Sweden,Portugal,France,the Netherlandsand
Germany.
Poorerhouseholdstendtospendalargershare of theirincome onconsumptionthanwealthier
households,whotendtohave a highersavingsrate.Asa consequence,VATpayments
disproportionallyburdenhouseholdsatthe bottomof the income distribution.
The reducedratestherefore worktoredistributepurchasingpowerfromrichertopoorer
households.
Comingback inAlbania,basedinthe factsfromthe EU countrieswe shouldsaythatconsumption
will notbe verysensitivetoshort-termfluctuationsinincome,becausemanyconsumerswill addto
or draw downtheirsavingstosmooththeirconsumption,andothersmaybe able torepayor add to
theirdebtsinorderto do so.
The argumentthat there isno income effectisthat,withperfectcapital markets,itmakesno
difference toconsumersatwhatpointintheirlivesincome isreceived. Since the governmentfaces
an inter-temporal budgetconstraint,atax reductionhasto be offsetbyhighertaxesinthe future,
so,if everyone includingthe governmentfacesthe same interestrate,consumersreceive no
discountednetadditiontotheirincome and,onthese groundsthere shouldnotbe anyincome
effect.Thisisa formof Ricardianequivalence.
There are a numberof objectionstothisargument.Some consumersare borrowingconstrained,and
hence there will be anincome effectfroma temporary VATcut.It is alsoclear,that borrowing
constraintsrise verystronglyduringafinancial crisis.Hence inordertoevaluate the impactsof the
recenttemporarycut inVATin the UK it isnecessarytoestimate the proportionof consumerswho
mightbe currentlyborrowingconstrained.
Obviouslythe effectof atemporaryVATchange dependsonthe extenttowhichbusinessespasson
the change to consumers.If the change is notpassedon the income effectislikelytobe delayed
since itappearsin profitsratherthanreal wages.