The fiscal impact of a seasonal increase in the rate of VAT on restaurant meals

Abstract

The purpose of this dissertation is to analyse and estimate the effects that an increase in the VAT rate on meals in restaurants, only for the summer months, would have on public finances. 'Summer months' for this dissertation are assumed to be the months of July, August and September. Using the Ordinary Least Squares (OLS) method, the price elasticity of demand for locals to restaurant meals was estimated at -0.54. This is the case in the long-run. Using an Error Correction Model (ECM), it was shown that in the short-run, the VAT increase would have no effect on demand. Using the -0.54 long-run estimate, it was concluded that a VAT rate increase from 18% to 25% for the summer months would generate around €7.5million in revenue for the government. It was also estimated that such a VAT increase would contribute 0.37% to the overall inflation rate. These results were based on two major assumptions. Primarily, it was assumed that foreign demand is perfectly price inelastic to changes in restaurant meal prices. Secondly, there is no inter-temporal substitution, i.e. local diners do not substitute relatively expensive summer meals with cheaper winter meals.