Competition and pass-through on international markets: Firm-level evidence from VAT shocks

We exploit French customs’ firm-level data to study how exporters pass a change in the VAT rate of one importing country through their prices. Looking at this reaction is of interest beyond a mere fiscal incidence analysis: VAT shocks provide instruments to identifying the extent of mark-up adjustment in exporting firms’ reaction to macroeconomic shocks. Indeed, and by contrast with more usual shocks, typically exchange rate fluctuations, variations in VAT rates leave the marginal cost of exporters unchanged. For a sample covering exportations to the Euro-area over the 1996-2005 period our estimates show that, on average, markups contract by 50% of the VAT hike one year after the shock, implying a pass-through to final prices of 50% of the shock as well. We furthermore exploit the individual dimension of the data to show that the extent of mark-up adjustment varies across firms and markets. More precisely it depends on the market power of an exporter, as measured by its relative market share, and competition on a given market, as measured by standard concentration indexes. These evidences are in line with a model featuring variable elasticity of demand and heterogeneous firms.