The (Non-)Neutrality of Value-Added Taxation

This paper employs a structural gravity model and EU value-added tax (VAT) regime data to investigate the impact of VAT rate changes on imports and domestic production of final goods. We find that the VAT is both non-neutral and de facto discriminatory. A one percentage point VAT increase reduces aggregate imports and internal trade by 3.1% and implies a 1.8 to 5.4% reduction of foreign imports relative to internal trade. Based on these results we conduct a countrerfactual equilibrium analysis and illustrate that VAT rate changes imply substantial welfare effects for an average country in the European Union