Olga Goldfayn-Frank

We exploit Germany’s temporary three-percentage-point VAT cut in the second half of 2020 to study the spending response to unconventional fiscal policy. We use survey and scanner data on household consumption expenditures and their perceived pass-through of the tax change into prices and a HANK model to quantify the effects of this VAT policy. The survey and scanner data show that the temporary VAT reduction led to a relative increase in durable and, to a lesser extent, semi-durable spending for individuals with high perceived pass-through. According to the HANK model, the VAT policy increased total aggregate consumption spending by 4.4 percent on impact.

In an effort to stabilize the economy during the Covid-19 pandemic, the German government reduced value added taxes (VAT) by three percentage points for a period of six months in the latter half of 2020. This measure resulted in a boost in aggregate consumer spending on both durable and semi-durable goods during the six-month period, with spending decreasing once the VAT reduction was reversed. The effect of the temporary VAT cut on durable spending was stronger than on semi-durable spending. Additionally, the temporary VAT cut also stabilized, and even slightly increased, inflation expectations in the second half of 2020.