VAT revenue elasticities: an analytical approach

In this paper we construct analytical estimates of the elasticity of VAT revenues with respect to underlying gross income and expenditure for Ireland. The responsiveness of VAT revenue from households in Ireland to changes in household gross income steadily increased up to the late 2000s. The introduction of the income levy and the doubling of the health levy resulted in a reduction in the VAT elasticity, as higher income tax rates also reduced disposable incomes. This spill-over effect highlights the importance of judging the broader implications of tax policy. It also suggests that policymakers during any subsequent fiscal crisis should be cautious when choosing the composition of tax adjustments, as there is a clear trade-off to be made. The VAT revenue elasticity is lower for Ireland than estimates for the UK, New Zealand and Australia, possibly reflecting the greater progressivity of the Irish income tax system compared to other OECD countries.