NEW YORK, Dec. 5 /PRNewswire/ -- The Royal Bank of Scotland (RBS) with Bloomberg and NTC Economics conducted a survey of German retailers and services in November to gauge their expectations of the impact of the coming VAT rise. This survey represents a comprehensive study based on a representative panel, which we hope will contribute to the debate surrounding the impact of the rise. The results were split between services and goods sectors (retailers). For the whole sample (goods and services) the main results are:
Pass-through -- More than two thirds of respondents, 69%, indicated that they would pass on the entire hike to consumers on those products and services that are affected by the change in the VAT rate. -- In total, results of the survey suggest that nearly 80% of the increase will ultimately be passed on to consumers. Timing -- The majority of respondents (64%) that intend to raise prices will do so in January. -- Over one fifth have either already increased prices or plan to do so before the year end, with less than 10% intending to pass on price hikes after January. Demand -- A very small percentage of respondents expect a very significant or significant positive impact on demand prior to the sales tax rise. The majority expect no effect. -- About half the sample expects no impact on consumer trends after the sales tax rise compared to the normal seasonal pattern. The other half expects a negative impact, with most of the answers expecting a small decline (36%). A little more than 10% of respondents expect a significant negative impact. Economic Impact -- RBS estimates that the impact in January on German headline inflation HICP will be around 0.8 percentage points. We also estimate that about 0.3 percentage points will have been passed on before January. Risks on the January impact are skewed to the upside. -- The impact on consumption before the January tax increase will probably be less pronounced than expected with a total lift of around 0.7ppts. The negative impact expected on demand post sales tax increase is higher than the positive effect (around -1.0ppts). There is thus evidence of a negative skew in the survey suggesting the net total impact on consumption will be negative. However, there is no evidence that a bust in spending is around the corner. Introduction
On January 1st 2007, the VAT rate on a large number of goods and services in Germany will be raised from 16% to 19%. Because this will be the first time Germany has experienced such a large increase in VAT (the last three rises, in 1983, 1993 and 1998, were of one percentage point), there is great uncertainty as to the likely macroeconomic impact, which could be significant not just for the German economy, but also the wider euro area.
To our knowledge there is no hard evidence to substantiate or quantify the effects of the tax rise on demand and prices. Consequently, RBS with Bloomberg and NTC Economics surveyed German retailers and services to obtain guidance on the dynamics of the tax hike and better understand the impact. The results constitute a comprehensive information source derived directly from retailers and services companies best placed to estimate effects on consumer demand and prices.
The survey had over 400 responses. Taking each question in turn, this report highlights key insights from the survey and considers the implications for inflation and the broader economy (see appendix 1 for a description of methodology and appendix 3 for an example questionnaire).
Assessment of pricing policy
Q1. What proportion of your turnover is subject to the 3 percentage points increase in VAT?
Results from respondents suggest that turnover of almost all retailers and services will be affected by the tax rise to some degree, with only 6% reporting that they will be entirely unaffected. Sixty per cent of respondents indicated that around 100% of their turnover would be affected. On the basis of the responses received, we estimate that the VAT increase will impact around 70% of the total value of respondents' turnover. This is consistent with the fact that the standard rate of VAT is only applied to a proportion of goods. Many foodstuffs, for example, attract a reduced rate (see appendix 4).
2% of retailers and 9% of service provider respondents will be unaffected. Otherwise the degree of hike coverage is similar across retailers and services. Sectors expecting turnover to be least affected were Food/Beverage (a significant proportion of the retail sample), Financial Intermediation and Other Services. The highest impact was expected by Motor/Fuel retailers and Hotels & Restaurants.
Q2a. For those products subject to the increase in VAT, which of the following is closest to the proportion of the VAT rise you expect to pass on to customers?
For those products subject to the increase in VAT, a significant proportion (10%) of respondents indicated that they would pass on none or nearly none of the increase
(The answers to this question were adjusted due to erroneous answers from some respondents, see appendix 1). Over two thirds of respondents indicated that they would pass on the entire hike. In total, results suggest that over 80% of the tax rise will be passed on to consumers.
There are some interesting disparities between retailers and services. While 85% of services intend to pass on the entire hike, less than half of retailers expect to do so (49%). Moreover, significantly more retailers were still undecided as to how much of the hike they will pass on (14% vs. 4%). The difference is largely due to the fact that many services are business-to- business, meaning the VAT is reclaimed and therefore less of an issue in terms of final demand. Moreover, demand for services is likely less sensitive to price fluctuations than in the tradable goods sector where the degree of competition is higher, making any price increase more difficult to implement even if they are related to a rise in costs (to which the VAT can be likened).
The difference is greater if Motor/Fuel retailers are excluded. Only 40% of nonautos/ fuel retailers expect to pass on the entire increase. The retailer average is dragged down by the food/beverage sector, which is a large part of the retail sample and is the sector least affected by the VAT rise. Nevertheless, the difference between services and retailers as a whole remains clear.
Q2b. If you expect to pass all or some of the VAT rise on to customers, when do you expect to pass the increase on?
The majority (64%) of those respondents that intend to raise prices will do so in January, but over a fifth (22%) have either already increased prices or plan to do so before the end of the year. Just 8% intend to pass on the hike after January, while 7% are undecided.
Around 30% of retailers will increase their prices in advance, twice the level among services. Excluding motor/fuel retailers, the proportion of retailers expecting to pass on the hike in advance of January increases to 38%. Far more retailers remained undecided (12% vs. 2%).
Collectively, an above-average proportion, around 50%, of Clothing/Footwear and Household Goods retailers intend to increase prices in advance. In contrast, 90% of Motor/Fuel sector respondents intend to wait until January. A high proportion (30%) of Food/Beverage retailers were undecided as to when to pass on the hike. Given the low level of incidence, this is perhaps due to uncertainty as to whether it will be necessary.
Assessment of impact on demand
Q3. Do you expect your pre 1 January turnover to be increased as a direct result of advance purchasing in anticipation of the VAT increase? If so, to what extent?
Almost no respondents expect a very significant increase in turnover prior to the VAT increase, while just 5% expected a significant increase. 60% of respondents thought that there would be no effect, while a third expected a small increase.
There is a clear difference between retailers and services. Nearly 80% of services expect there to be no effect on demand prior to January, compared to just 35% of retailers. 55% of retailers expect just a small increase, but a significant number (9%) expect a significant increase, compared to just 3% of services.
This pattern was consistent across sub sectors. A far larger proportion of service subsectors expect no significant increase in turnover compared to almost all retail sectors. Similarly, a significant proportion of retail sub- sectors expect a significant increase in demand prior to the hike, while almost no service sub-sectors do.
This disparity is to be expected, firstly due to the business-to-business factor mentioned earlier, but also because it is generally easier to purchase goods in advance than to bring forward consumption of many services (such as a holidays or financial intermediation). That these findings concur with expectations lends confidence to other conclusions drawn from the survey results.
Q4. Do you expect your post 1 January turnover to be negatively affected as a direct result of the VAT increase and, if so, to what extent?
52% of respondents expect there to be no impact on turnover due to the VAT hike, while 36% expect only a small decrease. 11% of respondents expected a significant decrease in turnover, while 1% expected a very significant decrease. The disparity in responses from retailers and services follows a similar pattern to the previous question. While only 24% of retailers expect there to be no post January impact, three times as many services expect no impact. While most (57%) retailers expect just a slight decline, nearly a fifth (17%) expect a significant decline. Among retailers, the Motors/Fuels and Clothing/Footwear sub-sectors expected the most significant decrease after January, while no service sub-sector stood out in this regard.
It is interesting to compare these results with those of the last question. Doing so we find that twice as many (12%) of respondents expect either a significant or very significant decline in demand post January as expect a significant or very significant increase in demand, indicating a negative skew to the net impact on consumer demand as a result of the hike. This is most pronounced amongst retailers where almost 20% expect either a significant or very significant decline post sales tax increase compared to 10% expecting a significant or very significant increase pre tax hike.
Economic impact assessment Assessment of impact on inflation
Using harmonised index of consumer prices (HICP) weights, we are able to work out a relatively precise contribution of each sector to headline German inflation. These estimations require some assumptions and approximations. Firstly, the mapping of the HICP weights into the sectoral breakdown of the survey is not straightforward and required some judgemental assessment (overall, the sum of the weights we use is 56% of the total HICP basket, while slightly more than 60% of the total basket will be affected). Secondly, the increase from 16% to 19% of the VAT rate is assumed equivalent to a price rise of 2.6% for a given item if the tax increase is fully passed on.
Previous VAT hike experience shows that in many instances price setters pass on more than the full tax increase. One example in the case of the 2007 VAT hike is the price of tobacco products which have increased by 5% in anticipation of the VAT rate hike, twice as much as the tax increase. We have used 3% price increase assumptions for a full pass-through, only slightly more than the 2.6% theoretical increase. We believe that this is an estimate on the low side and that risks lie on the upside. We therefore look at a risk scenario with a 5% price increase assumption.
Our baseline estimate is that the total contribution will be of 1.2 percentage points on German inflation (0.35ppts on euro area inflation), with 0.5ppts coming from services providers and 0.7ppts coming from retailers (see chart). Retailers propose to pass on a lower proportion of the VAT hike than services, but their contribution to inflation is higher due to their greater weight in the HICP basket.
Using information about the timing of the pass-through we can estimate almost month by month contributions. According to our analysis, around 0.3 percentage points should be passed on before January 1st while the rest will be passed on after this date. Around 0.8ppts will be added to German inflation in January in our baseline scenario. The residual will come thereafter. The front-loading in price increases is consistent with anecdotal evidence, although no precise quantification has been made to date.
As discussed above, there is an upside risk scenario that could materialise should retailers and services increase prices by more than the direct impact of the sales tax. The euro notes and coins experience and previous sales tax increases have shown this to be a clear possibility(1). Price setters in Germany have in some cases kept their prices unchanged for a significant amount of time and might take this opportunity to readjust their prices in one go (following the menu cost strategy). We calculate that in a high scenario (prices increased by 5% when full pass-through is assumed) the total impact would be 1.8 percentage points with a 1.3ppts impact on January inflation.
The impact on growth
The survey points towards a possibly smoother consumer spending profile than we had anticipated, with less front-loading than expected and a smaller negative impact anticipated in Q1. Probably the most surprising result is that not many participants anticipate a surge in spending ahead of the sales tax. While this does not rule out a late surge, it is at odds with consumer surveys that are pointing towards a exceptionally strong increase in intentions to buy at present.
(1) See for example Hoffmann and Kurz-Kim, Bundesbank Discussion Paper N.16, 2006.
Our survey shows that these intentions could remain just that and not materialise, putting a question mark over the willingness of the German consumer to return to a more sustained consumption growth path any time soon. Indeed, the incentive to frontload is in our view sufficiently strong to prompt a wave of buying especially in the goods sector. The absence of it may reflect (i) the fact that consumers have heard that some prices have already been increased, thereby deterring front-loading, and (ii) ongoing uncertainties about the state of personal finances next year keeping consumers on the cautious side and in a 'wait-and-see' mode.
The other striking result from the survey is that retailers and services see the overall net impact on demand as negatively skewed as more respondents see a risk of a significant decline in consumption than expect a significant increase ahead of the rate increase (see chart). That very few respondents expect a very significant decline (just 2%), despite a significant tax increase is a reassuring message, which goes against our earlier thought that we could see a boom-bust profile for spending and growth. However, the impact will still likely be highly visible.
It is more difficult to quantify the impact on domestic demand as the questions were more qualitative and thus do not offer a precise estimate on how sales volumes will be affected. However, we can make some reasonable assumptions to try and quantify the possible impact on consumption. In the table below we show which implicit numbers we use to translate the qualitative questions into estimates. We have chosen these numbers arbitrarily and would thus caution in over-interpreting the estimations derived from them. They should still provide some useful guidance about the overall impact.
Using these rough estimates and the economic weights of each sector we find that the positive impact on private consumption before the sales tax hike (no indication on timing) would be around +0.7pts while the negative impact on consumption could be of -1ppts following the tax increase. This would result in a net negative impact of 0.3ppts.
Implications for the euro area and the ECB
Based on the overall results of the survey, we estimate that the VAT hike will add 0.3 percentage points to euro area inflation next year. Excluding the VAT increase we forecast euro area inflation to be 1.7%/1.8% in 2007 (2.0% including the VAT). This result shows that holding the tax rate constant, euro area inflation would already be within the ECB comfort zone. The effect of the VAT rise will drop out in 2008, leaving the door open to a below 2% average in 08.
The direct negative impact on euro area consumption growth from the VAT increase will be of around -0.3ppts according to our calculations and of -0.2 percentage points on euro area GDP growth over that period. While there are still uncertainties around the impact of the VAT increase on the German economy and the euro area as a whole, we believe that survey has helped us in narrowing down the risks. Overall, we believe that while there are no indications from the survey of a protracted negative impact on the German economy the negative skew of the impact on demand does argue for some caution at the turn of the year. Should price setters increase by more than we anticipate, this would likely result in a sharper negative impact on domestic demand. Overall, this analysis is consistent with our forecast that the ECB will be in wait-and-see mode during the first quarter of 2007.
Recently published research by RBS Euro Economics Research All research can be accessed on Bloomberg RBES < GO > Euro Weekly An unexpected rise in foreign demand Nov 23 Decline in euro area inflation lifts real rates Nov 16 Euro area growth slowing only modestly Nov 09 Staff forecasts to be consistent with hike in 07 Nov 02 ECB already guiding expectations for 2007 Oct 27 Another leg down in inflation Oct 20 Holding tight Oct 13 Downside risks building Oct 06 ECB to go back to the front line Sep 28 Inflation moving down Sep 21 No need to get too downbeat (just yet) Sep 15 10 dollars lower Sep 07 Costs and Prices Analysis Price hikes in Germany ahead of VAT rise (Oct 06) Oct 25 German inflation declines sharply (Sep 06) Sep 25 Euro area inflation to fall below 2% in September Sep 18 Euro area inflation to hit 2% in September Sep 06 Monetary Policy Analysis The (small) role of M3 in ECB rate decisions Nov 10 ECB Preview: rate outlook to remain conditional Nov 02 ECB Preview: baseline scenario still tracking Oct 05 ECB Preview: Cautiously optimistic Aug 31 Business Cycle Analysis ZEW: expectations at a trough (Nov 06) Nov 14 Euro area growth slows only modestly (Q3) Nov 14 October's carbon copy of September (PMI-Oct 06) Nov 06 The euro area is not decoupling Nov 02 Euro area spider web report (Oct 06) Oct 31 IFO survey questions our slowdown scenario (Oct) Oct 25 ZEW: More of the same (Oct 06) Oct 17 EA composite PMI down for 3rd month (Sep 06) Oct 04 International Developments Analysis Sensitivity of the euro area to FX developments Nov 30 When the US sneezes, the ECB looks elsewhere Oct 18 Appendix 1 - Survey methodology & data issues
A panel of over 800 retailers and services received the questionnaire in appendix 3, with over 400 responses. The same sample was used as for the monthly PMI surveys conducted by NTC Economics. Respondents were split into the following groups:
Main sector Sub-Group Services Financial Intermediation Hotels & Restaurants Other Services Post and Telecommunication Renting & Business Activities Transport & Storage Services responses: 245 Retail Clothing/Footwear Food/Beverage Household Goods Motors/Fuel Other Retail Pharma/Toiletries Retailer responses: 175 Retail + Services Total responses: 420 Source: NTC
Results were tabulated and analysed. Summary tables and details of main findings are contained in the body of the report.
During analysis, is was noticed that too many respondents had replied to the question of how much of the VAT hike they would pass on given how many respondents had indicated that none of their turnover would be affected. Several such respondents had clearly mis-read question 2a, erroneously answering "zero or close to zero" instead of leaving it blank. The data were corrected for this problem.
Appendix 2 - Evolution of German VAT rates Date of adjustment Reduced rate Standard rate Jan 68 5 10 Jul 68 5.5 11 Jan 78 6 12 Jul 79 6 13 Jul 83 7 14 Jan 93 7 15 Apr 98 7 16 Germany has no increased or parking rates Source: European Commission EC DOC/2402/2003 - EN Appendix 3 - Questionnaire
On January 1st 2007, the VAT rate will be increased by 3 percentage points on certain goods and services. We would appreciate your answers to the following questions, in relation to your own business. The results of the survey will be
made available to you. 1. What proportion of your turnover is subject to the 3 percentage points increase in VAT? All/nearly all More than half Half or less than half Little None 2. For those services that are subject to the increase in VAT, which one of the following is closest to the proportion of the VAT rise you expect to pass on to your customers? (please use an appropriate average for your total VAT-applicable turnover mix) Not yet Little 25% of the 50% of the 75% of the All/nearly decided or none increase increase increase all of the increase If you expect to pass all or some of the VAT rise on to customers, when do you expect to pass the increase on? Already Before 1 In January Later/ Not yet doing so January 2007 2007 gradually in 2007 decided 3. Do you expect your pre 1 January turnover to be increased as a direct result of advance purchasing in anticipation of the VAT increase and, if so, to what extent? No impact Slight increase Significant increase Very significant increase 4. Do you expect your post 1 January turnover to be negatively affected as a direct result of the VAT increase and, if so, to what extent? No impact Slight decrease Significant decrease Very significant decrease Appendix 4 - VAT coverage (Source: EC DOC/2402/2003 - EN) VAT generally applied Beverages: Spirits 16 Wine 16 Beer 16 Mineral water 16 Lemonade 16 Fruit juices 16 Clothing: Adults 16 Children 16 Footwear: Adults 16 Children 16 Tobacco 16 HIFI-Video 16 CD / CD-roms 16 Household electrical appliances 16 Furs 16 Jewels 16 Water 7 Natural gas 16 Electricity 16 Firewood 16 Timber for industrial use 16 Telecommunications Phone/fax/telex/etc. 16 Pay TV/ cable TV 16 TV licence [ex] Petroleum products: Petrol(unleaded) 16 Diesel fuel 16 LPG 16 Heating oil 16 Lubricants 16 Motor vehicles 16 Domestic transport: Air 16 Sea 7 Inland waterway 16, 7 Rail 16, 7 Road 16, 7 Intra-community & international Air 0 Sea 0 Inland waterway 7 Rail 16, 7 Road 16, 7 Hotels 16 Restaurant Services Restaurants 16 Take away 7 Alcoholic beverages 16 Bars and cafes Bars and cafes 16 Nightclubs 16 Alcoholic beverages 16 Cut flowers and plants: Decorative use 7 Food production 7 Immovable property: Social Housing 16, 7 Renovation and repairing 16 Building land [ex] Supplies of new buildings [ex] Construction work on new buildings 16 Travel agencies [n] 16 Pesticides and plant protection materials 16 Treatment of waste and waste water 16, [-] Collection of household waste, ... 16, [-] Arrangements for the taxation of gold: Ingots and bars 16, ex Coins (currency) 16, 7 Jewelry, gold plate, medals, tools 16, 7 Services supplied by lawyers 16 Works of art, collector's items and antiques"Normal" rate 16 Rate on importation 7 Supplies by creators and occasional sales 7 Application of reduced VAT rates 1 Foodstuffs 16, 7 2 Water supplies 7 3 Pharmaceutical products 16 4 Medical equipment for disabled persons 7 5 Transport of passengers 16, 7 6 Books 7 Newspapers 7 Periodicals 7 7 Admissions to cultural services, shows (cinema, theatre) 7, [ex] Pay TV/cable TV 16 TV Licence [ex] 8 Writers, composers, ... 7 9 Social housing 16, 7 10 Agricultural inputs 7 11 Hotel accommodation 16 12 Admission to sporting events 16, 7 13 Use of sporting facilities [ex] 14 Social services 7 15 Cremation services 16 16 Medical and dental care 7, [ex] 17 Collection of domestic waste and street cleaning 16, [ex] VAT rates applied to selected labour-intensive services Small services repairing: Bicycles 16 Shoes and leather goods 16 Clothing, household linen (+ mending, alteration) 16 Renovation & repairing of private dwellings (exc. materials forming significant part of the value of supply) 16 Window cleaning and cleaning in private households 16 Domestic care services (e.g. home help and care of the young, elderly, sick or disabled) 16 Hairdressing 16
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