Government announces temporary VAT rise to cope with fiscal pressures

2010-08-04

The government on 3 August approved a Multiyear Financial Plan 2010-2013, setting forth measures designed to bring the general government deficit back down below 3% of GDP by the end of 2013 and prevent public debt from rising above 55% of GDP over this period.
At the heart of the plan – which is expected to raise an extra PLN 5bn (approx. €1.25bn) a year for the budget during 2011-2013 – are (small) temporary increases in the VAT on most goods and services effective from 2011, to be reversed as of 2014. Thus, the basic rate is to rise to 23% from 22% as of next year, the 7% reduced rate – which applies e.g. to building materials, pharmaceuticals, homes, or waste disposal services – will go up to 8%, whereas the bottom rate of 3%, applying to unprocessed food, will rise to 5%. At the same time, to cushion the impact on low-income consumers, the VAT on low-processed food products, currently at 7%, is to drop to 5%. This will leave the VAT system with three new rates: 5%, 8% and 23%, up from 3%, 7% and 22% at the moment. At the same time, the government said it did not rule out a further one-point increase in July 2011 and another one in July 2012 (also to be maintained for three years), depending on the fiscal situation, although this scenario is considered as rather unlikely.
Furthermore, the Plan envisages the continuation of ambitious privatisation efforts, with revenues expected to reach PLN 25bn (€6.2bn) over 2011-2013 (PLN 50bn or €12.5bn over 2010-2013).
Finally, the document introduces a spending rule that will cap any new expenditures at 1 percentage point above inflation effective from 2011.
Most observers reacted with disappointment, complaining the plan was not ambitious enough and amounted to minor tinkering, rather than tackling the spending side.


A rise in VAT is the simplest way of raising extra revenues for the budget. Although such a move is in line with current European trends (Poland is the 12^th EU country to have approved a VAT rise since the crisis began), it is not a growth-stimulating measure (it dampens consumption at a time when consumer spending is crucial to putting the Polish economy back on a path of rapid growth; it also hurts business competitiveness). It is worth noting that although the size of the increase is not very big compared with other countries, Poland’s basic VAT rate is already one of the highest in the EU.
Furthermore, despite its undisputed fiscal effectiveness, a rise of such modest size is merely a short-term solution that will fail to solve underlying fiscal problems. According to government estimates, it will raise only PLN 5-5.5bn (€1.25-1.4bn) in additional budget revenues next year (in 2011 the funding gap is to be closed partly thanks to high revenues from privatisation). Unless the economy accelerates sharply in the following years, the government will be forced to exercise the option of further VAT increases while being unable to avoid spending cuts as well.
The rise in VAT will not be without its impact on prices, although its modest scale means the resulting acceleration in inflation in 2011 should be moderate.

Paweł Sionko
Senior Economist
PMR Publications