Keeping an eye on the economic dangers still ahead

Prof. Dr. Andreas Stoffers - Country director, Friedrich Naumann Foundation for Freedom

The VAT move is a temporary reduction to be applied from February 1 to December 31, and the objective is to drive the recovery of the economy in the post-pandemic time. But can these measures achieve this goal, and what is the experience with VAT cuts in other countries?

The VAT cut covers goods in the import, manufacturing, processing, and trade sectors. Others such as banking and telecommunication services, metals, real estate, and IT services were exempted. In total, this measure will cost the national budget roughly $2.2 billion, which is one-third of the recorded loss of Germany after a surprise VAT tax cut at the end of 2020.

This is the second time Vietnam has resorted to this measure after the global financial crisis in 2009. Consumers will experience this VAT reduction in their daily lives, especially at supermarket checkouts and when shopping in larger shops. However, it will have less effect in traditional markets and street shops, where VAT invoices are often not issued.

On a bill of VND1 million ($43.50) when shopping in a WinMart, this reduction amounts to only VND20,000 ($0.87). At first glance, this may seem negligible. But a strong impact can be generated in Vietnam through the psychological effects.

Citizens in need, but also everyone else, get the feeling that their concerns are taken seriously by the government. Consumers can see the reduction directly in their bills. This human-psychological dimension should by no means be neglected. It can encourage consumers to buy more so that companies might not suffer from the increased demand.

However, it is important to keep an eye on the dangers as well. In Germany, in the wake of the pandemic crisis, there was an even higher VAT cut from 19 to 16 per cent on most goods from July 2020. This was supposed to give consumption and thus the economy a new boost. But when this temporary measure ceased at the end of 2020, the result was sobering.

The reason was that Germany’s very radical lockdown policy had left many companies in distress and not all of them had passed on the VAT reduction to their customers. Thus, in some cases, the gross price remained the same. Furthermore, there was also an increase in inflation, which amounted to 5.1 per cent in February this year. In combination with a zero-interest rate policy, which devalues the savings of citizens, this remains a challenge for the German economy.

Overall, the VAT reduction in Germany was not completely passed on to consumers, but according to the think-tank Ifo, it was nevertheless about two-thirds of the reduction. What was much more serious, however, was the fact that – albeit to a lesser extent – the savings for consumers were not turned into higher consumption by them. According to reports in the German media in January 2021, the reduction in VAT simply missed its target. Consumers were too reluctant to spend, some of whom saw uncertain prospects for the future.

For Vietnam, however, the situation is different, although the government should be cautious and take into account experiences from other countries. The bouncing effect of a VAT tax cut is possible to trigger right after preferences end.

The VAT reduction was an important step for Vietnam. However, it must go hand-in-hand with a real recovery of the economy. This includes an end to all pandemic-related restrictions, including the irreversible opening of the country. Fortunately, the country’s policies have made the threat of the virus manageable. Now it is a matter of recovering the economy.

In this context, one can be optimistic: monetary and fiscal measures have been prudent and not diminished the capacity of the State Bank of Vietnam and government to act.