Temporary VAT changes and consumer price pass-through evidence from UK catering.

Abstract

This paper estimates the pass-through of temporary VAT changes to consumer prices and examines the price-setting mechanism behind it. The United Kingdom cut hospitality VAT from 20% to 5% in July 2020, raised it to 12.5% in October 2021, and restored it to 20% in April 2022, a rare reduction- and-restoration cycle. Using 543,335 Office for National Statistics price quotes underlying the Consumer Prices Index, we estimate event-study pass-through for treated catering relative to on- trade alcohol, which was excluded from the relief and serves as a within-sector control. Transmission is incomplete at every event. The 2020 cut passed through weakly; its estimate is small and positive but imprecise and not cleanly identified, because pre-trends are not flat, whereas the two restorations reached about 28% and 26% of the statutory change. Beneath these averages, incomplete transmission operates through the incidence and direction of repricing, that is, whether and in which direction posted prices move, rather than the size of adjustment among prices that do move; pass- through is also higher for chain outlets than for independents. Tax incidence thus depends less on the statutory rate than on whether, and how, prices adjust.