The impact of a permanent VAT hike and a temporary VAT cut on household spending:
Evidence from Hypothetical Scenarios
Kazuki HiragaaaTakeshi Niizekib,c,†

Nagoya City University, 1, Yamanohata, Mizuho-cho,Mizuho-ku, Nagoya, 467-8501, Japanb

Chiba University, 1-33, Yayoicho, Inage-ku, Chiba-shi, Chiba, 263-8522, Japanc

Cabinet Office, 1-6-1 Nagata-cho, Chiyoda-ku, Tokyo 100-8914, Japan
October, 2023
Abstract

This paper examines the impact of a change in the value added tax (VAT) rate on household spending
based on randomly assigned hypothetical VAT rate scenarios. Our findings are as follows. First, anunanticipated VAT hike from the current 10% to 20% lowers non-durable spending, but is notstatistically significant. Second, an unanticipated temporary VAT cut from 10% to 0% significantly
stimulates household spending through intertemporal substitution effects. Finally, the way in which
increased tax revenue by the VAT hike is used and the way in which decreased tax revenue by the VAT
cut is compensated do not affect household spending behavior.
Keywords: value added tax, household expenditure, hypothetical scenarios, randomized control trial
JEL Classification: E21, E62, H20, H31

Corresponding author: Takeshi Niizeki (takeshi.niizeki@chiba-u.jp). The experiment was approved by the research
ethics committee at Ehime University on March 17, 2022. We would like to thank Masahiro Hori, Keiko Murata,
Koichiro Iwamoto, Junya Hamaaki, Fumihiko Suga, Kazuhito Higa, Taiyo Fukai, and Kyogo Kanazawa for theirvaluable comments. We are also grateful to INTAGE Inc. for providing us with the data we employed in the current
analysis. This research is financially supported by Chiba University. The views expressed in this paper are those of theauthor and do not represent those of the institutions with which we are affiliated.

1

1

Introduction

In many developed countries, value added tax (VAT) has been continuously increased to secure stable
tax revenues, raising concerns about their impact on household spending through negative income
effects. On the other hand, in some countries, such as the U.K. and Germany, have temporarily cut
VAT rate during the Great Recession and the COVID-19 pandemic as part of household spending
stimulus measures. However, there is limited analysis of the impact of VAT changes on householdspending.
One of the main reasons is that, in many cases, all households face the same VAT changes, making
it impossible to observe changes in household behavior if there were no change in the VAT. That is, ineconometric terms, there is only treatment group and no control group. To address this identification
problem, this paper provides randomly selected treatment groups with hypothetical VAT change
scenarios and examines how their spending plans change as a result. We randomly divided our sample
into three main groups. The first treatment groups (Groups 1 and 2) are provided with an unanticipatedpermanent VAT hike scenario in which the VAT rate permanently changes from the current 10% to20%. The second treatment groups (Groups 3 and 4), on the other hand, are provided with anunanticipated temporary VAT cut scenario in which the VAT rate would fall from the current 10% to
0% for one year only. Finally, the control group (Group 5) is given a scenario in which the current
10% VAT rate would continue in the future.
Household spending may depend on the use of tax revenue increased by the tax hike. If theincreased tax revenue is used for something that does not directly affect households’ lifetime resources,
such as paying down the national debt, there may be a large negative income effect. On the other hand,
if it is used to reduce income taxes to offset the burden on households, their expected lifetime resources,and hence household spending, may remain unchanged (Cashin and Unayama 2021). Therefore, theincreased tax revenue is set to be used to pay down the national debt in Group 1 and to implement
income tax cuts in Group 2. Similarly, the tax revenue deficiency caused by the temporary VAT cut is
set to be financed by government borrowing in Group 3 and by income tax increases in Group 4. See
Figure 1 for a summary of group assignments and Appendix B for the specific wording provided toeach group.
Our findings are summarized as follows. First, an unanticipated VAT hike from the current 10%
to 20% lowers the expected growth rate of real non-durable spending by 0.72‒0.83 percentage points,
but the impact is not statistically significant. On the other hand, the VAT hike increases the willingness
to purchase durable goods. The interpretation of this result is discussed in Section 3. Second, anunanticipated temporary VAT cut from the current 10% to 0% raises the expected growth rate of real
non-durable spending by 4.31‒4.90 percentage points and also increases the willingness to purchasedurable goods by 45 percentage points. Finally, the way in which increased tax revenue by the VAT
hike is used and the way in which decreased tax revenue by the VAT cut is made up do not affect2

household spending behavior.
This study seeks to contribute to the literature in the following three respects. First, this study
exploits the exogenous variations in VAT rates generated by randomly presenting different VAT ratescenarios, making the analysis more internally valid. Previous studies have sought to identify causal
relationships through comparing expenditures with other countries with no change in VAT rates overthe same time period (Baudisch and Neuenkirch 2023, D'Acunto et al. 2022, Crossley, Low, andSleeman 2014), comparing purchases of taxable and non-taxable items (Crossley, Low, and Sleeman2014), taking advantage of the strengths of high-frequency and high-granularity data (Cashin andUnayama 2021, 2016), and exploiting differences in perceived pass-through rates (Bachman et al.
2021). Our new identification strategy is expected to provide complementary evidence to previous
studies.
Of course, our method also comes at a cost. First, there is no guarantee that households’
responses to hypothetical scenarios will match their responses to actual changes in tax rates. Second,in our experiment, each respondent subjectively predicts the extent to which a change in the VAT rate
will pass-through to tax-inclusive prices. However, there is no guarantee that their predicted passthrough rate will match the pass-through rate when the VAT rate change is actually implemented.
These issues are discussed in Section 4. With these caveats in mind, the extent to which the estimatedresults in this paper have policy implications should be judged carefully.
Second, it provides new insights into the literature on the response of household spending tounanticipated income changes. According to the life-cycle/permanent income hypothesis (LC/PIH),
household consumption should not respond to anticipated income changes, but to unanticipatedincome changes. While numerous analyses have been conducted to test the former hypothesis, known
as the excess sensitivity test (Jappelli and Pistaferri 2010, Hsieh 2003, to name a few), there isinsufficient evidence on the latter. This is attributed to the fact that unanticipated income changes areoften unobservable to econometricians (Pistaferri 2001). For example, when a household income falls
by 5%, it is difficult for econometricians to determine whether it was anticipated or unanticipated forthat household. To address this issue, previous studies rely on hypothetical income changes (Fuster,
Kaplan, and Zafar 2021, Jappelli and Pistaferri 2020, 2014, Christelis et al. 2019, Bunn et al. 2018,
Sahm, Shapiro, and Slemrod 2012), and this study provides complementary evidence in this area.
Third, it provides new insights into the formation of inflation expectations and its impact onhousehold spending. A number of determinants of inflation expectations have been reported, includingchanges in the prices of goods and services frequently purchased (Kikuchi and Nakazono 2023,
Diamond, Watanabe, and Watanabe 2020), monetary policy announcements (Coibion et al. 2022, 2020,
Coibion, Gorodnichenko, and Weber 2022), trust in the central bank (Niizeki 2023, Christelis et al.
2020), past inflation experience (Malmendier and Nagel 2016), and cognitive ability (D’Acunto et al.
2022). However, there is a dearth of research on the impact of taxes, particularly changes in VAT rates,3

on the inflation expectations.
The remainder of the study is organized as follows. The next section provides a review of theexperimental design and data, while Section 3 presents the estimation results. Section 4 discusses some
remarks on the interpretation of the results. Finally, Section 5 concludes.
2

Experimental design and data

Data collection was conducted from February 1 to February 7, 2022, based on a pool of individuals
registered with INTAGE Inc., one of the largest research firms in Japan. We asked 37,465 randomly
selected individuals aged 20 to 69 from the pool to participate in the survey, which was completed
once we had received responses from approximately 4,000 respondents. The survey consists of fivequestions, with a median (mean) response time of 1 minutes 48 seconds (6 minutes 34 seconds).
As shown in Figure 1, we randomly assigned all respondents to one of five groups. After
providing hypothetical VAT rates, we elicited the information on the inflation expectations over the
coming year based on the provided VAT rate. To do so, respondents were asked to answer the inflation
expectations based on the goods and services purchased by the respondent households, rather than the
inflation expectations at the national level. In addition, to make it easier to answer the question, we
asked them in the form of how much they thought that the current price of 110 yen including tax would
be sold for over the coming year. The inflation expectations are calculated from the results of these
responses.
Next, we asked about the percentage change in tax-inclusive non-durable spending of
respondent households over the coming year compared to the last year. While we do not explicitly
instruct respondents to answer nominal expenditure growth rates, we assume that they are answering
nominal values to this question. To derive the real non-durable spending growth rate, we subtract the
inflation expectations from the (nominal) expenditure growth rate.
Finally, we asked whether durable goods are a good time to buy over the next year. This type ofquestion is often used in previous studies for ease of answering (e.g., Bachman, Berg, and Sims 2015).
The exact wording of all questions is included in Appendix B. The information on respondents’demographics (age, sex, household pretax income, etc.) is provided free of charge by INTAGE Inc.
Table 1 summarizes descriptive statistics by group. Respondents are excluded from the sample
if they are students or if we do not know whether they are working. We also confine our analysis to
only those respondents for whom all variables necessary for the analysis are not missing. The final
sample size is 1,401. As can be seen in Table 1, the respondent characteristics do not greatly differ
across the groups. Indeed, all groups pass the hypothesis test of whether the random assignment is
successful (see Table A1). The bottom of Table 1 reports the means for each group for the posttreatment outcome variables, but detailed comparisons will be made in the next section.
Before presenting the results in the next section, it is worth summarizing what the outcome
4variables in this paper represent. While we ask about inflation expectations for the coming year, we
ask about (nominal) spending growth expectations for the coming year compared to the past year.
Thus, unlike the former, the latter explicitly requests a comparison with the outcome for the past year.
However, even in the former, the question is asked in the form of how much the respondents think thatwhat was 110 yen including tax will be for the coming year. Therefore, we believe that it is safe to saythat respondents who received the VAT scenario, as depicted in Figure A1, are essentially answeringoutcomes for the coming year compared to before the VAT change.
In each scenario, the theoretically possible mechanisms and consequences are as follows. In theunanticipated VAT hike scenario (Groups 1 and 2), respondents would likely consider it a negative
permanent income shock. This is because their purchasing power will decline even though theirnominal expected lifetime income will remain unchanged. On the other hand, this scenario should notlead to intertemporal substitution effects. This is because the VAT hike was an unanticipated event.
Therefore, what we examine here is not the effects of unconventional fiscal policy (i.e., policy tostimulate spending by taking advantage of intertemporal substitution effects caused by announcing afuture VAT hike), but the extent to which household spending is affected solely by the negative income
effect of the VAT hike.
In the unanticipated temporary VAT cut scenarios (Groups 3 and 4), the abolition of the VAT for
one year only is expected to have strong intertemporal substitution effects, stimulating householdspending to a large extent. This prediction is supported both by theoretical and empirical evidence(Parodi 2023, Bachman et al. 2021, Baker, Johnson, and Kueng 2021, Agarwal, Marwell, andMcGranahan 2017, Crossley, Low, and Sleeman 2014, Crossley, Low, and Wakefield 2009). Moreover,the demand-stimulating effects produced by changes in inflation expectations should theoreticallyoccur in more durable goods (Bachman et al. 2023). We test this theoretical prediction by using thewillingness to purchase durable goods as the outcome variable.
For Groups 3 and 4, the VAT cuts may also produce positive income effects, but they are likely
to be small. First, since the VAT cuts are limited to one year, its impact on households’ lifetime
resources is likely to be small. Second, not only for Group 4, where the shortfall in tax revenue iscovered by an income tax hike, but also for Group 3, where the shortfall is covered by the issuance ofgovernment bonds, if households anticipate future tax hikes, the impact on households’ lifetime
resources is likely to be small. Thus, we assume that the response of household spending in Groups 3
and 4 is primarily driven by intertemporal substitution effects.
As for the impact on household spending of how the increased tax revenue is used and how the
shortfall in tax revenue is compensated, no ex ante judgement can be made since it depends on how
households perceive the changes in income taxes and the national debts. Therefore, in the next section,
we discuss households’ perceptions of these based on the estimation results obtained.

5

3

Results
3.1

Graphical analysis

Figure 2 shows a histogram of expected tax-inclusive prices by group over the next year. There
are several findings. First, about 40% of the control group expect that what was 110 yen including tax
will continue to be sold at 110 yen, but there are more than 30% who expect it to be 115 yen or more.
This means that even if there were no change in the VAT rate, households expect prices to rise, andthe average inflation expectations for the control group are calculated to be about 2.77% (see Table 1).
On the other hand, in Groups 1 and 2, which face a permanent VAT hike, about 70% of
respondents expect tax-inclusive prices of 120 yen or more over the next year. The average inflation
expectations for Groups 1 and 2 are 6.25% and 6.10%. Thus, compared to the control group, theinflation expectations for Groups 1 and 2 are 3.48 and 3.33 percentage points higher, and thisadditional increase can be attributed to the permanent VAT hike.
Now let us calculate the pass-through rates of the VAT hike scenarios based on Table 2. First, theexpected price level (tax inclusive) for the control group (Group 5) is 113.0 yen, while it is 116.9 yen
and 116.7 yen for Groups 1 and 2, respectively. If complete pass-through occurs, it would be 123.3
yen, whereas if the pass-through rate is 0%, the expected price level remains at 113.0 yen. Thus, thepass-through rate is approximately 37% = (116.9-113.0) / (123.3-113.0) for Group 1 and 36% forGroup 2.
In Groups 3 and 4, given a temporary VAT cut as a scenario, about 45% of respondents expect
the tax-inclusive price to be 100 yen over the next year. The average inflation expectations for Groups
3 and 4 calculated from Figure 3 are -3.16% and -3.38%. Thus, compared to the control group, theinflation expectations for Groups 3 and 4 are 5.94 and 6.15 percentage points lower, and this additional
decrease can be attributed to the temporary VAT cut. Calculating the pass-through rate in the manner
as Groups 1 and 2 above, the pass-through rate is approximately 64% for Group 3 and 66% for Group4 (see Table 2). We discuss whether these pass-through rates are realistic in Section 4.
Figure 3 illustrates the expected growth rates of (nominal) non-durable spending by group.
Compared to the control group, Groups 1 and 2 have about half of the respondents who say they will
increase (nominal) non-durable spending by more than 10%, but the impact on real expenditure is notclear from this figure, since these groups also expect tax-inclusive prices to rise by about 6.2%. Groups
3 and 4, on the other hand, have higher growth rates of (nominal) non-durable spending than thecontrol group, even though they expect tax-inclusive prices to decline by more than 3%. In other words,
the expected growth rates of real non-durable spending are significantly higher than the control group.
Finally, Figure 4 illustrates the distribution of expected growth rates of real non-durable
spending, calculated by subtracting the inflation expectations from the growth rates of nominal nondurable spending, by group. First, the control group provides us with the growth rates of real nondurable spending that households would expect if the VAT rate were permanently at 10%. Over 40%
6

of households have a growth rate of 0%, with the average being 1.19%.1 On the other hand, thepermanent VAT hike groups have many observations around 1‒2%, with the average being 0.22‒
0.37%. Thus, compared to the control group, the results suggest that the permanent VAT hike possibly
had a negative impact on real non-durable spending. This is consistent with the hypothesis thathouseholds viewed the permanent VAT hike as a negative permanent income shock, but we will check
whether the difference is statistically significant later when we run the regression analysis.
The distribution of the temporary VAT cut groups is the most dispersed, with clearly more
observations to the right of 0%. Thus, a temporary VAT cut is likely to stimulate real non-durable
spending, and as noted above, intertemporal substitution effects are the possible mechanism behind it.
One might wonder whether significant intertemporal substitution effects occur for non-durable
spending. Since our non-durable spending is the residual obtained by subtracting durable spending
from total spending, it includes spending on semi-durable such as clothing, as well as storable nondurable such as rice, canned goods, detergent, and commuter passes. Thus, the intertemporal elasticity
of substitution for non-durable, including semi-durable and storable non-durable, is considered to bereasonably high.
3.2

Regression analysis

In order to make the above discussion more quantitative and to check for statistical significance,
we perform a regression analysis below. The estimation equation is as follows.

𝑦 =𝛼+𝛽 𝐺𝑟𝑜𝑢𝑝 , + 𝛾 𝑥 + 𝜀 ,(1)𝑦 is the outcome variable, 𝐺𝑟𝑜𝑢𝑝 , is each group dummy, and 𝑥 is a vector of control variables,and 𝜀 is the error term. The control variables are male dummy, age, work dummy, number of children,
household pretax income, marriage dummy, and each region dummy. Since the control group (Group5) is excluded, 𝛽 represents the extent to which the outcome of group 𝑔 is different compared tothe control group. Since the assignment to each group is conducted randomly, control variables are notessential. In fact, the results do not differ significantly regardless of the presence or absence of control
variables, but this paper reports the estimation results with control variables.
Table 3 represents the estimation results. First, column (1) shows that compared to the control
group, the permanent VAT hike groups have a 2.62 percentage point higher expected (nominal) nondurable spending growth rate, while the temporary VAT cut groups have a 1.26 to 1.63 percentage

1

According to the latest Family Income and Expenditure Survey by the Ministry of Internal Affairs andCommunications, the growth rate of real non-durable spending for 2022 compared to 2021 is 1.73%. Thus, 1.19% is a
plausible figure.

7

point lower rate. Columns (2) and (3) show that the results of decomposing these nominal values into
inflation expectations and expected real non-durable spending growth rate. The permanent VAT hikegroups have 3.35-3.45 percentage points higher inflation expectations than the control group, resulting
in 0.72-0.83 percentage points lower expected growth rate of real non-durable spending, but thedifference is not statistically significant. To the extent that households perceive the unanticipatedpermanent VAT hike as a negative permanent income shock, this result is somewhat puzzling. One
factor that could explain this “excess smoothness” (Campbell and Deaton 1989) is insurance. Indeed,
under complete markets, all idiosyncratic income shocks to households can theoretically be insured.
However, this explanation does not apply in the current case since an unexpected permanent VAT hikeis not an insurable idiosyncratic shock such as an unanticipated illness or unemployment, but anaggregate shock that is difficult to insure.
Other possible explanations for the lack of significant response of real non-durable spending toa permanent VAT hike are as follows. We find the first two less compelling and the other two moreplausible. First, households may have already anticipated VAT hikes. Japan’s government debt-to-GDP
ratio at the time of the experiment was over 250%, the worst among developed countries, but the VAT
rate was relatively low at 10%. Thus, it is possible that many households anticipated that the
government would further increase the VAT rate in order to achieve fiscal consolidation. In this case,spending may have already declined when they anticipated it and did not significantly respond when
the VAT hike was implemented. However, it is dubious that many households would have anticipatedthe VAT rate to double from 10% to 20% at once.
Second, many households may not have viewed the VAT hike as a negative permanent income
shock. Cashin and Unayama (2021) report that the 1997 VAT hike in Japan did not produce negative
income effects because of the income tax cut implemented at the same time. Their finding is consistent
with the fact that real spending did not significantly respond in Group 2, where the increased tax
revenue is returned as an income tax cut. On the other hand, it is questionable whether a similar channel
would work in Group 1, where increased tax revenues are used to pay down the national debt. Indeed,
Niizeki (2022), based on a randomized control trail, finds no evidence that the government debt-toGDP ratio affects household spending and saving behavior in Japan.
Third, households have non-separable preferences of habit formation, and as a result, they may
respond gradually to negative income shocks. Similar to the current paper, Kubota (2010) examines
the response of Japanese household spending to a hypothetical permanent income change in whichmonthly income drops by 30% starting next month and then stays the same for the rest of their lives.
He finds that the largest proportion of households (41.7%) chose “reduce spending now and maintainit at that level,” but the second largest proportion (38.6%) chose “gradually reduce spending andeventually level off.” The latter household response is consistent with habit formation.
Fourth, many households may expect a gradual pass-through of the VAT hike to tax-inclusive
8

prices. Two results support this interpretation. First, the pass-through rates for VAT hike scenarios is36‒37%, which is far from complete pass-through. This may be because households expect the passthrough to be gradual over several years. Second, as shown in column (4), compared to the control
group, the permanent VAT hike groups respond that it is a good time to buy durable goods in the
coming year by about 20 percentage points. This result is puzzling to the extent that one assumes thata permanent VAT hike would result in negative income effects. However, if households expect a
gradual pass-through, that is, a gradual increase in tax-included prices over time, they may consider itbetter to purchase durable goods while prices are relatively low.
Next, the temporary VAT cut lowers inflation expectations by 5.94‒6.16 percentage points andincreases expected growth rate of real non-durable spending by 4.31‒4.90 percentage points.
Furthermore, the fraction of respondents who say it is a good time to buy durable goods in the coming
year is also 45 percentage points higher than the control group. As discussed earlier, these are likely
due to intertemporal substitution effects.
Finally, no significant differences in coefficients were detected between Groups 1 and 2 andbetween Groups 3 and 4 for all outcomes (see p-values at the bottom of Table 3). There are two possible
explanations for this result. One is the possibility that a given scenario had the similar impact on theoutcome. For example, (Ricardian) households might have expected the same degree of impact on
their expected lifetime resources whether the way of compensating for the shortfall in tax revenues
caused by the temporary VAT cut was by raising income taxes or by issuing government bonds. The
second possibility is that respondents did not read the given scenario thoroughly. Thus, they might
have understood the VAT rate path given to them, but responded without understanding how theincreased tax revenue would be used or how the shortfall in tax revenue would be made up. Since weunfortunately do not have enough information in this experiment to test which possibility is moreplausible, it is left for future research.
3.3

Distributional consequences

VAT is generally considered regressive. According to the survey that asked Japanese households andeconomists to evaluate the VAT, the most common response was “fair and appropriate” for economists,
while “regressive” ranked first for households, ahead of “negative impact on the economy” in second
place (Umeda, Kawamoto, and Hori 2018). The accumulation of evidence on whether VAT isregressive is still in progress and no consensus has been reached. For example, Crossley, Low, andWakefield (2009) argue that the temporary VAT cut in the U.K. in the aftermath of the Great Recession
was regressive, while Bachman et al. (2021) report that the temporary VAT cut in Germany amid the
COVID-19 disaster was progressive. The current paper attempts to provide additional insight into
whether VAT is regressive by examining the spending response to changes in the VAT rate by income
group.
9

Figure 5 illustrates the estimation results of equation (1) for each income group. The dependent
variable is expected growth rate of real non-durable spending. For simplicity, Groups 1 and 2, andGroups 3 and 4, are combined to form the permanent VAT hike group and the temporary VAT cut
group, respectively. First, as confirmed in Table 2, the spending response to a permanent VAT hike is
not significantly different for most income groups than for the control group. More importantly, there
are also no significant differences in spending responses across income groups. Thus, we find that thepermanent VAT hike is neither regressive nor progressive.
On the other hand, the spending response to a temporary VAT cut is much larger for householdswith income equal to or above 10 million yen (about 87,000 US dollars) than for other income groups.
This difference is statistically significant (see Table A2). Thus, the temporary VAT cut is regressive inthe sense that the rich spend more. Column (2) of Table A2 shows that the larger spending response ofhigh-income households is attributed to the fact that they expect prices to fall to a greater extent. Notethat the rich tend to purchase more luxury goods at the 10% standard VAT rate, while the poor tend topurchase more necessities at the reduced rate of 8%. Thus, the rich would benefit more from the 0%
VAT rate since the prices they face would be lower.
4

Discussions
4.1

Hypothetical bias

So far, our analysis has been based on the assumption that households’ responses to a hypothetical
VAT rate change are the same as those that would be observed if the VAT rate were actually changed.
However, there is no guarantee that these will coincide. In previous studies, the bias in which subjects’
responses differ between hypothetical and real situations is called “hypothetical bias”. In thissubsection, we briefly review previous studies on hypothetical bias and discuss the extent to which thecurrent analysis suffers from it.
First of all, to our knowledge, no studies have examined the extent to which hypothetical bias
exists in households’ spending responses to changes in tax rates. One of the fields in which
hypothetical bias has been most studied is preferences (time discount rates and risk aversion).
Matousek, Havranek, and Irsova (2022) provides a meta-analysis of whether hypothetical bias exists
in the measurement of time discount rates, based on 56 papers and 927 observations. The time discountrate is usually measured in the form of an option to receive $100 today versus an option to receive$100+X a year from now. In this case, the hypothetical situation is that the subjects do not actually
receive the money, while the real situation is that they do. The difference in time discount rates between
the two groups is the hypothetical bias in this case. They find no significant differences between thetwo groups. Branas-Garza et al. (2023) examine hypothetical bias in time discount rates in three areas:lab, field, and online, and observe no hypothetical bias in any area. Bickel (2009) conduct functional
magnetic resonance imaging (fMRI) assessments to subjects and find not only no difference in time10

discount rates between the two groups, but also no difference in brain activity during responses. No or
little hypothetical bias are also reported in risk aversion (Kuhberger, Schulte-Mecklenbeck, and Perner
2002, Irwin, McClelland, and Schulze 1996).
In contrast, there are numerous studies suggesting that hypothetical bias regarding willingness
to pay (WTP) for goods and services does exist. Murphy et al. (2005) perform a meta-analysis of 28
studies and 83 observations and find that the mean (median) calibration factor, defined as the mean
WTP in a hypothetical situation divided by the mean WTP in a real situation, is 2.60 (1.35). In thefield of marketing, Schmidt and Bijmolt (2020) conduct a meta-analysis based on 47 studies and 77
observations that measure WTP for various products. They find that the mean calibration factor is 1.21.
In summary, while hypothetical bias is not observed with respect to preferences, it appears toexist to a reasonable degree with respect to WTP for goods and services. Thus, as hypothetical bias isrobustly observed in some areas, the results of our analysis should also be evaluated with caution.
However, the VAT burden can be considered a relevant and important issue for many households.
Therefore, we believe that they respond to our survey by imaging their actual reactions in a reasonable
way.
4.2

Pass-through rates

The VAT pass-through rates in this paper are subjective expectations of each respondent and may
deviate from what is observed when VAT rates actually change. This subsection provides a brief reviewof the pass-through rates of VAT and individual excise taxes and discusses whether the pass-throughrates obtained in this paper are realistic.
Japan has so far experienced only VAT hikes, with the following pass-through rates reported:under-shifting (Shiraishi 2022), complete pass-through for 63% of goods (Shoji 2022), and 50%(Hiraga 2020). On the other hand, various pass-through rates have been reported in Europe withrespect to tax cuts: 17‒31% for restaurants in Sweden and Finland (Harju, Kosonen, and Skans 2018),
50% for hairdressing in Finland (Kosonen 2015), 100% for food in Norway (Gaarder 2018), 57% for
New cars and 77% for housing repair in France (Carbonnier 2007), 10% for sit-down restaurants inFrance (Benzarti and Carloni 2019), 40‒83% for fuel in Germany (Montag, Sagimuldina, andSchnitzer 2020), and 100% for electricity in Belgium (Hindriks and Serse 2022).
In addition, estimates of the pass-through rates using pooled data for both tax hikes and tax cuts
include the following: 21% for all goods in 17 European countries (Benedek et al. 2020), 85% forcigarette in the U.S. (Harding, Leibtag, and Lovenheim 2012), 70‒100% for gasoline in the U.S.
(Doyle and Samphantharak 2008), and 84‒133% for clothing and personal care in the U.S. (Poterba
1996).
One important feature regarding pass-through is asymmetry. Benzarti et al. (2020) focus on atemporary VAT cut that occurred in the hairdressing sector in Finland and find that the pass-through11rate was twice as high for tax hike as for tax cut. Using VAT data for European countries, they also
report that the pass-through was 34% for tax hikes and 6% for tax cuts. Similarly, Doyle andSamphantharak (2008) report that in a temporary cut in the gasoline sales tax in the U.S., the passthrough rate was 70% at the time of the tax cut, but 80‒100% when it returned to its original level. On
the other hand, some studies find no evidence of asymmetry in pass-through rates (Hindriks and Serse
2022, Benedek et al. 2020).
In conclusion, estimation results for pass-through rates are difficult to compare since the settings
such as country, time horizon, type of good, and estimation methodology differ across the studies.
However, based on the survey of previous studies, it appears that the pass-through rates we obtained(about 36‒37% for tax hikes and about 64‒66% for tax cuts) do not deviate significantly from theresults of previous studies. However, none of the previous studies support our result that pass-throughrates are higher for tax cuts than for tax hikes. Therefore, it is important to note that our finding of alarge spending stimulus effect due to a temporary VAT cut may be overstated.
5

Conclusion

In this paper, we examined the impact of a change in VAT rate on household spending behavior bypresenting a random set of hypothetical VAT rate scenarios. Our findings are as follows. First, thepermanent VAT hike had no significant negative impact on real household spending in the year ahead.
Possible mechanisms included habit formation and gradual pass-through. Second, we found that a
temporary VAT cut greatly stimulates households’ real non-durable spending and willingness topurchase durable goods. This is likely attributable to intertemporal substitution effects.
There are some caveats to our analysis. First, the results obtained in this paper represent the
response of households to a hypothetical VAT rate change, not the response to an actual VAT ratechange. Since there is no consensus on whether and to what extent hypothetical bias exists, one should
continue to keep this in mind. Second, the pass-through rates from changes in VAT rates obtained inthis paper are only the subjective expectations of each respondent and not the pass-through rates
observed when the actual VAT rate changes. The pass-through rates observed in this paper do notdeviate significantly from those obtained in previous studies, but it should be noted that the asymmetry
in pass-through rates for tax hikes and tax cuts is the opposite of that found in previous studies.
The current analysis can be extended in several ways. First, while this paper only included in theanalysis one year after the VAT rate change, it is important to examine longer-term responses ofhousehold spending. When viewed cumulatively, the impact of a permanent VAT hike may be moresignificant due to habit formation and/or gradual pass-through. It is also worth examining the extent
to which a temporary VAT cut will be followed by a subsequent rebound in spending (mainly on
durable goods). Second, it is also important to conduct experiments under more realistic settings.
Changes in VAT rate are usually made over a smaller range than in the setting of our paper. Thus, it is12necessary to confirm whether household spending would be similar to the results of this paper evenunder such a more realistic VAT rate change. Addressing these questions will be left for future research.

13

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17

Figure 1: Group assignments

Notes: The words in parentheses represent how the increased tax revenue is used or how the decreased tax revenue ismade up. Group 5 is the control group.

18

Figure 2: Distribution of expected price level (tax inclusive) by group
Permanently 20% (Debt)

Permanently 20% (Tax)

Stay at 10%100

Temporarily 0% (Debt)

100

105

110

115

120

105

110

115

120

Temporarily 0% (Tax)

100

105

110

115

120

Expected price level (tax inclusive)
Notes: The figure illustrates for each group the answer to the question, “How do you think the future path of theconsumption tax rate given above will affect the tax-inclusive prices of goods and services purchased by your household
over the next year? Please answer by how much you think that goods and services that used to cost 110 yen including
tax will now be sold for.” The options for answer are from 99 yen (or less) to 121 yen (or more) in increments of 1 yen.
When calculating inflation expectations, respondents who chose 99 yen or less and 121 yen or more were assigned 99
yen and 121 yen, respectively.

19

Figure 3: Distribution of expected growth rates of (nominal) spending by group
Permanently 20% (Debt)

Permanently 20% (Tax)

Stay at 10%-10

Temporarily 0% (Debt)

-10

-5

0

5

-5

0

5

10

Temporarily 0% (Tax)

10

-10

-5

0

5

10

Expected growth rates of (nominal) spending (%, tax inclusive)

Figure 4: Distribution of expected growth rates of real spending by group
Permanently 20% (Debt)

Permanently 20% (Tax)

Stay at 10%-20

Temporarily 0% (Debt)

-20

-10

0

10

-10

0

Temporarily 0% (Tax)

20

-20

-10

0

10

20

Expected growth rates of real spending (%, tax inclusive)

20

10

20

Figure 5: Distributional consequences
Temporary VAT cut

)
)
)
00
00
00
0,7
,10
0,5
0
0
0
[5
[3
[70

)
)
)
<= 00
00
00
00
00 <3
0,5
,10
0,7
0
10
0
0
[5
[3
[70

0
-5

Estimates

510

Permanent VAT hike

00
<3

<=
00
10

Income groups
Notes: The figure shows that the treatment effects for each income group for the permanent VAT hike group (Groups 1
and 2) and the temporary VAT cut group (Groups 3 and 4). The estimates shown on the vertical axis are derived fromestimation results from regressing expected growth rate of real non-durable spending on two treatment dummies andcontrol variables for each income group. The results are shown with 90% confidence intervals. Household pretax
income is shown in 10,000 yen units.

21

Table 1: Descriptive statistics

Notes: Of the respondent characteristics, all are dummy variables except for age, number of children, and household pretax income (in 10,000 yen). Borrowing constraint is a dummy
variable that takes one if the answer is yes and zero if the answer is no to Q1. Expected growth rate of (nominal) expenditures and inflation expectations are answers to Q4 and Q3,
respectively. The expected growth rate of real expenditures is calculated by subtracting the inflation expectations from the expected growth rate of (nominal) expenditures. The goodtime to buy durables is a dummy variable that takes one if the answer is “It is a good time” and zero if the answer is “It is a bad time” to Q5. See Appendix B for the questionnaire.

22

Table 2: Expected price level (yen, tax inclusive) by group

Notes: The second column represents the average expected price level (yen, tax inclusive) for each group. The expected
price level represents the responses to the question (Q3) of how much you think that goods and services that used tocost 110 yen including tax will be sold for over the coming year. The third column shows that the expected price levelthat would be obtained if the change in the VAT rate resulted in a complete pass-through, calculated by multiplying
113.0 by 1.2/1.1 for Groups 1 and 2, and by 113.0 by 1.0/1.1 for Groups 3 and 4. The fourth column, on the other hand,
represents the expected price level when the pass-through rate is zero. The last column shows that the pass-through rate
calculated for each group.

23

Table 3: Regression results

Notes: Each column shows estimation results based on equation (1). The p-values reported at the bottom of the table
are for testing whether the coefficients for Groups 1 and 2, and Groups 3 and 4 are the same. Heteroskedasticity-robust
standard errors are in parentheses. ***, **, * denote statistical significance at the 1, 5, and 10% levels, respectively.

24

Appendix A: Additional Figures and Tables
Figure A1: Clarification of research question for the current analysis

Table A1: Predictability of treatment status

Notes: The table reports the F-statistic and p-value in the F test where all coefficients are zero when each treatment
dummy is regressed on the respondent characteristics obtained before the treatment. The respondent characteristics
include all variables listed in Table 1.

25

Table A2: Regression results (high income v.s. low and middle income)Notes: The high-income dummy takes the value of one if the household pretax income is 10 million yen or more, andzero otherwise. See also notes for Table2.

26

Appendix B: Questionnaire and scenarios provided for each group(Q1) Is your household currently in a situation where you really want to achieve a higher level ofconsumption but are unable to borrow money and have decided against it?


Yes



No



I don’t know/I don’t want to answer*After Q1, respondents are randomly assigned to one of five groups, each presented with the following
scenario.
Group1As shown in the figure below, assume that the government suddenly decides to permanently raise theconsumption tax rate from 10% to 20%, effective today. Assume that the increased tax revenue will
be used to repay the national debt. Also, assume that the tax rate on items subject to the reduced tax
rate is increased from 8% to 16%.
Value added tax rates
20%

20%

20%

20%

20%

20%

0

1
2
3
Year before/after tax change

4

5

10%

-1

Group2As shown in the figure below, assume that the government suddenly decides to permanently raise theconsumption tax rate from 10% to 20%, effective today. Assume that the increased tax revenue will
be used to reduce income taxes. Also, assume that the tax rate on items subject to the reduced tax
rate is increased from 8% to 16%.

27

Value added tax rates
20%

20%

20%

20%

20%

20%

0

1
2
3
Year before/after tax change

4

5

10%

-1

Group3As shown in the figure below, assume that the consumption tax rate is suddenly reduced from 10% to
0% for one year from today. The decrease in tax revenues will be compensated for by the use ofgovernment debt.

Value added tax rates
10%

10%

10%

10%

10%

10%

1
2
3
Year before/after tax change

4

5

0%
-1

0

Group4
As shown in the figure below, assume that the consumption tax rate is suddenly reduced from 10% to
0% for one year from today. The decrease in tax revenue will be compensated for by an increase inincome tax.

28

Value added tax rates
10%

10%

10%

10%

10%

10%

1
2
3
Year before/after tax change

4

5

0%
-1

0

Group5As shown in the figure below, assume that the consumption tax rate will continue to remain at 10%
permanently in the future.

Value added tax rates
10%

10%

10%

10%

10%

10%

10%

-1

0

1
2
3
Year before/after tax change

45(Q2) To what extent do you think the future path of the consumption tax rate given above will affectyour household's well-being over the next year?


Quite negatively affected

Somewhat negatively affected

No impactSomewhat positively affected

Quite positively affected

I don’t know/I don’t want to answer(Q3) How do you think the future path of the consumption tax rate given above will affect the taxinclusive prices of goods and services purchased by your household over the next year? Please answer
29

by how much you think that goods and services that used to cost 110 yen including tax will now besold for.


99 yen or less

100 yen

101 yen

102 yen

103 yen

104 yen

105 yen

106 yen

107 yen

108 yen

109 yen

110 yen

111 yen

112 yen

113 yen

114 yen

115 yen

116 yen

117 yen

118 yen

119 yen

120 yen

121 yen or moreI don’t know

(Q4) Based on the future path of the consumption tax rate given above, by how much do you think theamount of (tax included) spending in your household over the next year will change compared to thepast year? Please exclude spending on durable goods (e.g., cars and appliances).
Increase by 10% or moreIncrease by about 9%Increase by about 8%Increase by about 7%Increase by about 6%30



Increase by about 5%Increase by about 4%Increase by about 3%Increase by about 2%

Increase by about 1%Remain unchanged

Decrease by about 1%Decrease by about 2%

Decrease by about 3%

Decrease by about 4%

Decrease by about 5%Decrease by about 6%Decrease by about 7%Decrease by about 8%Decrease by about 9%Decrease by 10% or moreI don’t know

(Q5) Based on the future path of the consumption tax rate given above, do you think the coming twelve
months will be a good time to buy durable goods (cars, appliances, etc.)?


It is a good time

It is a bad time

I don’t know

31