The VAT rate hike, government spending, economic growth and sectoral effects: CGE analysis

Abstract

The paper examines the sectoral and macroeconomic effects of the increase in the VAT rate and the additional increase in government spending. For this porpoise, the computable general equilibrium model of the Russian economy has been developed. We have found that the VAT rate hike leads to the output decrease in most industries, including the manufacturing sector. Despite the positive macroeconomic effect from the government spending increases, the sectoral structure is deteriorating, and there is not enough additional growth in demand to offset the negative effect of the increase in the VAT rate, in particular for the industrial sector. In the VAT rate hike and government spending increase scenario, the negative effects of the VAT hike are exacerbated for sectors such as agriculture and trade due to higher costs of production factors as a result of additional government demand. Favorable conditions are being created for the raw materials and the construction sectors as well as the electricity, heat, water and gas distribution sector that have already developed dynamically. Beyond these sectors, the multiplier effects of government spending do not actually extend. The industrial sector is failing to realize its potential. Balanced and sustainable economic growth thus requires additional efforts on the part of industrial policy.