Do investors care about consumption taxes? Evidence from financial markets!

This web site belongs to 2010 number of posts by PhD students at work market.

Regardless of the near global adoption of worth-added taxation (VAT) policies, relatively little is famous concerning the financial market reaction to VAT changes. Within my employment market paper I address this gap by supplying a solution to the issue, “Do investors worry about consumption taxes?” I’ve found they do. Utilizing an event-study setup and daily stock exchange returns, I measure the impact of VAT policy bulletins for country-index and firm-level equity returns in advanced and emerging economies between 1990 and 2014. I’ve found an optimistic financial market reaction to policy bulletins regarding a VAT rise in emerging economies. The positive fact is amplified in occasions of worsening macroeconomic-indicators (for example greater fiscal deficits and inflation) as well as for firms rich in-amounts of corporate debt.

Methodology and Results

First, I create a country-level specs, to evaluate how country-level index returns react to VAT policy bulletins. Particularly, I examine how returns are impacted across the distribution of fiscal space measures. Figure 1 plots the marginal results of a VAT increase announcement, across the distribution of fiscal space measures (95-percent confidence bands are proven). Panel (a) plots the marginal effects across the distribution of fiscal balance like a percent of GDP. Panel (b) plots the marginal effects using fiscal balance like a percent of average tax revenue because the fiscal space variable. The outcomes in panels (a) and (b) reveal that a VAT increase announcement results in greater index returns. In emerging economies, the financial fact is most powerful as fiscal space worsens. For instance, once the fiscal balance is zero the purpose estimate is positive although not statistically not the same as zero. However, once the fiscal balance (% GDP) reaches -10%, a VAT increase announcement results in a 5 percentage point index-return.

Figure 1: Marginal Results of a VAT Increase across the Distribution of Fiscal Space

Some four stock charts showing Figure 1: Marginal Results of a VAT Increase across the Distribution of Fiscal Space

The rest of Figure 1, panels (c) and (d), shows recent results for an example of advanced economies. In advanced economies, the outcome of VAT increase bulletins isn’t statistically not the same as zero across the distribution of fiscal space, in comparison using the recent results for the emerging market sample. A likewise divergent pattern for advanced and emerging economies can also be found plotting the marginal results of a VAT increase across the distribution of inflation. In emerging economies, I’ve found that at greater rates of inflation, a VAT increase announcement includes a bigger (and statistically significant) marginal impact on index returns than at lower rates of inflation.

Next, I create a firm-level specs to be able to take into account the function of firm-level characteristics within the financial market reaction to VAT policies. Figure 2 shows the marginal aftereffect of a VAT increase announcement across the distribution of firm-level debt, measured because the logarithm of lengthy-term debt and short-term debt individually. In Figure 2, Panels (a) and (b) reveal that for emerging economies, within a variety of relatively high-corporate debt, there’s an optimistic and statistically significant impact of the VAT increase announcement on firm-level equity returns. In comparison, the outcome of the similar announcement in advanced economies isn’t statistically significant.

Figure 2: Marginal Results of a VAT Increase across the Distribution of Corporate Debt

Some four stock charts showing Figure 2: Marginal Results of a VAT Increase across the Distribution of Corporate Debt

Policy Implications

When it comes to policy, this paper highlights different policy impacts in advanced and emerging economies.

Initial macroeconomic conditions play a huge role in figuring out the financial market impact of recent tax policies. Like a policy-maker responsible for tax reform or perhaps in handling the insurance policy response currently of fiscal stress, an exam of fiscal space and inflation should influence the tax policy direction.

The outcome of VAT policies is depending on firm-level debt. Yet another policy implication is the fact that an awareness of firm-level issues throughout the economy should lead to a particular policy proposals.

Overall, incorporating an exam around the macro- and micro- conditions from the economy (i.e. both sovereign debt and company debt) may provide policy insight in designing tax reform, which can be crucial for macroeconomic stability. This pertains to recent findings that credible fiscal coverage is important (IMF, 2021). It could also be that investors expect future rate of interest declines because of VAT increases, which may benefit firms with relatively high corporate debt and countries in additional fiscally precarious situations.

Hayley Pallan is really a PhD candidate in the Graduate Institute in Geneva. Much more about her research are available here.

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