Thinking straight about EVAT - the growth angle

Representative Joey Salceda (erstwhile Expanded Value Added Tax, or EVAT advocate) has asked for a EVAT deferment. One of the provisions of EVAT is removal of VAT exemption of oil companies. He warns that with the world oil price spike, imposing EVAT now would slow down growth and end up bloating the deficit.

Come on now. Even without the oil price hikes, we knew that the EVAT will slow down growth. Based on simulations of the Ateneo Macroeconomic Forecasting Model, a two-percentage-point increase in GDP tax effort in 2005 (which the EVAT seeks to accomplish) will shave off a terrifying 0.07 percentage points from the GDP growth rate. Yes folks, 0.07 percentage points. (For example, from 5.3% to 5.23%). However the miniscule slowdown will hardly affect revenue collection, so that the ratio of the government deficit to GDP in 2005 should be 20% lower (for example, from 4% to 3.2%). Deficit reduction confers a long-term benefit which I think outweighs the short-run growth impact.

Now what about under higher oil prices? It doesn't matter. Higher oil prices will slow down growth, with or without the EVAT. The EVAT will slow down growth, with or without higher oil prices. A confluence of the two - EVAT at a higher level of oil prices - will not make a big difference on the impact of the VAT on growth.

If so, then the impact on the deficit will also be largely unaffected. Salceda is wrong in alleging that implementing EVAT under a higher oil price regime will worsen the deficit. His thinking is in fact a version of "supply-side economics" which is the laughingstock of mainstream economics. The usual hypothesis of the supply-siders is that tax reduction would reduce the deficit (indirectly, by increasing production); here Salceda is flipping it - alleging that tax increases will worsen the deficit.

How about the impact on inflation? More on that tomorrow.