Taxing value added in the financial sector: An input-output approach and effects of the Norwegian FAT

Cathrine Sørensen, OFS scholarship recipient 2016

Abstract

In my thesis I illuminate the effects on social welfare created by the introduction of a financial activity tax (FAT) on financial services. Many financial services are exempt from value added tax (VAT). Even though it may be wanted, there are technical difficulties in implementing a VAT on these services. In order to make up for the missing taxation, a FAT was introduced on financial services in Norway January 1 2017. The Norwegian FAT is a 5 % tax on wages and an additional 1 % on corporate income tax rate. Such a tax effects consumer prices and the government tax revenue. Taken together, these two factors are treated as social welfare. To what degree does FAT make up for missing VAT when comparing to a neutral tax regime? Using a theoretical presentation of an input-output analysis, I highlight the distortionary effects on welfare caused by either regime. A VAT gives a too low consumer price of financial services, but cascading of taxes gives a too high price of commodities produced using financial services as inputs. Alternatively, a FAT increases the price for final consumers of financial services, but it does not solve the problem with tax-cascading. In the empirical analysis I interpret output from model simulations done by using the MSG6-model to look at effects of a FAT on consumer prices. To incorporate a FAT in the MSG6-model, the user price of capital is increased by the same amount as the loan interest rate has to be increased in order to keep the interest margin constant when the payroll tax increase. The effects on consumer prices are results of full pass through, and changes in spending are results of price increases and that the additional tax revenue is distributed using lump-sum transfers. Modest increases in consumer prices and reductions in consumption of most goods are observed. The larger the dependence of capital as input in production, the larger is the price increase. Price of food, non-alcoholic beverages, consumption of own means of transport increases with respectively 0.0276 %, 0.0352 % and 0.0322 %, and a reduction in spending is observed. The largest price increase is in consumption of housing, with almost 0.29 %, which may be economically efficient because of a previously rather low taxation compared to other investment opportunities. The effect on social welfare depend on consumers’ valuation of their reallocated consumption bundle compared to the initial spending in the reference scenario. The tax will in addition reduce some of the risk posed on the economy by the financial sector.

 

Read the thesis in UiO's research archive

Published Sep. 1, 2020 1:49 PM - Last modified Sep. 1, 2020 1:49 PM