I’m on a roll here (abstract; emphasis added):
The Economic Incidence of Replacing a Retail Sales Tax by a Value-Added Tax: Evidence from Canadian Experience
Richard Miller Bird & Michael Smart
A decade ago, several Canadian provinces replaced the retail sales taxes by value-added taxes. This paper estimates the effects of this tax substitution on consumer prices in the reforming provinces. Consistent with theory, we find that the resulting effective tax rate changes were shifted forward to consumers in most sectors of the economy. The overall effect on tax-inclusive consumer prices was small, albeit perhaps somewhat regressive.
This needs some explanation – we’re looking at a very similar scenario in Malaysia that Canada has already gone through. To wit, replacing a sales tax with a value-added tax and at the same time changing the marginal tax rate.
The research is particularly interesting because the shift in the tax structure was not conducted on a national level, but at a state level and only for certain states (the Canadian Federal government already levies a GST; these are state level taxes). Some states switched to a VAT, while the others retained the Sales Tax.
So what we have here is that rarest of economic beasts - a “natural experiment”. Changes in taxes and prices can be compared across provinces, thus neutralising the impact of changing economic circumstances within the national economy on econometric estimation and analysis. Some of the data can be seen in Figures 1 and 2 (pg. 93).
What these two gentlemen have found, is that changes in the tax rate was largely passed through (“shifted forward”) to the consumer – the estimate lies between 60% to 100% of the change in the tax rate was reflected in consumer prices, depending on which measure you prefer to use. What makes this conclusion more robust is that there’s no obvious incentive for businesses to cut prices if the tax rate is cut, unlike in the case of an increase.
There were some substantial differences in the different categories of consumer expenditure items (transportation for instance had a negative elasticity, i.e. the reduction in tax rate caused an increase in the final price; medical costs on the other hand had a huge positive elasticity estimate), but for the most part theory and empirical experience come together. Changing the mode of taxation from sales to VAT, and simultaneously cutting the tax rate, results in lower consumer prices.
At the risk of over-generalising, if Malaysia were to implement GST at 7% relative to the current Sales Tax rate of 10%, the likelihood then is at worse, we should not see much change in the overall price level. Using the lower elasticity estimate (60%, or to be more precise, 0.6), we should see an approximately 1.8% overall reduction in consumer prices (0.6 x (10 - 7) = 1.8).
How on earth, under these circumstances, will implementing GST be inflationary?
Bird, Richard Miller, & Michael Smart, "The Economic Incidence of Replacing a Retail Sales Tax by a Value-Added Tax: Evidence from Canadian Experience", Canadian Public Policy – Analyse De Politiques, Vol XXXV No 1, 2009