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VAT Rate: A Political Decision Rather Than A Fiscal Measure.

The decision about the increase or not of VAT rate from 21% to 22% will have in Italy a strong impact both from an economic and political perspectives. From the economic side, an increase in the VAT rate in order to finance 1 billion euro would have a strong detrimental impact on the private consumption especially during recession period like this we are living. From the political side, the right-wing party gained a big consensus in the past elections thanks to the "promises" to abolish IMU (the tax on residential and industrial real estates) and to keep the actual level of VAT (21%), therefore in order to keep that consensus is repetitively threatening the Government's stability every time the proposal to increase VAT comes out.

In this article I took a closer look at current and historical levels of households consumption in Italy in order to understand which trend we are experiencing, then comparing it with Germany and the broader Euro Area.

The first chart below shows the level of households consumption from 1970 to 2012 and provide us with the two very first information we have to take into account in the analysis. The first one is that Italy experienced a continuous growth in household consumption up to the beginning of 2000s, the second is that from the beginning of 2000, consumption levels tended to be stable as result of a decade of slow economic growth if not stagnation. As a matter of facts at the end of 2012 the level of households consumption went back to the levels of the early 2000s (1.028 billion euro Vs 1.024 bln € in 2001).

Such stagnation in consumption is well depicted by the following graph showing the historical growth rates and comparing them with Germany and the average in the Euro Area.

Since the past 10 years Italy, as well as the Euro Area, have been experiencing a crisis in the internal demand characterized by low levels of consumption and investments. Indeed households consumption remarkably deteriorated first with the 2008 financial crisis and then with the sovereign crisis and the exacerbating policies of austerity.

The real question is then how the Italian Government should stimulate internal demand and boost consumption rather than to discuss about the increase or not of VAT with the well predicted consequences that this action would have on households consumption and the economy in general.

I think that the attention should be focused on the disposable income of households that has dramatically dropped with the financial crisis and is now continuing to fall.

The high level of unemployment and taxation are playing a crucial role in the reduction of the real net disposable income of households. Expansive fiscal measures aimed to restructure the taxation on individual and corporate income would have a strong positive impact on the economy being able to invert the trend in consumption and investments. Households and workers will have a higher disposable income that would be addressed to buy products and services therefore stimulating production, investments and consequently lower level of unemployment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.