Cutting VAT, Cutting Prices: How a temporary tax policy brought real relief to Portuguese shoppers
What happens when the government slashes taxes on basic food items? Do prices actually fall or do retailers pocket the difference? In 2023, Portugal put that question to the test. In an effort to ease the sting of food inflation, the Portuguese government temporarily cut the value-added tax (VAT) on 46 essential food items (from bread and pasta to vegetables and milk) from 6% to 0%. The policy began in April and ran until early January 2024.
The research shows that the VAT cut worked exactly as intended. Prices dropped immediately, stayed low for months, and bounced back to their original levels when the tax was reinstated. In other words: the VAT cut was fully passed on to consumers, stayed that way, and reversed cleanly.
This is a rare finding. In most countries and contexts, tax cuts on consumption are only partly reflected in prices—and when taxes go back up, prices often jump even higher than before. Not this time.
What did the researchers find?
Using a unique data set of daily online prices from four major supermarket chains, the researchers tracked the prices of over 43,000 food items, more than 10,000 of which were directly affected by the VAT cut.
Their key findings:
- Immediate impact: Prices of VAT-exempt items dropped by the full amount of the tax (about 5.66%) as soon as the cut took effect.
- Staying power: Prices remained lower for the full nine months of the policy.
- Symmetry: When the VAT was reintroduced in January 2024, prices jumped back up by about 6% restoring them to pre-cut levels.
This meant that the policy achieved a full, persistent, and symmetric pass-through to consumer prices.
Why did it work so well?
The researchers believe two key factors explain the success:
- High visibility (or “salience”): The VAT cut was widely publicized. Supermarkets labelled affected products clearly, media outlets reported heavily on it, and consumer groups tracked prices closely. In a high-inflation environment, shoppers were already paying close attention to food costs, making any price change more noticeable. This public scrutiny likely pressured retailers to pass the savings on.
- Falling wholesale prices: Around the same time, producer prices (what supermarkets pay their suppliers) were dropping. This gave retailers more wiggle room to lower prices without hurting profit margins.
A boost to households – and the inflation rate
Portugal’s temporary VAT cut didn’t just help individual shoppers, it also affected the national economy. The policy shaved 0.68 percentage points off the headline inflation rate on impact. For a country trying to bring down the cost of living, that’s a meaningful result.
But the policy came with a price tag: the government gave up more than 500 million Euros in tax revenue. That’s comparable to the amount spent on direct cash transfers to families during the same period. Critics might argue that direct aid could be better targeted, but the transparency and effectiveness of the VAT cut are hard to ignore.
How Portugal bucked the trend
Portugal’s VAT experiment stands out because similar efforts elsewhere have often disappointed. In many countries, VAT cuts only partly lower prices and when the tax returns, prices rise more than they should. The Portuguese case shows that, under the right conditions (clear communication, high public awareness, and cooperative retail markets) tax cuts can translate directly into consumer savings.
As countries around the world grapple with inflation, Portugal’s approach offers an important lesson: when it comes to fighting rising prices, design and execution matter as much as the policy itself. A temporary VAT cut in Portugal was fully passed on to food prices, stayed in effect for months, and reversed cleanly – an unusual but encouraging success story for economic policy.
The paper "The full, persistent, and symmetric pass-through of a temporary VAT cut" by graduate students Tiago Bernardino (IIES) and João Quelhas (Department of Economics) at Stockholm University and economists from Banco de Portugal, Federal Reserve Board Washington DC and Nova SBE has been published in the Journal of Public Economics.
Last updated: June 17, 2025
Source: Institute for International Economic Studies (IIES)