Investigating the Effect of VAT on Inflation in Iran Provinces

Value Added Taxes, as a suitable substitute for all types of sales taxes, despite the benefits, lead to disadvantages such as the pressure on the general level of prices (Ikpe & Nteegah, 2013). As inflation has always been one of the most important problems in the Iranian economy, it was a concern that in a situation where the country faces a severe structural inflation and inflationary sanctions, will the implementation of the value added tax program increase inflation?
Taking into account the predictions made by the researchers and the executives of the project, we aim to study the issue. 7 years have passed since the VAT was implemented, therefore, it will be necessary to survey the effects of this tax. This paper will survey the inflationary effects of VAT in Iran provinces.
Theoretical Framework: Implementation of value added tax (VAT) from two direct and indirect channels affects the general level of prices. Since the value added tax is an indirect tax based on consumption, a portion of this tax burden is imposed on the final consumer. As a result, implementation of VAT, at least in the early stages, directly leads to a leap in the price of goods and services that are taxed.
Also, the implementation of the value added tax affects the general level of prices indirectly by affecting determining factors of inflation, such as liquidity, expectations and production costs. Experiences of different countries in controlling inflationary effects of VAT show that there are two issues in this regard. The first is which tax does VAT replace? (Which taxes have been eliminated) and the second is the country’s monetary situation (Tait, 1988). If the value added tax replaces one or more direct and indirect taxes, it does not impose a severe pressure on prices because the amount of tax received from the goods does not change much, and only the types of taxes and taxation methods change.
The study of other countries’ experiences shows that if inflation control is one of the main goals of monetary and credit policies and that the government in monetary and financial policies takes into account the issue of inflation, then the implementation of the VAT system along with the inflation controlling short-run policies can be made without a sharp increase in prices (Naderan & Ranjabarkey, 2008).
In order to test the hypothesis that VAT has a positive and significant effect on inflation in Iran's provinces, we use provinces variables such as inflation, effective rate of VAT, unemployment rate, current and construction, local government size, oil and without oil production per capita, and the ratio of deposits to production from 2008 to 2013. The Econometric hypothesis testing method is a multivariate regression analysis with panel data.
Findings: The findings show that there is a positive and significant relationship between unemployment rate and provinces’ inflation, which shows the stagflation in Iran's economy Moreover, the current size of the government has a positive effect on inflation, since an increase in government spending will lead to an increase in the budget deficit, public sector debt will increase, and will lead to an increase in the supply of money. Given the positive relationship between the general level of prices and liquidity, raising the money supply will lead to an increase in the general level of prices. Whatever the state budget allocates to development expenditures and government development expenditures by improving production and strengthening the supply side will cause macroeconomic surpluses and will reduce inflation. Since VAT affects the sale price of final goods, it is likely that sellers will conceive of increasing production costs and transfer tax burden to consumers. On the other hand, some manufacturers of goods that are not subject to VAT imagine that the tax on their goods and services will also apply and increase the price of their goods. Therefore, the findings show that there is a positive and significant relationship between the value added tax and inflation in the provinces of the country. The high ratio of deposits to production in the in the ceteris paribus situation indicates that people prefer to hold liquidity in banks. This liquidity will be driven by investment in the supply of various sectors of the economy and will reduce inflation. An increase in domestic production of oil will lead to an increase in the supply of foreign currency and, subsequently, a decline in the exchange rate. Due to the negative relationship between the exchange rate and the rate of inflation, the exchange rate cuts have led to an increase in inflation, and the negative relationship between oil production and inflation is justified. Also, the findings show that there is a positive and significant relationship between the oil-free domestic production and inflation in different provinces.
Conclusions and Suggestions: In this study, the inflationary effects of VAT were investigated using multivariate regression in panel data. For this purpose, after collecting provincial data, the inflation effect of VAT in a model with dependent variable of price level growth rate along with the major variables affecting inflation was measured. Given the positive impact of VAT on inflation, it is recommended that the government initially takes caution in increasing the VAT rate, and secondly, pay closer attention to direct taxes and alternative VAT taxes that have high incomes and low inflationary effect.