Restaurant VAT cut: Cheaper meal and more service?

This paper provides causally plausible estimates of the effects of consumption taxes in a service sector on prices and demand for restaurant services. We utilize a large VAT reform affecting restaurant meals, where the VAT rate was cut from 22% to 13% in 2010 in Finland. By comparing with restaurants in neighboring countries and other related sectors in Finland, the reform offers a natural experimental approach. The results indicate that restaurants reduced their prices on average by only 2%, which equals roughly a quarter of the full pass-through. Remarkably, at the same time a majority of restaurants did not reduce their prices at all and a non-trivial fraction of restaurants reduced their prices by exactly the full pass-through. Larger restaurants reduced their prices more often than smaller restaurants. We do not observe any increases in the quantity of services sold or in wage sums paid to employees. Furthermore, there are no changes in mediumterm entry and exit due to the reform.