VAT in Estonia rose to 24 percent in July. Why, then, are prices rising more than the forecast 1.6 percent?

First of all, tax increases are often used as a pretext. If a company's costs – such as for raw materials, labor, or transport – have been rising for some time, but prices haven't yet been adjusted, a VAT change is seen as a convenient point at which all previous cost increases can pass to final prices, all at once. In this way, prices get aligned with actual input costs, but communicatively this is done "on the tax hike's coat tails."

Secondly, psychology plays a role here. When consumers expect price increases, their price sensitivity temporarily decreases – but companies take advantage of this. When people are used to fearing price hikes, it becomes easier to "sell" this to them, allowing businesses the opportunity to improve profitability.

Thirdly, pricing hinges on competition. In highly competitive sectors, hiking prices is difficult; in such cases a business may prefer to "swallow" the VAT increase itself. However in low-competition or niche product areas, what counts is how much the customer is willing to pay – and prices are raised based on that estimate, and not merely by the tax increase amount.

It is important to understand that VAT is a consumption tax, the actual burden of which falls on the end consumer. Companies themselves pay VAT to the state only on the value they have added – they deduct the VAT they have already paid on their purchases. Therefore, it is not realistic to expect a one-to-one correspondence between price increases and tax increases – market logic, psychology, and business practice also play a role.

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