The rapid rise in the cost of living is pushing politicians to look for solutions to improve people's livelihoods. One proposal from Estonian retailers has been for the state to lower VAT on food. However, politicians are skeptical, arguing that it would not deliver the desired results and would only widen the state budget deficit.

Researchers have now reviewed existing academic literature examining the impact of lowering VAT on food. Luca Alfieri, a Research Fellow at School of Economics and Business Administration, University of Tartu, said understanding the existing literature is a necessary step before moving on to scenario analysis or simulations specifically focused on Estonia.

In the latest literature review, researchers examined data from 19 studies. The sample included Estonia, Latvia, Lithuania, Ireland and other small or medium-sized countries, with studies published from 2015–2025. The authors aimed to determine the actual extent of price reductions under different policy measures.

In short, the conclusion was that consumers rarely benefit from tax changes.

Anastasia Sinitsyna, a Research Fellow at the Asia Centre, University of Tartu, noted that people in smaller countries spend a larger share of their income on food than those in larger countries. Put simply, the average Estonian consumer spends a much larger portion of their income in grocery stores than the average German. Therefore, the debate on food taxation may be more important and sensitive in Estonia. In addition, small economies are more open to global markets.

"Sometimes this is beneficial, but it also means that local consumers are more affected by changes in global food prices. So they are under a kind of double pressure, and any VAT changes — especially on essential goods — should be planned very carefully," Sinitsyna said.

The reason a tax change would likely not produce the desired results in Estonia lies in the country's small economy. Alfieri explained that small open economies cannot influence international prices and are therefore more vulnerable to external shocks, which have shaken the world in recent years.

"In such a situation, maintaining sufficient fiscal space is essential. Changes in VAT or other taxes can affect government revenues, which means such decisions in small open economies require especially careful consideration," Alfieri said.

Prices did not fall in restaurants

Instead of increasing consumers' purchasing power, tax cuts often benefit businesses, especially in the food service sector. Data from Lithuania and Ireland showed restaurant prices sometimes did not fall at all following VAT reductions.

By contrast, for staple food products, researchers observed somewhat better price adjustments. The prices of bread, cereal products and milk in Poland responded more strongly to tax changes. However, achieving such results required a massive financial outlay from the state.

The situation is complicated by the limited fiscal capacity and narrow tax base of small countries. For example, Poland lost 8.5 billion zlotys — about €2 billion — in budget revenue due to a zero VAT rate on food products. For a smaller country, a similar cost would represent a heavy burden.

In addition to the financial loss, the policy also fails to meet its main social objective — redistribution of wealth. Lower-income households spend a larger share of their budgets on food, so in theory they should benefit the most from lower taxes. In practice, however, this potential gain is offset by uneven price reductions in stores.

Effects vary across countries

Data from European Union countries reveal large regional disparities in the policy's impact. In Estonia and Bulgaria, the financial benefit reaching consumers amounts to barely five percent from the taxpayer's perspective. Meanwhile, households in Portugal and Cyprus save as much as a quarter more in taxes. Each small country's market responds differently, depending on local competition.

At first glance, reducing taxes on essential goods may seem fair based on the literature, but in reality the benefits are distributed very unevenly across markets and tend to favor intermediaries. Cross-border shopping makes the system even more vulnerable, drawing money into cheaper neighboring countries.

Sinitsyna noted that people's expectations are very simplified: taxes go down, and prices immediately follow. Reality, however, is different. "There are several reasons why, based on other countries' experience, we do not see full pass-through," she said.

According to her, taxes alone do not determine the final consumer price in Estonia. Prices are also shaped by energy costs, storage, wages, rent, packaging, import costs and many other factors.

"If these costs are increasing, a tax reduction may simply be eaten up by these rising costs. And the final price of, let's say, milk will be the same or maybe even higher for the final consumer. It also does not mean that shops or retailers will get additional profit. I would say that this tax change is a good multi-solution and a nice way to support consumption, but I would rather say that it might work better in a more stable or predictable economic environment."  Sinitsyna said.

Alfieri added that it is overly simplistic to attribute unchanged prices solely to retailers' profit motives. The degree of pass-through depends largely on market structure and the level of competition, which vary across countries and product categories.

"To draw firm conclusions for Estonia, further studies and simulations would be needed," Alfieri said.

Possible policy measures

Alfieri noted the review highlights alternative policy measures for Estonia, such as targeted low-income financial support, food assistance programs or healthy product subsidies, which may prove more effective than lowering VAT.

"Each of these can help address affordability without necessarily relying on price reductions that may not fully materialize at the consumer level. That said, further analysis and simulations of the Estonian case specifically would be valuable before drawing strong policy conclusions," Alfieri said.

In light of these findings, researchers recommend that governments refrain from broad-based tax cuts. The revenue lost to the state budget could instead fund much more targeted social measures. For example, direct support for low-income families would likely be more effective, as would food assistance programs.

Although a general reduction in VAT on food does not achieve its intended goal according to the analysis, researchers see potential in the healthcare domain. Differentiated tax rates can help steer consumption habits and promote public health. Taxing saturated fats and subsidizing the purchase of fruits and vegetables could bring multiple societal benefits. Studies show that such measures lead to noticeable changes in dietary patterns.

Models by Swedish researchers further predict that if healthy food becomes cheaper, people also live longer in good health. A fat tax combined with lower VAT on fruits and vegetables could prevent more than 2,000 diet-related deaths annually in Sweden. Such measures would also reduce agricultural pollution and greenhouse gas emissions. Studies from the Netherlands likewise point to positive environmental effects.

Sinitsyna added that she travels frequently for her work and often asks people in other countries what they know about Estonia. "Of course, in the first place — e-governance; Estonia is widely recognised as a digital tiger. Secondly, Estonia is known for its science and data-driven policies. I believe that from our side, as researchers, it is our responsibility to deliver a scientific basis for policymakers' decisions, especially in such important social questions as VAT and food taxation."

The analysis is part of a project 'Promotion of the population's balanced diet' (Rahvastiku tasakaalustatud toitumise edendamine) financed by Estonian Research Council.

Link to the news story in Estonian, with a full list of publications reviewed.

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