Slovakia saw substantial changes in tax policies in 2025. What will be the effect of these changes on investment activity by the private sector? This blog suggests that a rise in VAT may reduce the expected return on investment of planned projects. Taking into account also the recent increase in corporate income tax for “larger” companies, I conclude that the tax policy changes enacted in 2025 could lead to a reduction in investment and growth in the coming years.
An analyst working with an Excel spreadsheet outlining an investment project will typically aim to calculate the rate of return on investment. He will look at estimates of the necessary investments, including a value-added tax (VAT) charged on the project’s procured investment. The analyst will also scrutinize the revenue streams that the project would generate and all costs incurred. Again, VAT would also be taken into consideration. Interestingly, the analyst will likely quickly realize something that might have important implications. An increase in VAT rate in the economy seems to reduce the project’s rate of return on invested capital (ROIC).
VAT rise could affect ROIC
Why is it so? While there are various ways to gauge the profitability of projects, many analysts may use ROIC framework. Let us break down the ROIC ratio, defined as a net operating profit divided by the invested capital, into the numerator and denominator. Speaking of the numerator of the ROIC, if the company does not increase its prices but its margin absorbs the VAT increase, the numerator will decrease because the rise in the VAT rate reduces the profit in years ahead. At the other extreme, if the company passes the VAT rise fully onto consumers and raises consumer prices, the sales volume will likely decline due to a lower quantity demanded, leading again to a reduction of the ex-VAT revenues. At both extremes, the VAT rate rise should reduce the numerator, with intermediate cases likely to have the same effect.
Looking at the denominator, although one can claim a credit for VAT paid on the project’s investment costs, the VAT credit is typically not paid back instantly but only over time. Since we know that money has a time value, this results in a loss, or the denominator of the ROIC becomes effectively slightly higher. The higher the VAT rate, the higher the loss. When a numerator and denominator are combined, the rise in the VAT rate seems to lead to somewhat lower ROIC.
This is particularly true in the case of a start-up, a new stand-alone FDI project, or any other investment undertaking where the higher VAT paid on the procured investment cannot be amortized within a larger concern’s accounting instantly. Companies that are not registered as VAT payers, typically small companies, might also be at a disadvantage.
In theory, VAT is not meant to be a permanent cost for most businesses, because they can usually deduct VAT they have paid. What matters here , however, is that higher VAT can temporarily tie up more cash and weaken demand, so that projects earn a lower effective return than before.
From projects to aggregate investment
Can any of this be interesting from a macroeconomic viewpoint? In my opinion, it might be.
In a typical economy, investors consider thousands of potential investment projects each year and usually have a threshold ROIC in mind when conducting their internal calculations. Even a slight reduction in ROICs due to an increase in VAT may mean that some projects fall below the threshold and are not undertaken. Conversely, a drop in the VAT rate in a sector or across the whole economy may trigger additional investment. This is an interesting fact because economists usually worship indirect taxation vis-à-vis direct taxes for its less detrimental effect on long-term economic growth. Overall, they are probably right in that conclusion, but a higher VAT rate may still somewhat adversely affect investment in an economy. And as we know, in the long run, an economy’s growth rate depends heavily on investment.
Will recent tax changes depress private investments?
This might be worth noting, given the recent changes in the VAT rates in Slovakia. Enough has been written about last year’s fiscal consolidation efforts – they place too much emphasis on revenues rather than on cutting expenditures. However, one thing was perhaps overlooked. It seems that the massive increase in VAT (by 3 % points to 23%) might have an additional effect on the economy: a slowdown in private investment. If one adds a substantial increase in the corporate income tax rate for companies with profits over EUR 5 million (increased from 21% to 24%), we could expect an adverse effect of the policy changes on private-sector investment in the coming years. Needless to say, a lower investment than in the absence of the tax policy changes will most likely translate into somewhat lower economic growth in the years ahead. Perhaps, an exception might be the hospitality sector, which saw a sharp drop in the applicable VAT rate (to 5%), and many firms in that sector may qualify for the favorable income tax treatment designed for micro companies.
Policymakers and economic forecasters alike should take heed and expect these tax policy changes to affect private-sector investment activity. Since investments are planned in advance and are likely to have an implementation time lag, the effects of these changes might become fully visible in 2026 and in the coming years.
Vladimír Zlacký, LookingEast.eu