The livestock sector plays a significant role in Georgian agriculture, accounting for more than half of the total output. Although livestock farming is spread throughout the country, agriculture is dominated by livestock in the mountains, which cover over 50% of Georgian territory. The livestock sector contributed to around 4% of the country’s overall GDP in 2018, and dairy production remains one of the most traditional Georgian agricultural sub-sectors.

Though the demand for milk and dairy products has maintained an increasing trend in Georgia, compared to the domestic production of milk, which has been decreasing over the last decade, the increasing shortage is often satisfied by imported milk powder, milk cream (e.g. butter), and other dairy products. As a result, the milk and dairy self-sufficiency ratio has been constantly decreasing over the past decade; it amounted to 81% in 2018 compared to 92% in 2009. Moreover, increased demand for live animals on export markets has stimulated a decrease in the number of cows and has, thus, reduced the country’s milk production.

With the intention of strengthening the dairy sector by increasing demand for domestic raw milk, dairy associations via the Ministry of Finance initiated a draft law in which the entire supply chain of raw milk and raw milk products are to be exempt from VAT. Currently, the VAT exemption only applies to primary production of raw milk, raw milk which is bottled in volumes over two litres, and to cheese that is produced from domestic raw milk. The objective of the draft law is to support local milk and dairy production through the VAT exemption of milk and lactic acid products created from domestic raw milk.

The main goal of the study is to estimate the potential impacts of VAT exemption for increasing competitiveness in the Georgian dairy sector. The study produced qualitative and quantitative research to provide a financial and fiscal analysis of the costs and benefits of VAT exemption in the domestic milk sector under various VAT-related scenarios.

According to the estimation results, the demand elasticity for dairy products is -0.30, while supply elasticity is 0.69. Thus, both demand and supply are inelastic as the elasticity coefficients are less than one in absolute value. The inelastic demand and supply each imply that the deadweight loss of tax is small, therefore a tax cut would result in relatively little relief for society.

Within the raw milk market, the elasticity of demand for raw milk is -0.06, while the elasticity of supply is 0.16. As both elasticity coefficients are low, thus indicating an inelastic supply and demand for raw milk.

A joint solution through clearing squared excess supply on the two markets leads to the conclusion that if dairy products are exempt from VAT both the demand and supply of dairy products would increase by 3.4%, while the price of dairy products would decrease by 11.0%. On the other hand, VAT exemption is projected to increase raw milk prices by 6.7%, leading to a 1% increase in demand and supply of domestic raw milk.