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2016-05-19 11:11:54
Reforms to VAT may lead to a more democratic but convoluted system
May 14th 2016
IN THE battle to smash the patriarchy, feminist campaigners have found an unlikely ally: the European Commission. Their gripe is with the tampon tax, the minimum 5% rate of value-added tax (VAT) on sanitary products imposed by European law. This is tantamount, in their eyes, to a tax on women and worse, one which European governments have no power to undo. But new proposals on VAT reform from the commission may change that.
The European Union has no authority over income and payroll taxes, but great authority over VAT. Members must apply a standard VAT rate of no less than 15%; they can have up to two concessionary rates, of at least 5%, but these can only be applied to certain goods, including food, books and medical equipment. There are numerous exceptions to these rules (Ireland exempts tampons from all VAT, for instance), but they were negotiated by the countries concerned upon joining the EU.
This system of centrally imposed exceptions is an odd compromise between two sensible but incompatible goals. It is not very flexible or democratic, as governments have only limited scope to modify the system. But it is not simple or coherent either: rates on a single item can vary wildly (see chart). Moreover, the past 40 years have seen 750 court decisions interpreting VAT law. Surely the European Court of Justice has better things to do than mull Poland s refusal to levy VAT on disinfectants or France s low rate on early performances at theatres with bars?
The effort to minimise the variation in rates stems from a time when VAT was charged according to the rate in a product s country of origin, rather than where it was bought. The commission did not want countries to give their manufacturers a leg-up (or to poach firms from other members) by setting lower VAT rates on their wares. But since it is now the VAT rate in the purchaser s country that applies, there is no longer any risk of that. Consumers, after all, are relatively immobile, despite the odd cross-border shopping trip.
The commission has proposed two options for reform, both of which hand more VAT-setting power to national governments. The first would maintain a central list of items on which reduced rates are allowed, but expand it and review it more often. It would also rationalise the rules, by letting any country charge the lowest rate on a given item that applies anywhere else in the EU. Britain, for example, could exempt tampons from VAT, as Ireland does.
The second option is more radical: it would scrap the list, and transfer VAT-setting powers to national governments. There would be limits if countries started applying sweeping carve-outs in an effort to entice shoppers over the border, the commission might intervene but otherwise countries would be free to adopt as many rates and exemptions as they liked.
No country currently applies the minimum 15% standard rate (the average is 21%), so it seems unlikely that governments would take the opportunity to lower rates across the board. Rather, they would probably tinker: since the crisis there has been an increase in the number of countries using two reduced rates, from 14 out of 28 in 2007 to 19 this year. Analysis from the Centre for Social and Economic Research found that in 2013 countries sacrificed a median of 11.3% of potential VAT revenue via reduced rates. If the current restrictions were lifted, discounts and exemptions would presumably proliferate, to the delight of special interests.
Although such concessions may be good politics, they are sloppy economics. The more exemptions there are, the higher the standard rate has to be to raise the same amount of revenue. Different rates also distort people s spending, penalising some industries and rewarding others. It is an inefficient way to redistribute: when Sir James Mirrlees, a Nobel-prize-winning economist, reviewed Britain s tax system, he found that the government could scrap all concessionary rates, compensate the losers and still bring in 3 billion ($4.8 billion) more.
Grzegorz Poniatowski, an economist, notes that a proliferation of reduced rates provides more scope for tax dodging by misclassifying products as low-rate items. For Patrick Gibbels of the European Small Business Alliance, there is too much fragmentation. Encouraging a multitude of different systems could create an administrative burden, which would be particularly onerous for small businesses of the sort that Europeans are keen to cultivate. He prefers the first, more cautious option.
But Pierre Moscovici, the commissioner in charge of VAT, prefers the more radical option. Even if governments do not use the extra freedom wisely, there is a case for letting them make their own mistakes.