« John McCain Interview | Main | But Words Will Never Hurt Me? »

Tuesday, June 20, 2006

Problems with the Value-Added Tax in Europe

Conservative columnist Bruce Bartlett and others have pushed hard for the imposition of a Value-Added Tax in the U.S. to replace other federal taxes. My own reaction has been:

VATs are  regressive, but they're an important source of revenue for highly progressive tax-and-transfer systems, so their characteristics depend upon the details of the implementation. However, one thing I do know, making estate tax repeal permanent while introducing a VAT would be a nasty case of bait and switch...

In supporting the VAT, Bartlett argues:

This is the best strategy tax economists have ever devised for raising revenue without investing a lot in enforcement and economic incentives. The V.A.T. is a kind of sales tax embedded in the price of goods. ... [T]he tax is largely self-enforcing. And because the tax is applied only to consumption, its impact on incentives is minimal. ...

But is it self-enforcing? Since VATs continue to enter policy discussions, knowledge of how they've worked in countries that have used them can be helpful. According to this analysis in the Financial Times there are two main problems with the VAT in Europe where it has been widely adopted, fraud and complexity:

Evasion and exemptions erode VAT’s own value added, Financial Times: In half a century, value added tax has taken the world by storm... But despite its reach, some are ready to declare it an idea whose time has gone.

VAT fraud has become pervasive and, at least in Europe, the tax is at a watershed. Can it survive in its current form? ...[I]t is in Europe that the weaknesses are at their most glaring. This month the European Commission launched an “in-depth debate” on whether VAT should be modified. Chas Roy-Chowdhury of the Association of Chartered Certified Accountants says: “I think the writing is on the wall for the VAT system.”

European VAT is in a mess for two main reasons: its vulnerability to fraud and its complexity. Fraud, evasion and avoidance cost at least one in every 10 euros of the tax collected – roughly double that in other industrialised countries... VAT abuse takes many forms – most commonly the reluctance of traders in the black economy to have anything to do with the tax. But the biggest headache is sophisticated fraud. ...

The problem lies largely in the refund process... VAT is normally self-policing: everyone in the supply chain has an incentive to act as tax-collectors as they offset the VAT they pay their suppliers against the VAT they charge their customers. But in some circumstances, notably when exporting goods – which are VAT-free under nearly all national systems – businesses can claim refunds. ... This fraud ... has forced governments to consider drastic remedies. ... Germany and Austria are pressing for a “reverse charge” mechanism that would in effect turn VAT into a hybrid sales tax.

As well as the administrative hassles faced by exporters, businesses are often left paying big VAT bills as a result of governments’ desire to exempt certain types of goods and services, such as education, from the tax. Some critics argue that governments should reduce, if not eliminate, exemptions and reductions. ...

And Germany is pressing hard for action. From a June 8 Financial Times report:

Germany blocks EU deal on e-commerce services, by By George Parker and Vanessa Houlder, Financial Times: Germany yesterday claimed at a monthly Ecofin council of European Union finance ministers that value added tax fraud was costing it €17bn-€18bn a year and demanded that it be allowed to change its tax rules to tackle the problem.

Peer Steinbrück, German finance minister, blocked a separate agreement on the taxation of e-commerce services, indicating he would not budge until Berlin won permission to adopt measures to tackle VAT fraud.

Germany and Austria, the current holder of the EU presidency, want to make wide use of so-called "reverse" charging of VAT, a mechanism for accounting for VAT that denies a fraudulent supplier the opportunity to pocket the tax.

Although Laszlo Kovacs, the EU tax commissioner, is sceptical about whether the system is effective in beating fraud, he was asked to draft legislation that would give the countries the option to use reverse charging. ...

For a tax sold as "largely self-enforcing," the finding that fraud, evasion and avoidance result in lost tax collections that are "roughly double that in other industrialised countries" is notable. And repeating from above, if Germany and Austria prevail in their reform efforts, the ""reverse charge" mechanism ... would in effect turn VAT into a hybrid sales tax."

    Posted by on Tuesday, June 20, 2006 at 09:54 AM in Economics, Policy, Politics, Taxes | Permalink  TrackBack (0)  Comments (15)


    TrackBack URL for this entry:

    Listed below are links to weblogs that reference Problems with the Value-Added Tax in Europe:


    Feed You can follow this conversation by subscribing to the comment feed for this post.