Within Europe differentiated rates structures date back to the introduction of VAT itself. Although evidence as regards potential negative consequences of applying multiple rates was largely unavailable at that time, difficulties have been apparent for some decades. In light of this reality, since the late 1980s, there have been several attempts to amend European rates structures under the political guidance of the European Commission. There has however been surprising resistance by Member States to any proposed amendments which might lead to a reduced rate differentiation – thus giving weight to the intuition that once reduced rates of VAT are introduced it is almost politically impossible to remove then. Indeed the most recent agreed upon amendments to the rates structure have increased the level of differentiation, rather than decreased it, with more goods and services being subject to reduced rates in Europe today than even as recently as ten years ago (see Council Directive 2009/47/EC of 5 May 2009).
Yet this reality has changed in the last few years as a result of the economic and financial crisis which has fallen upon Europe. Since 2009 twenty-five of the thirty-three OECD countries have increased their VAT rates, resulting in a broad convergence of VAT standard rates across the EU around the 20% mark. Furthermore, there has also been a decrease in levels of differentiation with a reduction in number of VAT rates applicable in many Member States, as well as various base broadening measures. Clearly keen to harness the political momentum, the European Commission listed review of the rate structure as a priority area in its 2011 Communication on the Future of VAT. A year later it launched a public consultation on the review of EU VAT rates, which as opposed to previous initiatives that were broad in their scope, was targeted, concentrating on specific sectors of the economy.
Given its limited scope, whether the latest European Commission’s initiative gathers the necessary support or not, it is clear that only limited improvements to the structure can be achieved. Therefore, if significant gains are to be achieved, they must come through a different route; and if the political momentum is to be seized, it is necessary to think outside the box. In this context, would it be possible to have significantly improved, converging, European VAT rate structures, through national, uncoordinated, action? The answer is yes. So, what would be suitable criteria for better, more efficient, more neutral, European VAT rate structures? Taking into consideration both budgetary, as well as legal limitations (see full paper), four criteria are proposed:
Criterion 1: Elimination of application of reduced rates of VAT, where the rationale for its application is the creation of positive externalities and/or correction of externalities (e.g. books, environmentally friendly products, etc).
Criterion 2: Maintaining the application of reduced rates of VAT where the rationale for is application is vertical equity (e.g. food, medication).
Criterion 3: Maintaining the application of reduced rates of VAT where its elimination would have a serious impact on industries which are either labour-intensive or key for economic recovery (e.g. tourism).
Criterion 4: Rationalisation of categories of goods and services to which reduced rates of VAT apply, by eliminating distinctions within categories.
The criteria proposed for reform of national VAT rate structures will not result in the best VAT possible, but rather in the best VAT Member States can possible have given the circumstances. A broader-based VAT, which will result in increased revenue, decreased administrative and compliance costs, and less susceptibility to fraud, avoidance and planning; overall a more efficient, more neutral VAT. In the process the holy grail of EU VAT might be finally attained: decreased divergence and even approximation of VAT rates structures across the EU. Not through a process of EU harmonisation, but instead through a process of natural convergence of national VAT policies – a rare case of significant gain, with limited pain.
Prof. Rita de la Feira,
Durham Law School
Based on presentation given to European Law Academy, Trier, 29/11/13