Commission seeks unified VAT rates

EU Tax Commissioner Laszlo Kovacs has unveiled proposals to simplify tax rules and reduce the number of items that qualify for reduced rates across the 27-nation bloc. But his plans are likely to face opposition from a number of member states which are looking to use VAT cuts to promote family-friendly and job policies.

The Commission called, on 5 July 2007, for a “simplification and rationalisation” of European VAT rules, after an independent economic study showed that using a single uniform VAT rate – rather than the myriad of different ones currently applied – would improve consumer welfare, cut costs for businesses and reduce distortions in the internal market. 

The Commission proposal would nevertheless maintain the possibility of applying “a very low rate” for “goods and services of first necessity”, such as food. It would also allow a second reduced – but slightly higher – rate for “goods and services deserving preferential treatment for cultural, educational, public transport, employment and environmental reasons” – although it points out that, while the use of reduced rates can boost demand for such “under-consumed” products and services, other economic tools, such as direct subsidies, could be more efficient. 

The Commission is also proposing to extend current derogations – including those granted to the new member states, and which were due to expire next year at the latest – until the end of 2010 in order to ensure equal treatment between all the EU members. 

But finding an agreement on a new system will prove to be a tough job for Tax Commissioner Laszlo Kovacs. Indeed, any new scheme will require the unanimous agreement among all 27 member states. And, while some countries, like Germany, are firmly against introducing lower taxes for more industries, others, like France, Hungary, Poland, Spain and Portugal are seeking to extend lower tax rates to new sectors such as restaurants and diapers. 

"A new framework for reduced rates is needed, more rational, more transparent and more flexible for the member states," said EU Tax Commissioner Laszlo Kovacs, urging member states to come to a compromise. But he acknowledged that the Commission was in controversial territory: "The application of VAT reduced rates is a very sensitive issue in an area where the unanimity principle forces all stakeholders to be inclined to compromise." 

The UK government has already signalled it would veto any proposal to reduce the number of items excluded from VAT and those that qualify for lower rates. A spokesman for the new Chancellor of the Exchequer Alistair Darling said: "The UK's zero rates are worth over £28billion to UK households each year…We will not agree to proposals that would harm our social objectives or undermine the fairness of the UK VAT system." 

French finance minister Christine Lagarde welcomed the fact that the Commission was showing “openness” on the issue of applying reduced rates for restaurants, cafes and hotels – a move promised by new French President Nicolas Sarkozy. 

Hans-Werner Müller, Secretary General of UEAPME, the European craft and SME employers’ organisation, welcomed the Commission’s proposal to rationalise and simplify the use of VAT rates, saying: “Today’s communication highlights the need to streamline the current VAT rate structure, which is the product of endless political negotiations and patchy last-minute compromises rather than a consistent, logical and economics-based framework.” 

He also urged member states to make the application of reduced VAT rates in labour-intensive sectors permanent: “It is now time for the legal framework on this crucial issue to be made permanent. This would provide long-term regulatory certainty and boost businesses’ confidence. Reduced VAT rates in some key labour-intensive sectors such as construction have no real impact on cross border trade, but play an important role in domestic markets by protecting jobs and making undeclared work a less attractive option.” 

The European Builders Confederation (EBC) said that reduced VAT rates for certain locally-provided services can help to fight undeclared work and do-it-yourself activities, whilst increasing the use of the formal economy. “The more reduced the VAT rate, the greater is the effect of economic arbitrage between undeclared work or D-I-Y AND declared work, resulting in job creation in the construction sector,” said EBC President David Croft.

Nevertheless the EBC warned that, by proposing 2 levels of reduced VAT rates, the Commission was risking a return of “problematic and never-ending discussions”. 

Current EU rules on value-added tax specify that member states must subject supplies of goods and services to a rate of at least 15%. However, it also allows countries to apply reduced rates (never less than 5%) in a broad range of areas deemed essential, like medicines, or labour-intensive services, including renovation of private dwellings, cleaning and hairdressing (EURACTIV 27/07/06). 

This has led to a highly disparate and very complex VAT structure, with all 27 EU countries applying a multitude of individual exceptions. This not only complicates matters for businesses operating across borders, it also creates distortions in the internal market as shoppers head to neighbouring countries to benefit from lower rates, as is the case in Luxembourg with its low-price cigarettes and fuel. 

The current situation is also unjustifiably unfair on the new member states. Indeed, while it allows member states that joined the EU before 1995 (the EU-15) to maintain derogations until the adoption of a definitive VAT system, those granted to the new member states expire at the end of 2007 or in 2008. 

However, establishing a new system will not be easy as member states consider VAT to be a national matter and an important policy tool for promoting social objectives. 

  • End 2008-beginning 2009: The Commission could put forward a legislative proposal based on consultations with of member states, Parliament and the European Economic and Social Committee.
  • End 2010: Expiry date for the current VAT regime with a 15% minimum level and derogations for labour-intensive services.

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