The VAT base and VAT rates - A contribution to the EU VAT Action Plan

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TAXATION On the 7 of April 2016 the European Commission adopted the Action Plan on VAT - Towards a single EU VAT area. As a part of the action plan the Commission will present a proposal on VAT rates, with the aim of giving member states more freedom in this area. From a Swedish perspective this is the perfect time to further analyse and discuss how we want the VAT rules to be designed in the future.

The purpose of this report is to widen the Swedish debate. Today it is a one-sided discussion focusing on a single VAT rate applied on current tax base. A broader discussion covering the size of the VAT base, effects of exemptions, blocked input tax and cumulative effects, is needed. This report is limited to different aspects on VAT. General fiscal matters are only touched upon by way of exception.

VAT is a tax on consumption, paid by the final consumer. Member states don’t receive the VAT directly from the consumer, but from companies acting as unpaid tax-collectors. The OECD, IMF and EU-Commission do all point out the advantage of a broad VAT base. According to EU-calculations only 52 percent of the Swedish VAT base is taxed, which is somewhat lower than the EU-average of 56 percent. New Zealand is often referred to as a comparison with a VAT base of 96 percent and a lower VAT rate (15 percent) than the EU-average (21,5 percent). Several countries outside the EU are currently implementing VAT with a broad tax base, e.g. China and the Gulf states.

Almost half the Swedish VAT base consists of exempt transactions (40 percent) and reduced rates (8 percent). Exempt transactions are often referred to as free of VAT, which is misleading, as they are loaded with blocked input VAT leading to cumulative effects. This hidden cost of VAT entails several problems in society, such as that kindergarten and eldercare has problem finding facilities, self-supplies are encourage over outsourcing and investments are postponed. The consumer is also affected by hidden double taxation or that some transactions do not take place at all. This in turn does hinder growth and community development. The current VAT rules are not in line with the fundamental principles, purpose and the intention of VAT. The VAT-system should be a simple and general consumption tax with few exemptions and which is neutral and economically efficient.  

The VAT legislation is complicated and at the top when measuring regulatory and administrative burden. Difficulties to apply the rules affects both businesses, tax authorities and courts. Even if defining boundaries between different VAT rates can be difficult the problems are even greater with exempt transactions. This is because exemptions results in input VAT that cannot be deducted and blocked input tax occurs. Despite the above, VAT is not analysed and discussed on the same general level as other tax rules. The complexity of the legislation makes it impossible to overview.

Looking just at VAT, instead of the current standard VAT rate of 25 percent a broadening of the VAT base could mean a standard tax rate between 13,3-20,8 percent depending on the extent of the VAT base. Alternative can be e.g. a transition from social exemptions to social VAT rates. Looking at the whole tax system a broadened VAT base would create the possibility for other much needed actions, such as lower marginal tax rate and lower tax on capital. This is however not discussed in the current report.

From a Swedish perspective there is a need for an analysis and discussion on how the rules should be designed. There are problems with complex rules, blocked input tax and cumulative effects. A broader VAT base can be part of the solution to these problems. It is essential that the rules are enhanced and simplified in accordance with the original aim to create a simple, neutral consumption tax with minimal impact on growth.

The Commissions’ topic on the presented action plan is “Towards a single EU VAT Area – Time to decide”. For Sweden it is essential to sort out how the VAT system should be designed now that the proposals will be discussed and decided on EU-level. Our most important challenges and top priorities for changes of the Directive need to be identified. It is time that we analyse and discuss VAT from a wider perspective than before and that our opinions are presented at EU-level. Otherwise other countries will decide for us.

Please find enclosed the report (in Swedish) and a link to the public consultation on reform on VAT rates.

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