The Lithuanian Free Market Institute has submitted a response to the European Commission’s Consultation paper “Review of existing VAT legislation on public bodies and tax exemptions in the public interest.”
Q3. Reform measures
Of the five options presented by the European Commission, the first one – the Full Taxation Model – is considered to be the most comprehensive, eliminating all competition distortions that currently arise when certain public bodies do not pay VAT.
However, its foremost flaw is that this option would increase the tax burden on European taxpayers. The European Union is the highest tax-paying area in the world. According to the 2013 edition of the European Commission’s “Taxation Trends in the European Union”, the overall tax ratio in the EU stood at 38.8% of GDP in 2011, compared to 25.2% in the US and 28.7% in Japan. The high tax burden hurts European consumers and undermines the region’s competitiveness. The consultation paper cautiously mentions that the implementation of the Full Taxation Model could coincide with a cut in the standard VAT rate. However, a reduction of the standard rate is by no means guaranteed and even if it is materialized, it might not be large enough to compensate for the tax increase resulting from the full taxation of services performed by public bodies.
The second option – a Refund system – would be flawed. The European Commission provides no justification why this system would be applicable only to public bodies. The arguments in favour of this system also hold for non-profit institutions such as charities, associations, quasi-governmental or non-governmental organizations. These organizations could also outsource their non-core activities, but the current VAT rules make this less attractive. Thus, the Refund system would be an unjust and groundless mechanism that would increase privileges awarded to the public sector. Also, this mechanism would not eliminate the output distortions that the European Commission has highlighted.
The third option – deleting of Article 13 while keeping the tax exemptions in the public interest – also raises doubts. First, this option would keep input side distortions intact. Second, it would increase the tax burden on European taxpayers, which is not a desirable option.
The fourth and fifth options – Sectorial reform or selective amendments of the current rules – would also be only partial solutions to the problems addressed by the European Commission. They would not solve input side distortions and would increase the tax burden.
The European Commission’s consultation paper does not contemplate yet another option, namely replacing VAT with a sales tax. This is a comprehensive option that would reduce existing competition distortions and offer the following benefits and advantages:
It would significantly reduce compliance costs on businesses and administrative costs for the tax administrators.
VAT is one of the most difficult taxes to administer and comply with. In terms of VAT administration for public bodies, the tax administrators do not have an established uniform position, so their decisions vary case by case even in the same tax jurisdiction. For example, in Lithuania there are instances when public bodies register as VAT payers in order to avoid disputes with the tax administrator. This is just one of many examples showing that the administration of this tax is onerous and incoherent.
Admittedly, the administrative costs as a percentage of the revenue yield are small. However, this is due to a large revenue yield rather than easy administration. The replacement of VAT with a sales tax would benefit small businesses the most, given that small businesses carry a disproportionately heavier burden than larger businesses.
Reveal the real tax burden on European consumers.
Currently, European taxpayers are unaware of the actual amount of VAT they pay on their consumption. Since a sales tax is levied at the point of purchase and it is not included in the price tags on the store shelves, the sales tax makes taxpayers aware of how much consumption is taxed. A transparent tax system is desirable both from the standpoint of the taxpayers and the state, as the taxpayers become aware of the taxes they pay and exert a pressure on the state to receive services that are worth what they have paid in taxes.
We therefore recommend replacing the current VAT system with a sales tax levied at the point of purchase. The sale of raw materials and resold items would be exempt from the tax, ensuring that the tax is paid by the end consumer rather than at all stages of production.