Impacts of Differentiated VAT Rates

Impacts of Differentiated VAT Rates

April 13, 2015

Having agreed in February 2006 to prolong the experiment with reduced VAT rates on labour intensive services, the ECOFIN Council invited the Commission to provide a report on the impact of reduced rates on job creation, economic growth and the internal market. The report was to be built upon a study carried out by an independent consultancy. Copenhagen Economics was selected to carry out the study.

At a press conference on Thursday, July 5, 2007, Commissioner Laszlo Kovacs unravelled the results of our study to the public in the form of a Communication, which calls for a broad debate to raise the awareness across the member states of the costs and merits of selective VAT reductions they choose to implement.

Based upon new empirical evidence, model simulations, theory and country experiences, the study concludes:

  • There are strong general arguments for having just one VAT rate per member state. A single rate can improve economic efficiency, reduce compliance costs and smooth the functioning of the internal market.
  • However, we agree that reduced rates in selective cases may have merit. It can (1) increase efficiency by increasing productivity or by reducing structural unemployment and/or (2) enhance equity by improving the income distribution or by making particular products more accessible to the entire population.
  • We largely conclude that in the areas where efficiency or equity can be improved in a cost effective manner by way of reduced rates, adverse internal market effects such as distorted competition across borders are for the most part insignificant. In contrast, we define a number of other areas where reduced rates are detrimental to the internal market without having strong positive impacts on national objectives. 
  • Finally, we underline that targeted direct budget subsidies can often achieve better results at lower costs than reduced VAT rates, which should be factored into discussions on the use of reduced VAT rates.

Throughout the study, we propose some practical guidelines and tests that can be used to translate these conclusions into actual policy making including the balance between national and community objectives.

Read the Commission’s communication here

Read the full report here

For further information please contact Helge Sigurd Næss-Schmidt or Christian Jervelund