Effects of VAT-exemption for financial services in Sweden

The financial crisis has triggered a renewed interest in the taxation of the financial sector. In Sweden, it has led to the establishment of a government committee that is to review possible implications and tax revenues related to the VAT exemption. On this background, Svenska Bankföreningen (Swedish Bankers’ Association) has asked Copenhagen Economics to review who actually gains from the tax exemption and identify the consequences of this exemption.

In the paper, we address how the current VAT exempt system has negative distortional effects on the Swedish economy.

• First, it drives a tax wedge increasing the cost of financial services for enterprises – especially small local business – while decreasing the cost of financial services for consumers. Hereby the relative prices diverge from relative costs, with large negative economic impacts. The effect through the consumer market dominates and, in isolation, the VAT exemption may lead to a higher demand for financial services in Sweden in the order of around 7 per cent.
• Secondly, Swedish financial institutions has distorted incentives to insource too many functions in their value chain (IT etc.), and they have a competitive disadvantages in relation to financial companies in countries with a lower VAT rates as well as non-financial firms providing financial services.
• Finally, the exemption leads to a tax revenue loss of 16-18 billion SEK, i.e. the under-taxation of private consumers is higher than the over-taxation of enterprises. However, this tax loss must not be confused with a tax advantage for the financial sector. In line with other reviews, we expect that the lower/higher costs for financial services are passed on to consumers in the form of lower/higher prices with the caveat about international competition in financial services.

The study is commissioned by Svenska Bankforeningen