One rate, no exemptions, and immediate rebates for qualifying individuals at the time of purchase: this is a proposal for addressing the real or perceived regressivity of VAT without significantly compromising tax revenues.
In their recent paper ‘Designing a progressive VAT’, Rita de la Feria from the University of Leeds and Artur Swistak from the International Monetary Fund challenge the effectiveness of the traditional approach to fighting regressivity through exclusions from the VAT base by way of exemptions, zero or reduced rates of selected goods and services, typical of the EU and UK VAT systems.
‘Customers are ready for the progressive VAT approach but not all tax administrations are there yet’
They define their approach as ‘novel’. ‘You can achieve some progressivity in VAT with the traditional approach – for example, by zero-rating essential food items – but at a huge cost to the Revenue, and most of the benefit often goes to people who need them the least,’ says Swistak.
Real-time revolution
Technology could be used to enable those who need financial support, such as lower income individuals, to pay zero VAT rate at the point of purchasing retail products or services. Everybody by default would pay the universal rate of VAT applicable at the time, with subsidies in the form of automated, instant reimbursement to the bank accounts or digital wallets of those recognised as qualifying for VAT rebates (subject to a ceiling to prevent abuses).
‘Our idea came from seeing how real-time technology has been used in countries such as Portugal for anti-fraud purposes,’ says de la Feria. ‘Tax information is collected directly from the purchasing points. By modifying the objectives of this technology, we believe you can introduce progressivity in the VAT system.’
Although this sounds an appealing way for governments around the world to strike a better balance between raising tax revenues and finding a progressive distribution of benefits, it would all depend on tax authorities’ digital capabilities.
‘Any member state can already get rid of all the reduced and zero rates and still be compliant’
‘Customers are ready for the progressive VAT approach pretty much everywhere,’ says Swistak, ‘but not all tax administrations are there yet. Although only a handful of countries have the technology to enable our approach, many are working hard to get there, and there are promising signs that they can do so in the near future.
‘I am hopeful that in a few years from now a large number of countries will have real-time technology in place to enable a progressive VAT.’
Legislative change
Legislative changes would also be needed to create a VAT system with only one rate, no zero-rated goods or services, and no or a very limited pool of exemptions.
However, de la Feria explains that in Europe only one article of the EU VAT directive would need to be amended: article 132, which prescribes exemptions from VAT for supplies of medical, education, sports activities and postal services, among others.
‘But you can still leave all the exemptions and implement the rest of our progressive VAT proposal in one or all member states without changing the EU VAT Directive,’ says de la Feria. ‘Any member state can already get rid of all the reduced and zero rates and still be compliant.’
‘Simply removing the zero rate would already be transformational’
One of the non-EU countries that still makes significant use of the zero rate of VAT for equity purposes is the UK, with a considerable impact on tax revenues as a consequence.
‘Leaving all the exemptions in the UK VAT system and simply removing the zero rate would already be transformational for the UK,’ says de la Feria.
Another selling point of de la Feria and Swistak’s proposed approach could be the simplification of the VAT system. Having one rate applicable across the board would mean that time-consuming and expensive legal disputes on the VAT status of, say, food items (see a previous AB article) would be a thing of the past.
It would also allow tax advisers to focus on the real value- add for clients: taxation issues around complex supply chains and cross-border transactions.
