Tax Planning International: can VAT rises defy inflation |
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Richard Asquith The plan was simple, if politically hazardous: a massive shift of the tax burden away from businesses onto the consumer. It was fundamental to European Union economies holding onto their competitive position as a location for international commerce, and fighting the tide of globalisation. The latest TMF EU VAT Tracker highlights this strategy, but also illustrates the fresh impact of resurgent inflation and recessionary threats. The Tracker calculates a GNP-weighted average for VAT amongst the European Union member states. In the past three years, the Tracker has shown an increase of the weighted EU VAT rate from 18.6 percent to 19.2 percent in 2007 – predicting a further rise to 19.9 percent in 2008. However, as Richard Asquith, who heads-up TMF VAT, explains, European VAT went into reverse with recent rises in inflation has now fallen back to 19 percent for the end of 2008. However, the Irish Ministry of Finance and others may now beg to differ as a new foe, recession, comes over the horizon. The build-up to European VAT increases Over the past 10 years, European economies were feeling the pain of losing manufacturing output to emerging markets. These new interlopers were offering more business-friendly tax regimes, making production costs appear high in the EU. Typically, this meant low corporate tax rates and light employment surcharges – often neatly packaged in simplified flat-rate tax systems. This tax mix was typically supported by the adoption of VAT (or its close relation, GST) systems to spread the burden on to the consumer. Many tax theorists opined that this was a healthy and motivating widening of the tax burden; European governments feared it was yet another way encourage their national companies to relocate jobs abroad. What became clear by the early 2000’s was that European states would have to follow suit to remain competitive in the now global job market. It was clear that business taxes had to fall, and that the consumer had to meet the bill. As a result, in the past five years it has become an article of faith amongst tax analysts, government officials and corporate executives that EU VAT was on the upward march. Leading this movement, the global financial organisations spread the gospel of indirect tax increases. It seemed the International Monetary Fund was dictating to countries that consumer taxes must be increased to pay for cuts in corporate taxes. CFO’s and FD’s around the region went on red-alert. Surveys and seminars poured forth on managing the new VAT changes and associated risks. VAT was voted the biggest worry for the world’s finance departments. The first major significant rise came from a surprising source. Never a fiscal reform leader, Swept to power in 2005 promising economic stimulus reform, Angela Merkel’s CDU party needed to shake up German business. Faced with its industrial heartland seeping away to At the end of 2006, a three percent increase in VAT to 19 percent was announced. This catapulted It seemed a big gamble for a country which was only just coming out of recession. Historically, the introduction of VAT regimes or big increases usually resulted in hefty increases in inflation. Many campaigned against the increase, warning that it would choke off the new found economic growth. At first, it seemed that the warnings had been prescient. In addition to the direct impact on prices, it quickly became clear that key economic indicators, such as new motor vehicle registrations, had fallen off alarmingly. However by mid-2007, the economy had shrugged off the VAT rise and regained its confidence. The Germans received huge plaudits from all corners for its achievement: redressing the fiscal imbalances to help guarantee the attractiveness of Form an orderly queue for VAT rises Buoyed by the German VAT success, many other countries, in dire need of a solution to their loss of global competitiveness, were eager to follow. Even Dutch courage took a grip by the end of 2007 when the
The mould was set for the VAT increase formula. Some of the major economies had shown their cards. Rumours swirled around other countries, such as The For the nearest thing to a scientific trial of the efficacy and side effects of VAT to solving direct tax objectives, In 2007, To make up for the cut in direct tax revenues, The results held some interesting lessons for its EU neighbours harbouring thoughts of VAT increases to subsidise corporation tax reductions. Firstly, the GST implementation went smoothly, with the expected proportionate lift in inflation. However, by April inflation had risen by seven percent, which begs the question: was the introduction of GST used as an excuse for a wider increase in prices by retailers? It mirrored the inflationary experiences of the introduction of the Euro in 2000, and the There is now a push to exempt a number of essential goods from GST to offset some of these side effects. Inflation’s back The scene had been set: everyone was braced for similar VAT rises across the EU. However, the old enemy, inflation, re-emerged to spoil the campaign. The explosive rises in food, oil and commodity prices burst upon the world economies as 2007 rolled on. Oil rocketed towards US$150 per barrel; grain and basic food ingredients price rises which had plagued the developing world for two years now spilled into European supermarkets. Inflation quickly picked up momentum to climb way in excess of central bank limits. Central banks quickly responded with interest rate increases in an attempt to cool off the economies. The surprise re-emergence of inflation meant VAT increases now came off the agenda. Dutch discourage European countries quickly went from “consultation” to procrastination to retreat. The most dramatic climb down came from the On top of these retreats, came the surprise Portuguese VAT rate cut from 21 percent to 20 percent in July 2008. This was seen as a popularist sop from a government facing re-election, and worried about its slowing economy. So, by mid-2008, inflation looked to have conquered the EU’s fiscal strategy. It would not be unreasonable to conclude that many countries had missed this opportunity to rebalance the tax mix in the good times. Now, faced with rising prices and slowing economies, this strategy seemed off-limits for the time being. European shivers spread to international VAT However, by the end of 2008, worldwide tax authorities were also feeling nervous about replicating plans to move to indirect tax for relief. The most prominent example was the UAE, which promised GST by 2009. This move was planned as the Fiscal deficit realities force EU VAT increases? Bringing the story up-to-date, what had seemed like a measured economic slow down is now rapidly escalating into full-blown recession across Whilst some European economies, such as Can you increase tax in a recession? Surely consumers cannot withstand a further blow to confidence. Many say no, but history tells it differently: in the EU VAT hikes are back On October 15, 2008, the Minister of Finance of Ireland announced a 0.5 percent increase in its standard VAT rate. This was part of a package of tax rate increases to meet a growing black hole in government finances. Richard Asquith heads-up TMF VAT services, which provides non-advisory compliance services. It is part of the TMF Group, which provides global independent management and accounting outsourcing (www.tmf-group.com). For further information, please contact Richard by email at: richard.asquith@tmf-group.com |
