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Reforms could open door to a more environmentally friendly VAT system. However, the green element is missing from current proposals.

In April the European Commission released an action plan [1] setting out the pathway to the creation of a single EU VAT area “that can support a deeper and fairer single market, and help to boost jobs, growth, investment and competitiveness”.

The communication highlights two options for VAT reform in Member States. The first would limit VAT reduction to 15%. The second option would remove this minimum level and allow Member States to legally retain current low VAT rates or apply further reductions – subject to certain safeguards, such as avoiding unfair competition and maintaining legal certainty.

The second option presents an opportunity to create a more environmentally-friendly VAT system, favouring the purchase of renewable products by allowing Member States to differentiate their VAT rates on the basis of sustainability or circularity. This would be of particular interest to the UK, which last year was instructed by the European Court of Justice to raise its 5% VAT on solar panels as they did not fall under “renovation to a property”, and thus are not eligible for the lower VAT rate.

Furthermore, VAT reform offers a chance to implement the Europe 2020 Strategy (Smart, Sustainable and inclusive growth) and the Circular Economy package. Done properly, reform could support the 2030 climate and energy framework, and help steer the EU economy in line with the 1.5°C guardrail agreed in Paris last December.

However, at present, the reform proposals only mention competition and compliance costs as drivers of the reform. The omission of sustainability objectives risks inconsistency with the EU’s long term fiscal and environmental targets. It also risks bringing in an un-environmentally friendly VAT reform if environmental goals are not factored in.

Green Budget Europe sees a window of opportunity for VAT to be reformed and restructured in line with the EU’s overarching climate and environmental goals. This can be done by modifying VAT rates in line with the environmental impacts of particular products. On the one hand, this means applying reduced or zero rates to products which are themselves, or can bring about, improved energy and resource efficiency, e.g. highly efficient white goods, insulation materials, and recycled items. On the other hand, this means taxing at the full VAT rate resource- or energy-intensive products and services, e.g. air travel, meat and dairy products.

The ECON Committee of the European Parliament will soon review the proposed VAT reform and the two options outlined by the European Commission. In light of the positive impact that such a reform can have on GHG emissions reduction and recycling targets, Green Budget Europe urges the Committee to make amendments which steer the VAT reform on an environmentally friendly path, in line with the EU’s internal and international economic goals.

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Background:

•  Value-Added Tax (VAT) is a popular way of implementing a consumption tax in Europe, Japan, and many other countries. It differs from the sales tax in that taxes are applied to the difference between the seller-purchased price and the resale price. This is accomplished by taking full tax on all sales, but refunding the tax difference to the sellers.

•  The common VAT system is a core element of Europe’s single market. By removing obstacles that distorted competition and prevented the free movement of goods, it has facilitated trade within the single market. It is a major and growing source of revenue in the EU, raising almost EUR 1 trillion in 2014, which corresponds to 7% of EU GDP. One of the EU’s own resources is also based on VAT. As a broad-based consumption tax, it is one of the most growth-friendly forms of taxation.

• According to the European Commission, the current VAT system, which was intended to be a transitional system, is fragmented, complex for the growing number of businesses operating cross-border and leaves the door open to fraud: domestic and cross-border transactions are treated differently and goods or services can be bought free of VAT within the single market.

• Option 1 of the proposed VAT reform reads as follows (page 12):

 The minimum standard VAT rate of 15% would be maintained. The list of goods and services that can benefit from the application of a reduced rate would be reviewed in the context of the transition to the definitive system and then at regular intervals, in particular taking account of political priorities. Member States would be able to submit to the Commission their views on the needs for adjustment.

The Commission, with the support of the Member States, would analyse whether such changes would pose any risk to the functioning of the single market or distort competition, and would report its findings before any change.

Under this option all currently existing reduced rates, including derogations, legally applied in Member States would be maintained and could be included in the list of optional reduced rates available to all Member States, ensuring equal treatment

• Option 2 of the proposed VAT reform reads as follows (page 12):

The most ambitious approach in terms of granting Member States greater rate-setting power would be to abolish the list and allow them greater freedom on the number of reduced rates and their level.

While Member States would remain constrained by EU legislation, such as single market or competition rules, and the EU’s economic governance framework, this option would require safeguards to be put in place to avoid unfair tax competition within the single market, while also guaranteeing legal certainty and reducing compliance costs.

The freedom to set VAT rates should be thus accompanied by a number of basic rules framing the cases in which reduced rates may be applied. In particular, Member States could be asked to inform the Commission and other Member States about any new measure and to assess any impact it might have on the single market. To prevent unfair tax competition in cross-border shopping, one possible solution could be to prevent application of reduced rates to high-value goods and services, in particular easily transportable items.

To ensure the overall consistency and simplicity of the rates system, the total number of reduced rates allowed by Member States could be limited. These elements would limit the possibility of narrowly targeting sectors for unfair tax relief.

Also under this option all currently existing reduced rates, including derogations, legally applied in Member States would be maintained, the possibility to apply them could be made available to all Member States. The minimum standard VAT rate would be removed.

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