Institute for Research in Economic and Fiscal issues

IREF Europe - Institute for Research in Economic and Fiscal issues

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New EU members banned from zero
Dawn of Zeroastrianism?

In 2006, the EU outlawed the zero, banning it from VAT rates of member states. Within two years the zero struck back. It now rules supreme in at least three economic areas, but in the tax domain it continues to be banned. Any newcomers to the EU will be hit especially hard. Why would anyone institute a minimum tax anyway? Surely we need protection from a maximum, not a minimum!

The zero strikes back

The onset of financial turmoil in 2008 has heralded a dawn of a new economic situation in the EU dominated by the number 0: zero interest rates, zero growth and zero inflation. .

The first is hated by all savers (including future pensioners), and also by traditional banks which aren’t all that motivated at such rate to lend money (and finance investment). The second is hated by just about everyone who has been used to the “customary” 2-3% annual post-war growth.

The third is hated by central bankers for the following reason: Almost the world over they are charged with a pursuit of what people actually like: price stability. So people would be happy with zero inflation, and so should central bankers. But the latter have generally redefined price stability to mean around a 2% annual rise of price level. Stable and low inflation instead of stable prices is the modern idea of price stability. And now when much of Europe is experiencing zero inflation, central bankers are not reaching their “inflation targets” (their words, not ours) and see themselves as a failure.

These zeroes cannot be legislated against.
But there is one hated economic zero which can be – and is – legislated against.

Council Directive 2006/112/EC

This EU Council Directive of 28 November 2006 sets out what must be implemented in national law, unless a member state negotiated an exemption from a particular provision.

Article 29 provides that no country shall charge a standard Value Added Tax (VAT) rate of less than 15%.

That itself is interesting. Why would anyone want to legislate for a minimum tax rate? If laws are to protect people from “th’ oppressor’s wrong”, perhaps it should legislate a maximum, not a minimum tax rate. In Switzerland, for example, no tax increasing legislation is valid unless it has subsequently been confirmed in a referendum. (The real reason for a minimum, of course, is to create a taxation cartel and prevent any “prince” offering his subjects a better deal. Only worse deals are allowed.)

To be fair, the Directive mercifully allows (in Article 98) for not one but even whole two “reduced rates” of VAT, but only for specific items listed one by one in Annex III of the Directive.

Article 99 then dryly provides that no such reduced rates can be lower than 5%. Bang, zero has just been legislated out of VAT taxes, increasingly the main source of income for EU governments.

Sorry. New members only.

These rules should apply to all members, but as so often in the EU, current members have been able to negotiate an exemption. The UK, for example, has a 0 rate of VAT on groceries, books, children’s clothes, medical supplies. Ireland on food. France has a rate of 2.2% (albeit not 0, still “illegal”). In all likelihood, no new member would be able to negotiate a similar exemption.

Ukraine signed its association agreements with the EU. Currently it has 0% VAT on items contributing to its exports, on infants’ nutrition, medical supplies, public transport and some publishing. If it ever joins, it will be forced to charge at least 5% on those. Of course, some members could in the future be characterized as “new” only technically. If Scotland had become independent (or if it ever does in the future), as a new member state it would have to increase the tax on those goods on which it now charges 0% within the UK.

Zero rate vs. exemption

To be fair, it is possible that in the future new members may be able to declare some goods or services completely exempt from VAT. The Directive only specifies that no actually applied reduced VAT rate can be less that 5% (and no standard rate less than 15%), but rules governing what must get a VAT “treatment” at all are more lenient.
The difference between a good being exempt and VAT being “charged” at 0% may appear only cosmetic, but there is more to it.

Any producer of a good charged at 0% VAT is still a VAT tax-payer who has to register as such. She then can reclaim any VAT paid on things it used in the production. A producer of an exempt good, on the other hand, does not become a “tax payer” and cannot register. As a result, any VAT he has paid in the production cannot be refunded to him and it becomes an additional expense to the business. Paradoxically, therefore, the government may be gaining less revenue from production of zero-rated VAT goods than from the production of VAT-exempt goods.

5%: small but sensitive

Some may argue that being forced to go from 0% to 5% is not such a big deal, especially given that the VAT paperwork is pretty much the same even under the 0% rate, as we have just seen. Well, it’s still five percent, and social consequences are likely to be greater than if the 5 percentage point difference were between, say, 20% and 25% rate. The low (or zero) rates are generally applied to items which are considered socially sensitive, predominantly purchased by the economically poorer or fragile consumers.

And the argument is a double-edged sword. If 5% really did not matter much and therefore it weren’t a big deal if countries are banned from charging less, then why bother instituting a minimum in the first place?

Whatever the reasons and however low the limit is, the worst is the message it is sending: that something untaxed is something unnatural and guarded against. That’s a terrible message - which should be guarded against!

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