sou · GTB357 · 2006-01-01 00:00:00 — sporting activities in cases where the services are not provided by the state, a municipality or a non-profit association Apart from these regulations on reduced tax rates there are also regulations on tax exemptions. These regulations follow current EC provisions and apply, for example, to care, education and some cultural services. The intention has been to compare the present system and its three different tax rates with other alternatives. The possible alternatives for the sake of comparison are a value added tax system based on a flat tax rate, or an arrangement with a standard tax rate plus a single reduced rate of tax. The analysis is intended to lead to conclusions 1 The zero tax rate means that no output VAT need be reported, although the taxable person is still entitled to reimbursement of all input VAT incurred in the course of operations. about the positive and negative effects that may result in the event of a change in the regulations on tax rates. Under the Inquirys terms of reference, the review should aim to limit the demarcation problems. Proposals for changes in the value added tax system that have cost consequences must be accompanied by proposals for financing within the value added tax system. This implies that the alternative tax rate structures and tax rate changes that are analysed must be designed so that lower value added tax receipts for certain types of consumption are counterbalanced by higher receipts from other types of consumption. The report contains a thorough survey of the demarcation problems associated with the application of reduced tax rates in different areas. The survey shows clearly that there are substantial demarcation problems in most of the areas where a reduced tax rate is applicable. Even if the legislator has tried carefully to describe the sales of goods and services that are intended to fall within the scope of a reduced tax rate, in practice it appears that demarcation problems very often arise. The problems lie in determining whether the sale of a good or service belongs in the low-tax or in the full-tax area. Decisions of this kind are made by the or by courts. Ques- tions frequently arise. In a system involving differentiated tax rates, it is businesses that use different tax rates that have most difficulty applying the correct rate. These businesses need to be able to decide which tax rate is applicable before selling a good or service. In certain cases they can do this without any great difficulty. However, different VAT rates can also considerably complicate application of the rules. This is the case, for example, when the business is new, when it changes direction, when the types of sales are not easy to define, or when rules or practices have changed. Examples of situations that have often proved very difficult to assess are where to draw the line between food () and restaurant service (), what consti- tutes sport () and what does not (), and where to draw the line between different sales in the cultural area (6, 12 or , or tax-exempt). Difficulties in assessing which tax rate to apply can also have troublesome financial consequences for business operators if they misinterpret the regulations. In such cases the business may face a retroactive liability to report to the the amounts corresponding to taxation at the correct rate, and may also be liable for any additional taxes due. In these cases it is obvi- ously difficult for the business operator to turn to the original customer, long after the transaction has been completed, to request payment of a corresponding amount. Differentiated VAT rates also lead to demarcation and applica- tion problems of a slightly different nature. These concern cases where goods and services are supplied together, often for a single payment. These situations are very common in practice. One example is when a visitor pays an entrance fee to an amusement park and the entrance ticket is also valid for a concert in the park. If different VAT rates are applicable, as in this case, problems of assessment and valuation arise that are not easy to deal with. Other examples are services supplied at hotel and health (lodging , breakfast , some preventive health activities that are classified as sport for VAT purposes , health care, which is VAT-exempt, etc.), services associated with passenger transport (transport , cabin , restaurant service ), and various goods that are supplied along with books and magazines (books and magazines , CDs , various gift items ). Since the circumstances are never exactly the same from case to case, the issues are of a nature that prevents their ever being fully resolved by case-law. If there were no differentiated VAT rates or no VAT exemptions, this type of problem of application would not arise at all. A number of proposals have been made for extending the VAT rate for culture to goods and services that are now taxed at 25 per cent. In these cases it has been claimed that on grounds of demar- cation, fairness or competition there is reason to place these goods and services on the same footing as goods and services in the cul- tural area that are now taxed at 6 per cent. Goods and services that are more or less clearly linked to cultural life are currently taxed variously at 6, 12 or 25 per cent, or in some cases are VAT-exempt. If any such extension of the low-VAT area is undertaken, this will automatically lead to a need to adjudicate new demarcation problems, at least for a transitional period. It is a moot question whether new provisions of this type will reduce demarcation and other problems in the long term. There is a risk that they will have the opposite effect. However, more extensive work than has been possible when producing this interim report is required to allow a detailed assessment of the feasibility of dealing with the new demarcation problems that would arise from an extension of the area in which a reduced tax rate applies. A more in-depth analysis of this kind may be warranted if, after receiving consultation comments on this interim report, the Inquiry works in its final report on the assump- tion that the way to achieve necessary simplification is not, as now advocated, to introduce a flat tax rate but instead to modify the present regulations. Administrative costs and compliance costs From the point of view of demarcation, as from the perspective of competition and fairness, it is obvious that a transition to a single flat rate of VAT is preferable. There are considerable simplification gains to be made from applying a single tax rate. The size of the sums to be gained from simplification can be estimated on the basis of the account of administrative costs to the authorities and com- pliance costs to companies. It should be emphasised, above all, that simplification is signifi- cant for companies. Even if complicated tax regulations always entail increased costs for the authorities concerned, the conse- quences are considerably greater for the companies that have to apply the regulations. In view of the large number of companies that are liable for VAT, regulatory simplification has a significant impact. Another aspect is that companies that are currently actually allowed to apply a reduced rate of VAT may feel that the direct financial benefits of the reduced rate are greater than the difficul- ties caused by the differentiation as such. This is presumably also the reason why various industries would like to be allowed to begin to apply a reduced tax rate in their business. In order to obtain an idea of the scale of the costs involved, the Inquiry has made a comparison with the costs that would arise if only one tax rate were used (retaining the present exemptions from taxation). A switch to a flat rate of VAT would enable authorities and tax- able persons to save costs. The sum arrived at by the Inquiry, with the assistance of the head office of the and a survey at the in , indicates a cost to the authori- ties of around million per year. For taxable persons, com- pliance costs for VAT attributable to the need to apply more than one tax rate have been estimated to amount to approximately million per year. The point of the proposals that have been put forward in different connections that new sectors should be allowed to apply a reduced tax rate is not always to solve real demarcation problems. The intention is instead to increase the fairness of taxation, in the view of those making such proposals. Differentiation of VAT rates and regulations granting exemp- tions from VAT affect the conditions for competition between different companies. VAT differentiation means that producers of different goods and services are treated differently. Production goes down in more highly taxed areas, while production in areas with lower taxes is affected positively. If there is a high degree of substitutability between goods and services with different tax rates, this situation can be described as a direct distortion of competition. Clearly, the lower VAT rates have often come about so as to specially influence the consumption of certain goods and services, which in turn affects economic conditions for the companies that produce those particular goods or services. A reduced rate of VAT, which is a means of increasing consumer demand for a good or ser- vice, can be said to entail a form of subsidy for the business that produces the good or service. European Community law contains certain requirements for equal treatment of similar or competing products. However, this obviously does not prevent the Member States from using differ- entiated VAT rates, it merely means there are certain restrictions in view of the risk of distorting competition. It is difficult to know exactly where to draw the line. While there is no reason to suppose that present Swedish differentiations are not permissible under Community law, this does not mean they are unproblematic from a competition point of view in economic and practical terms. It is obvious that a value added tax differentiation aimed at favouring a certain type of consumption or production should always be questioned from the standpoint of competition. It may seem surprising that such aspects have not been more influential when decisions have been taken on reduced VAT rates. The argu- ments for such changes have mainly focused on potential positive effects that it may be supposed will arise for the industry receiving the tax reduction. consideration has generally been given to the impact on other actors, which it must often be assumed will be of a negative nature. Different VAT rates therefore affect conditions for competition. Criticisms concerning inequities often stem from a feeling among business operators who sell goods or services for which the lower VAT rates are not applicable that they are at a competitive dis- advantage. They can also originate from a more general argument about fairness that is not related to a concrete competitive situa- tion. Nonetheless, criticisms of the present system show that com- petition aspects should be taken seriously. The Inquiry also be- lieves it is impossible in principle to design a system based on dif- ferentiated tax rates that everyone will consider fair. Developments also show that any differentiation automatically leads to pressure for a further increase in the use of differentiated VAT rates. The Inquirys terms of reference indicate that international com- petition issues are a factor that must be taken into account when determining a suitable structure for tax rates. The increasing inter- nationalisation of trade in goods and services can affect not only what total levy of indirect taxes, such as value added tax, is appro- priate and practicable. The tax rate structure chosen can also be more or less optimal from the point of view of internationalisation. The Tax Base Inquiry (Swedish Government Official Reports 2002:47) gave as its opinion that the standard Swedish tax rate is high compared with the level applied in other EU countries and that the differences therefore have a one-sided effect to disadvantage. The Tax Base Inquiry advocates a reorganisation of taxes so as to replace the present differentiated system with a lower general rate. The Value Added Tax Rate Inquiry notes that very attention has been paid to internationalisation aspects when deter- mining the present Swedish VAT rate structure. The standard tax rate of 25 per cent has been in existence for many years. Before the work of the Tax Base Inquiry, probably no very close thought was given to the question of how well judged the standard tax rate is from the point of view of internationalisation. We have found that there are areas where a VAT rate of 25 per cent is problematic in view of internationalisation. This is true, for example, of trade by private persons across internal EU borders, primarily in capital goods (such as second-hand cars). With respect to trade in capital goods, the Inquiry learned from a visit to that such trade is extensive. There it mainly involves Danish nationals taking advantage of the lower tax rate in for purchases of capital goods. A problem that is potentially even more significant is the cross- border trade in various services. This includes Internet shopping, but also telecommunications and radio and television services. Community regulations on taxation of these services mean that if there is a substantial difference between the Swedish VAT level and the VAT level in other EU countries, Swedish companies could be driven out of business by the competition or, in the long run, forced to move their business abroad. On the other hand we have established that the areas in which currently applies the lower VAT rates are in the main not exposed to any decisive inter- national competition. The Community regulations are designed so as in principle only to allow the use of reduced tax rates in cases where this cannot lead to competition problems for other countries in the internal market. The fact that other EU countries also have lower VAT rates on many of the goods and services on which we currently apply reduced tax rates will therefore broadly speaking not necessarily mean competition problems for if we introduce a single flat rate of value added tax. The economy and differentiated value added tax The Inquiry has estimated the different costs to the Swedish economy of different VAT rate structures. The costs have then been expressed as the loss of consumer utility that can be presumed to occur as a result of the tax being levied. The estimates are based on the assumption that in the long run and given perfect competi- tion, a change in the VAT levied will be fully reflected in consumer Assuming that consumption does not give rise to external effects, the change in consumer utility can then be measured on the basis of the price elasticity of demand. The connection between price sensitivity and, on the one hand, the level of the VAT rate and, on the other hand, consumer utility has sometimes been advanced as a reason for different VAT rate structures. The Inquiry concludes, however, that the potential im- pact of budget-neutral VAT changes on total consumption and consumer utility is limited and uncertain. This can therefore not be made the basis on which to build a new system of VAT rates. An analysis of consumer utility can, however, provide one among sev- eral valuable inputs when undertaking an overall assessment of the structure of VAT rates. According to the Inquirys estimates, a switch to a flat rate of VAT on the goods and services that are presently included in the VAT system would be weakly positive for total household con- sumer utility. This means that the new production structure that would result from such a change in the VAT rate structure would overall be at least as rational as the current structure of production. The present differentiation of tax rates is the result of political considerations, often based on the to control consumption patterns or purchasing power by influencing relative prices. In recent years, value added tax has increasingly been used as a politi- cal policy lever of this type. The Inquirys review of value added tax as a policy lever shows that in many cases it is questionable how effective the reduced rate of VAT has been in terms of the intended effect on consumption patterns or purchasing power. There is therefore reason to investi- gate whether methods other than reduced VAT might be available if politicians want to move consumption, production or household purchasing power in a certain direction in the future. Value added tax could then be made a pure financing instrument. A budget-neutral switch to a new VAT rate structure will not affect general government sector finances. This means that overall company and household finances will also be unaffected. Budget neutrality in connection with a switch to a new VAT rate structure will not apply to every individual household. Since households consume different goods, those households that con- sume relatively large amounts of the goods on which the VAT rate is reduced will win relative to the households that consume rela- tively large amounts of the goods on which the VAT rate is in- creased. If a switch is made to a flat-rate value added tax, the VAT system will become somewhat less progressive. Households with lower economic standards2 will pay more VAT while households with higher standards will pay less VAT, in relative terms. The change in economic standard associated with a switch to a flat VAT structure is limited and will amount to at most ±0.5 per cent per year be- tween different types of household. The introduction of a VAT rate structure with a standard tax rate and only one reduced rate could have economic effects similar to those that would result from the introduction of a flat rate of VAT. These effects would, however, be less extensive and would depend on which goods and services were still taxable at the reduced rate. The Inquirys recommendation is that continued work towards the final report should focus on switching to a single flat tax rate. On a provisional estimate, this flat tax rate would be 21.7 per cent. The exact percentage rate depends partly on whether certain sales that now have zero VAT can be taxed at the flat rate. This applies in the pharmaceuticals sector in particular.3 The reasons on which we base our recommendation that a flat rate of value added tax should be chosen are essentially as follows. The present differentiation of VAT into three different levels – 6, 12 and 25 per cent – causes demarcation problems. It is quite simply often unclear which tax rate is applicable. The analysis has shown that these demarcation problems can scarcely be remedied effectively by, for example, modifying the text of the law. These demarcation problems become a direct cost for the au- thorities and business operators responsible for applying value added tax. A system with the standard tax rate and just one reduced tax rate may work better than the current structure with its three different 2Economic standard is a concept that takes into account both household disposable income and the composition of households (number of adults and children). 3The percentage rate 21.7 has been calculated excluding the effects of possible abolition of the zero tax rate. If this is also abolished, the level can be brought down slightly further than to 21.7 per cent. tax rates, though this depends on which goods and services qualify for the reduced tax rate. In principle, however, the nature of the problems remains the same, no matter whether one or two reduced tax rates are to apply. A single flat rate of tax would completely eliminate these demarcation problems. The existence of differentiated tax rates leads to concrete distor- tions of competition on a more or less serious scale. Demarcations can also result in certain actors considering that they are being treated unfairly, as their operations ought to be comparable, for one reason or another, to operations that are allowed to apply a reduced tax rate. It is difficult to draw the line between areas with different tax rates so as to prevent such inequities arising. It is therefore also difficult to design a system with differentiated VAT rates so as to ensure that the system can win general acceptance. As a result, a system with differentiated VAT rates tends to be un- stable. The business operators who feel they are placed at a dis- advantage by the advantageous tax rates granted to other operators press for broader reductions. This is presumably one of the factors behind developments so far. A flat rate, on the other hand, is easier to defend against different special interests. Consequently, a flat- rate VAT is also a more stable source of financing for public sector undertakings. This was one of the major reasons for the principle of a flat-rate value added tax that was advanced in the 1990/91 Swedish tax reform. Differentiated value added taxes are used as a means to favour certain types of business or certain groups of consumers. However, any differentiation also has a reverse effect. The goods and services that do not share in the lower VAT rate must instead be taxed at a higher rate than would have been the case without differentiation. This is an aspect that is not commented on when differentiations are proposed. In addition, a subsidy in the form of VAT differen- tiation becomes a permanent arrangement. It is not continuously reviewed to see whether it is still necessary. In contrast, subsidies that are paid more directly, by means of a grant, are generally subject to continuous follow-up. VAT differentiation enables the political system to control con- sumer prices so as to lead consumer demand in a certain direction. In itself, this possibility of using VAT as a policy lever in support of cultural policy, distribution policy or other objectives may be assumed to have some value. However, one essential question in this context is whether VAT is the most appropriate measure for exercising this type of control. The effects of a subsidy in the form of reduced VAT can often be difficult to judge in advance and hard to follow up after implementation. A VAT reduction can have dif- ferent effects in the short and long term, and these effects can vary depending on the price elasticity of goods or services and other factors. A subsidy in the form of reduced VAT is often expensive from the point of view of government finances. This is evident in the present situation. The lowering of the tax rate just on food, which leads to a redistribution of purchasing power from households with higher incomes to households with lower incomes of less than billion per year, means that in 2005, VAT on goods taxed at the standard rate has to be raised by nearly billion. In order to finance a subsidy in the form of low VAT in some selected sectors, the VAT level in the many unsubsidised sectors has to be set at the present rate of 25 per cent, instead of the 21.7 per cent that would otherwise have been possible. A flat rate of VAT will therefore allow a substantial reduction in the tax level that applies for most goods and services. This is sig- nificant from the point of view of internationalisation. Goods and services that are exposed to international competition are now usu- ally taxed at 25 per cent, even though the EU average is about 19.6 per cent. Value added tax at a flat rate of 21.7 per cent is a step to- wards levelling such differences, which are or may become trouble- some from the point of view of competition. Meanwhile, on our assessment, there are no substantial problems of international competition associated with removing the lower tax rates that has at present.