Can you achieve desired behaviour through VAT measures?

Sigrid Hemels, professor of Tax Law at Erasmus School of Law, states in an opinion piece in the Financieele Dagblad that VAT is not a good policy instrument for several reasons. Even though, VAT is often used to encourage desirable behaviour.

Some believe that the Dutch can become healthier, fairer, or more sustainable by means of a lower VAT rate. However, she is of the opinion that VAT is only a suitable means of raising money for government spending. Other goals, such as promoting health through fruit and vegetable consumption and promoting sustainability through country and thrift shops, are challenging to achieve by lowering the VAT rate.

Pigouvian tax

A Pigouvian tax, named after Arthur Pigou who introduced this concept in the last century, aims to include social costs in prices. The Dutch air passenger tax, the London congestion tax, and the European plastic tax are examples of Pigouvian taxes. 

Harmonization

VAT is a tax harmonized in the European Union (EU). Member States pay about 0,3 percent of national VAT revenues to the EU. Member States have limited policy space: they must comply with European VAT regulations. There is a limited number of goods and services to which Member States can apply a reduced VAT rate or exemption. There is a proposal from the European Commission to give the Member States more freedom in using the reduced VAT rate, but the Member States have not agreed on that proposal yet. 

Effective

The question arises of whether a VAT reduction achieves the intended goal. The CPB Netherlands Bureau for Economic Policy Analysis states that this is not the case. People with lower incomes consume a large part of their income and use a larger part of their total income for consumption. Consumption taxes therefore often weigh disproportionately on these people. It is more effective if there is a specific measure for people who want to change their behaviour but do not yet have enough income than a generic rate reduction from which also high income consumers and consumers that already showed the desired behaviour benefit.

Hemels is not in favour of VAT measures as they are often not effective and difficult to implement: ‘There is certainly reason to better express social costs and benefits in the price of products, but VAT is not suitable for this. More creativity is needed for feasible and practical solutions in the short term.

More information

Read the full article in the Financieele Dagblad here (in Dutch).