“Politicians cannot currently justify a VAT reduction to their voters”

On 10 July, an expert contribution by Prof. Sigrid Hemels, Professor of Tax Law at Erasmus School of Law, was published in the Financieele Dagblad. In this contribution, she emphasizes the inefficiency of the temporary VAT reduction that has been introduced by different European countries. Given the limited benefits and the fact that consumers have to pay the price once the temporary reduction ends, the measure will contribute very little to poverty reduction and the people that are affected by the crisis are better off receiving a specific subsidy.

The COVID-19 crisis had led to a temporary VAT reduction in some European countries. For example, Germany has already lowered the regular VAT rate from 19% to 16% and the reduced rate from 7% to 5%. Other countries such as Austria and the United Kingdom followed, and Italy is also considering to join this movement. With this reduction, they hope to stimulate consumption. After all, for big expenses such as a car, television or renovation it can provide a significant profit.

Inefficient measure
However, according to the German think tank DIW, people will be reluctant to purchase large consumer goods due to the uncertainty of the current economic situation. In the Netherlands, the support of low incomes is mentioned as an argument for the VAT reduction. However, the reduction is expected to have little impact on small expenses. As the price reduction is minimal, it will not lead to increased consumption. In addition, the measure will not only reduce the price for the low-income group but for everyone.

In addition, it is not yet certain whether entrepreneurs will translate the VAT reduction into an equally substantial price reduction. After all, entrepreneurs are not obliged to allow the reduction to benefit their customers and can very well keep the profit themselves. While this may be part of the goal, a generic VAT reduction is not an effective means of supporting entrepreneurs affected by the corona-measures as it also subsidizes unaffected businesses.

Finally, the VAT reduction is a temporary crisis measure and will therefore eventually be reversed. The past has shown that a VAT increase often leads to a higher price increase than the rate increase. This means that consumers have to pay the price once the reduction ends.

The alternative
Prof. Hemels labels the temporary VAT reduction as a costly and inefficient form of poverty reduction. She states that it would be better to provide a targeted subsidy, as it is less costly for the government and provides more benefits to those who are affected. Because a VAT reduction might sound like a sympathetic and attractive solution provided by politicians, the consequences outlined in this article prove that politicians cannot currently justify a VAT reduction to their voters. The measure is very costly for the government – and therefore the taxpayer-, is inefficient and ends up being provided to groups that do not need it. Prof. Hemels therefore expresses her support for the cabinet that currently does not intend to follow this movement of VAT reduction and labels it as ineffective.