Box 1 - Is there a case for differentiated VAT rates?
An important question for policy is whether or not to have differentiated commodity taxes such as reduced VAT
rates. Alongside the Community's interest to avoid distortions of consumption and VAT revenues, Member States
have put forward four main cases which could justify their interest in having differentiated VAT rates. First, taxes
or subsidies shall promote merit goods or discourage the consumption of de-merit goods or bads. This view has
certainly some good points, although the choice of merit goods may be arbitrary and subject to specific lobbying.
Second, differentiated tax rates could be used to redistribute income by taxing lightly goods of first necessity such
as food. The problem with this rule is that it is far from clear that consumption taxes is an efficient instrument of
redistribution both theoretically (income taxes are shown to act much better^29 ) and empirically (as a sizeable part
of the VAT reduction benefits the riches). Third, reduced VAT rates are seen as having positive effects on
employment, an argument that shall be qualified. Value-added taxes seem to act on the demand for labour but not
so much on the supply, leaving ambiguous the effect on employment. In addition, the reduction of other taxes
may have similar if not larger effects as it is the case for taxes on labour. Fourth and finally, Member States may
want to have reduced VAT rates because it can raise productivity. Recent research shed new light on this issue^30.
To put things simple, this research departs from the traditional goods-services market production by including a
third sector: the household production of services such as house cleaning, baby care, car-washing, or do-it-
yourself activities. It can be shown that a high tax on these activities, which are complement to leisure, are not an
efficient way to stimulate labour supply, as they will tend to encourage substitution of home production for
market production.
The traditional view is that taxes or subsidies shall correct externalities and that uniform VAT is not necessarily
optimal from an efficiency perspective. On the other hand, neutral and uniform VAT taxes may be the best
solution as a lot of guiding variables are in practice unobservable. Indeed, very little is known about the cross-
price elasticities between leisure and all goods and services (we have difficulties in identifying them), so the best
practical policy may be to act as if they were all equally substitutable and try to tend to uniform VAT taxation.
This view is also reinforced by the fact that: (a) a non-linear income tax is more optimal for redistribution
purposes than differentiated VAT rates, (b) uniform VAT is easier to administrate and less prone to fraud (by re-
labelling goods), (c) there is no need to change the relative rates when tastes or technologies are changing, and (d)
uniform VAT rates better prevent wasteful lobbyism. Even though there may be a theoretical case for non-
uniform commodity taxation, it seems desirable to maintain neutrality as the general norm. This is because
governments may not have full information on the adequate parameters to fine-tune their taxes and non-uniform
taxes are subject to lobbyism. Hence, the burden of the proof shall always be carried by those who argue for
deviations from uniformity^31.3.2. Globalisation, tax competition and the shift from mobile to immobile tax bases.
Another point of concern for tax authorities is the potential effects of globalisation and tax competition
that could force them to shift the tax burden from (geographically) mobile to immobile tax bases. The
impact of tax competition has been the focus of a sizeable amount of academic research^32 , especially in
relation to corporate taxation. As we have seen above, statutory corporate tax rates in Europe have fallen
considerably during the last 25 years and this decline in corporate tax rates has induced fears of a race-to-
the-bottom in the European Union. This could ultimately erode corporate tax revenues and impose a
threat to the financing of the European welfare states.
One important question is of course whether the decline in corporate tax rates is the result of tax
competition and whether there is a "race to the bottom". Several authors have tried to estimate whether
jurisdictions of various natures were setting taxes in an interdependent fashion. Many studies found some
(^29) See Atkinson and Stiglitz (1976).
(^30) See Kleven (2004) or the discussion in Sorensen (2006)
(^31) Sorensen (2006).
(^32) See Nicodème (2006) for a recent review with a focus on the European Union.