Luxembourg for Finance, May 2013

The Importance of indirect taxes is growing

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The tightness of many EU Member States’ budgets doesn’t leave much room for manoeuvre. To finance their budgets, many countries rely on indirect taxes. The 2013 EY report, “Indirect Tax in 2013” has found that the trend in raising VAT rates has been particularly strong in Europe.

Did you know that Costa Rica and Norway have increased excise duties on soft drinks, that Finland has introduced such a tax on sweets and ice cream and that in France a tax has been introduced on suppliers of beverages with added sugar or sweeteners? Michel Lambion is Tax Partner at EY Luxembourg. He notes that the original reason for the introduction of excise duties was to raise revenue but sustainability considerations have come into play. “Excise duties are increasingly being used to discourage consumption of certain products considered to be harmful. The series of tax hikes on tobacco has led globally to a decrease in the consumption of cigarettes”.

According to the EY report, there seems to be a trend reversal when it comes to excise duties. While the percentage of government revenues from this indirect tax has been in constant decline over the past few years, excise rates are on the rise again.

Speaking of increases, between 2008 and 2012 the average EU standard VAT rate increased from 19.5% to more than 21%. In Asia-Pacific, the upward trend is less explicit but still noticeable, while in Latin America rates have not changed much for the last few years. Michel Lambion on the specificities on indirect tax. “Even a slight rise in VAT has the advantage of massively increasing the government’s revenues. What is more, it is also a tax that is more difficult to escape than others because in the end it is the businesses that pays VAT to the Treasury rather than the consumers themselves. Furthermore, taxes like VAT are less sensitive to the economic situation of a country. In bad times you still consume, though it might be less than during good times”.

Mr Lambion underlines that it is not enough to decide to raise taxes. A government needs to have the appropriate measures to have an efficient tax collecting system; otherwise it loses a lot of revenue. “Collecting taxes is much costlier in some countries than in others; in France it is more expensive than in Germany, for instance, and even within France there are cost differences from one region to another.” So when the system becomes more complex, it is important for tax authorities to make sure that people and companies are compliant. The EY study reveals that indirect tax systems have become more efficient. Increased use of IT tools, data transmission and filing have all contributed to this efficiency.

If you think that there is an obvious link between the global level of taxation and the competitiveness of a country, you might be on you may not be on the right path. “Sweden has global tax revenues and global spending close to France, but both economies have followed different trends these last years. One has to analyse what the government does with the tax revenues: does it spend a lot of money on research and development, does it invest in state of the art infrastructure or does it only reinvest the tax money into the welfare state? Tax stability is another important element. Investors don’t like it when rules change every single day. The way a country’s tax system is understood and applied is also a factor in competitiveness”.

Luxembourg’s fiscal framework is known to be very stable; the country’s standard VAT rate has been unchanged since January 1992. At 15%, it is currently the lowest in the European Union. But Prime Minister Jean-Claude Juncker has announced that there are changes in the horizon. In his State of the Nation speech in April 2013 he declared that Luxembourg would raise its VAT as of 2015.

Michel Lambion of EY says that is extremely difficult, if not impossible, to foresee what the tax policy of the government will look like in the years to come. “We know that Luxembourg wants to keep the lowest VAT rate in the EU. We could therefore estimate that it will not be higher than 18% because that is the current rate in Malta and Cyprus and the latter has announced that VAT will be raised to 19% in 2014. It is difficult to be more precise than that”.

The EY expert concludes that at this stage it is difficult to anticipate whether the rate will increase gradually or not. What is more, the situation could evolve due to the elections taking place in 2014 and the evolution of the economic situation, Mr Lambion completes. CW