EU plans for VAT taxation are doomed to fail. Again.

Taxation is the potential downfall of the EU as an institution. The reason is that within the EU, several member states are making money from the tax evasion in other member states, a situation akin to having a wife slowly murdering her husband with poison. Unless this stops, a divorce becomes inevitable.

Luxemburg, the Netherlands, Ireland, Lichtenstein, Austria, London, and several others are at it: they help large corporations avoid their taxation responsibilities. They either make deals that allow companies to hide their tax obligation, have idiosyncratic definitions under which there are less tax obligations, provide re-labelling services such that head-offices can be a mere post-box, etc.

These tax-avoidance enablers have also systematically frustrated all attempts over the last 30 years to harmonise taxation and reverse the damage they have done to the integrity of the other nation states in the EU. Whenever the issue of tax evasion was in the public eye, for instance during the GFC, they stalled by insisting tax evasion should be solved internationally and should include all other tax havens. Predictably, these were impossible demands. They have also made life difficult inside committees and government forums.

The EU bureaucracy has just put out a new set of proposals regarding VAT on large international corporations (like Google and Amazon), impact evaluated and all. I have read them and predict they will not be implemented, nor would they work anyway.

For one, the EU commission has no power to enforce new tax rules, and these proposals are in a long line of ignored prior proposals. To become law they would need the unanimous backing of all EU members. They hence need the cooperation of about 5 countries that would lose billions if they complied. Fat chance, even with Brexit reducing the political clout of London.

Secondly, the proposals repeat the main mistake of the past: they advocate a rules-based administrative system of taxation which is cumbersome, highly-complex, and easy to game. I explain how over the fold. 

What are the two serious ‘options’ proposed (I am ignoring the ‘enforce the current rules’ and other distractions)?

The first one is ‘reverse charge’ value added tax by making it compulsory for the consumer to declare every transaction and give the tax man the VAT money. There are several variations on this theme in the 150 pages of the proposal, but the basic idea is that you stop trying to force the manufacturer or seller of goods and services to give the tax man the VAT, and rather force the consumer.

How do they know who the consumer is? Well, they want to force each person in the EU to have a VAT-identification-number which they would be obliged to give in any transaction, either electronically or otherwise.

One problem here is similar to that of enforcement of taxation on household production or of intellectual property rights on downloaded films: small entities (single individuals) will find it easy to cheat on their obligation. They can pretend not to live in the EU, have an actual place of residence that includes somewhere outside of the EU (we will all be 10-dollar Latvians!), adopt a fake identity for the purpose of buying small stuff, adopt a company identity, or conveniently mis-report their VAT number and feign ignorance. Good luck trying to police small entities!

A bigger problem is that you still need a common level of VAT, because otherwise you will get VAT-shopping inside the EU, with any small or large entity flowing their VAT-obligations via Luxemburg or somewhere else. In stead of the supplier shopping for a country, the consumer will shop for a country (helped by the supplier no doubt. Easy to do if the consumer is a company itself, which we can all be).

A third problem is the measurement apparatus needed. Giving everyone a VAT number is not an easy exercise, particularly if individuals can be a 1,000 companies and be registered in 100 countries. Having 10 year olds who buy stuff, live in 5 countries, and who regularly travel have a VAT number is also not innocuous. The hassles and IT systems needed would be large. That means it would take years and years to set up, a handy delay for the tax-avoiders.

All these elements make it dead easy for countries to resist. Even if they agreed at first, they could nit-pick about the IT systems needed or the rules on VAT numbers for dual citizens and whatnot. A new complex system is easy pickings for both large companies and recalcitrant countries.

The second proposal then is to follow the ‘contractual flow’ rather than the ‘physical flow’ (which is the current system). This would mean that when a company in country X sells to someone ‘based’ in country Y, the VAT rate of country Y is immediately applied and the supplier (or customer) has to collect and report the tax.

“Horrible”, is my immediate reaction to this idea. With a country-specific VAT rate, you have the easy counter-measure above: tax-shopping within the EU and outside of it on the consumer side. If I were a tax haven, I might even be in favour of this, hoping to attract even more money than before.

And, with contractual flows important and physical flows not, the consumer shopping is easier since it is then not even illegal to collect the goods in one country and bring it into another without worrying about VAT.

Similar problems to the current system also apply to this one: the issue of just which company makes the sale and hence has the obligation, the rules on people with a non-EU nationality, etc.

Another problem with both proposals is that the system focuses on a headline monetary price as the unit on which VAT is charged, which is vulnerable to bartering arrangements, ie to avoid monetary trade. If I exchange 100 hours of consulting for a holiday in the Bahamas (easy to do with modern technology, very tough previously) and say that that holiday would be worth very little, then I need pay little VAT for my 100 hours of consulting. Individuals and companies can thus cheat by deciding on a dual-trade where both sell the other something of very low headline price, meaning VAT is low. This kind of possibility would have been very difficult before the internet, but would now be very easy to set up a large network of bartering arrangements, conveniently parking the value in the tax havens. Indeed, I am surprised it is not already there.

Tax authorities would be hard put for a countermove to this. Bartering is not in principle illegal and the issue then turns to the question of what the ‘fair price’ is of all the things traded in the bartering community. Even in the current priced economy you have ever changing prices, ‘discounts’, and differences in price levels between countries. If you design a barter economy you can play with these prices, discounts, etc. and have these prices change every micro-second. You will hopefully see how childishly simple it would be to shift real value to the country where it is hardly taxed, essentially by making many commodities into money that has a super-rapidly changing exchange rate.

So the EU VAT plans are doomed to failure because of complexity and counter-moves: they would need large new systems to administrate, are easily derailed politically for a long period of time, and internet-based counter-measures by organisations and individuals can be devised. The EU plans are then old-style and unimaginative.

I see two better options. One is where the selling platforms are EU-nationalised, ie compulsory market places for buying a very large set of services and goods, where tax rules can thus be enforced far more easily. A second, even more fundamental shift in thinking, is to go to national taxation on the basis of estimated turnover and profits rather than proven turnover and profits, at least for large corporations. Both of these might sound revolutionary, but they were both normal in the history of taxation and are the way to go once more.

Author: paulfrijters

Professor of Wellbeing and Economics at the London School of Economics, Centre for Economic Performance