How the municipal VAT exemptions promote tax increases in the EU

10 January 2018

As a general rule, local governments are exempt from VAT in the EU. Thus, VAT is not payable on the tax-financed consumption of municipalities and other local governments, at least when the services are produced in-house.
This implies that it is cheaper to finance consumption through local taxes than on the open market, which is a problem when local governments have the authority to set their own tax rates, as the VAT exemption is an implicit subsidy of local government consumption. This tend to increase local tax burdens.
New Zealand operates a model whereby all consumption, public and private, is subject to VAT. Local property taxes are also subject to VAT, implying that there is no incentive to expand local government operations for VAT reasons.
There is an ongoing discussion on the need for VAT reform in Europe. The European Commission should look to New Zealand for inspiration and push for the complete inclusion of local authorities into the VAT system.
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Download PDF Distortions caused by the public sector VAT exemption in the EU (formatted)

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