VAT and economic crises

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The entire world is currently doing its best to curb the corona crisis. During the last months, many governments announced economic rescue packages with a value of trillions of euros to tackle healthcare issues and related economic problems that the outbreak of the coronavirus is causing. These packages vary per country. However, all countries seem to agree on the fact that VAT adjustments can help. Ministries of Finance around the world decided to alleviate the financial burden for businesses by reassessing their VAT policies. Some already lowered their VAT rates, others postponed VAT payments or gave companies VAT breaks for a certain period. In this blogpost, we will take a closer look into the relation between VAT and crises. We show that many countries rely on VAT in times of crisis. This makes an efficient VAT collection essential in effectively using VAT to combat a crisis.

VAT as a support mechanism in times of crisis

The list of countries that currently take VAT measures is vast; Germany allows VAT payments to be postponed until 31 December 2020, Chile gave a VAT payment break to small companies until June, Vietnam postpones VAT payments from March to May and Norway lowered its reduced VAT rate from 12% to 7%. This list goes on and on and on.[1] Governments try to compensate businesses, now that many were forced to close down due to a “lock-down” (that is seen in many variants) in order to stop the spread of the coronavirus. This prominent role of VAT as a fiscal stimulus was also apparent during the financial crisis (2007-2008) and the European debt crisis (2009-2014).

For instance, the UK cut its standard VAT rate by 2.5%, from 17.5% to 15% from December 2008 to Januari 2010 to stimulate consumer spending. This was the first time a cut on the standard VAT rate was used in this particular, temporary way in the midst of a crisis. The measure resulted in a 1% overall rise in retail sales. Although sales dropped slightly after raising the VAT rate back to 17.5% again at the end of the period, overall the measure seemed to be successful.[2] In the Netherlands the same theory was also put into practice (although not on the standard VAT) with a temporary VAT cut on home improvement (from 19% to 6%). Again, a sharp rise in consumption was the result. Interestingly, sales in the home improvement sector did not drop below pre-reform figures after restoring the VAT to its old value.[3] Thus, these researches give a good indication of the fact that a temporary VAT cut is indeed an effective fiscal stimulus.

However, in the aftermath (or sometimes even in the middle) of past crises countries raised their VAT rates again en masse. For example, out of the 41 VAT rate reassessments made in the European Union between September 2008 (fall Lehman Brothers) until the end of 2016, 87% represented a rise of VAT rates.[4] Although this might sound counterintuitive, it does make sense. During an economic crisis, just as is happening now, governments are lending billions of euros to save their economies, causing a massive increase in their national debts. As VAT is an important funding mechanism of many countries in the world[5], it’s an excellent partner in raising funds to fill the national treasury again. Furthermore, it is not a good idea to raise taxes on labour and capital for this purpose as in times of economic hardship employment and investment will be essential to realise a higher economic output.[6]

“Owens et al. (2011) anticipated that a growing part of VAT amongst tax receipts would continue even in post-crisis periods, because personal and corporate income as tax bases need more time to recover."[7]

Following this rationale, it is a realistic scenario that VAT rates will increase after overcoming the most pressing healthcare and economic issues that this crisis is causing. Although this is not 100% certain, the above makes clear that VAT policy and VAT collection play an important role in rebuilding the economy. Governments might now welcome VAT revenue even more than during the earlier mentioned crises as Harvard economist Kenneth S. Rogoff gloomingly predicts that “the 2008 financial crisis was just a dry run for this.”[8] The IMF’s World Economic Outlook Growth Projections confirm this bleak prognose; the IMF projects that the world will suffer an economic contraction of 3%, with the so-called advanced economies even suffering a contraction of 6.1%.[9]

Decrease in compliance, increase in fraud

High taxpayer compliance would enhance the effectiveness of using VAT related measures to mitigate the negative effects of an economic crisis as this would result in higher government revenues. Unfortunately, during times of crisis this compliance is often lower. IMF researcher John Brandolo found, analysing VAT compliance in the European Union between 1995-2008, that VAT efficiency (which is “a measure of the effective coverage of the VAT”) tends to decline during crises, concluding that this is suggestive for a decline in VAT compliance.[10] As governments often raise VAT rates after these crises, it might also be problematic that, in general, a higher VAT rate negatively correlates with lower VAT compliance.[11]

Additionally, during financial crises the amount of fraud, including VAT fraud, committed often increases. This was also apparent during the Great Recession; the EU VAT gap increased from 166.9 billion euro in 2008 to 182 billion euro in 2009. The effect during the European debt crisis was similar; after decreasing to 152 billion euro in 2010, it rose to 171 in 2011 and even 177 in 2012, only decreasing slowly afterwards.[12] Although the cause of the previously mentioned crises and the current crisis are completely different, they have something in common that aggravates the amount of fraud; there is a lack of control.[13] We discussed this lack of control in an earlier blogpost and fraudsters make good use of this. Furthermore, the many economic measures to lower the risk on cash-flow problems for businesses introduced by governments, also serve as an invitation to fraudsters.

Using modern technology to increase VAT revenue

Previously we wrote about the blockchain based invoice reporting system, called TX++, that summitto developed. Although our solution is not the only solution to VAT fraud out there, we hope that by sharing our knowledge we can spark a discussion about what is the best way forward regarding tackling VAT fraud in a confidential way.The implementation of a system such as TX++ can provide a single source of truth for invoices, making it impossible for VAT fraud to go undetected, without infringing on the taxpayer’s right to confidentiality. This could help governments in tackling the current crisis in three ways.

Increasing Government revenue

First, the revenue of the government will increase significantly. The European Commission estimates that EU Member States lose roughly 50 billion euro on an annual basis.[14] This fraud will not go undetected anymore. Furthermore, TX++ will also eliminate non-compliance. Above we argued that non-compliance increases in times of crisis, and after a government decides to raise its VAT rates (something that often happens after crises). The money retrieved from fraud and non-compliance could be used for e.g. more extensive economic aid programmes.

Making SME compliance easier

Secondly, VAT fraud does not only hurt governments, in many cases it also directly damages honest businesses. When a VAT fraudster is caught, businesses that are a part of the fraudster’s value chain can be held liable for the VAT debt incurred if the authorities decide that a business knew or ought to have known that it was taking part in this fraudulent value chain.[15] With an increase in VAT fraud, the risk of becoming part of such a fraudulent value chain is also increasing. With TX++ companies will be compliant by design and honest companies can easily show that they did everything in their power to prevent fraud. This will eliminate the risk for businesses to be held liable for something they were not even aware of. Additionally, honest businesses are also hurt because fraudsters can ask for significant lower prices by not paying any VAT. This hurts honest businesses, as they cannot compete with these unfair prices. TX++ will level the playing field, as businesses will be compliant-by-design.

Making tax authorities more efficient

Lastly, the workforce of tax authorities can be used more efficiently. In the EU roughly 30% of the Full Time Equivalents (FTEs) of tax authorities are used for “audit, investigation and other verification” purposes. By automating the audit process, we estimate that the usage of TX++ can reduce the workload necessary for audit related work by at least 1,636 FTE.[16] These can then be used to increase the efficiency of other departments that are e.g. focusing on the payment of social benefits.

Conclusion

In this blogpost we showed that VAT has played an important role in previous economic crises and also already does in the current coronavirus induced crisis. In times of crisis, countries are often introducing emergency VAT breaks as a fiscal stimulus. In contrast, in the aftermath they tend to increase VAT rates to generate revenues for the treasury. Especially problematic is that during an economic downturn, when governments are in desperate need for funds, VAT compliance decreases and VAT fraud increases. Summitto’s TX++ can help to overcome this problem and to increase overall compliance and VAT revenue. The system detects all VAT fraud committed, minimises non-compliance and improves the efficiency of the tax authority. The resources that become available can then be used where they are needed the most to fight the economic crisis. If you want to know more about summitto and TX++ or if you want to reach out to us for any other reason, please send an email to info@summitto.com.

  1. Richard Asquith (2020). World Turn to VAT cuts on Coronavirus Covid-19 Threat. Retrieved from: https://www.avalara.com/vatlive/en/vat-news/world-turns-to-vat-cuts-on-coronavirus-threat.html

  2. Crossely et al. (2014). Using a Temporary Indirect Tax Cut as a Fiscal Stimulus: Evidence from the UK. Retrieved from: https://www.ifs.org.uk/uploads/publications/wps/wp201416.pdf.

  3. Goes, J., Jongen, E. and Van Loon, E. (2019). Using Temporary VAT Cuts as Fiscal Stimuli - Evidence from the Netherlands. Retrieved from: https://pdfs.semanticscholar.org/5420/a97ab53e733f8f38c02ed0b89289bf5176a0.pdf?_ga=2.100663006.1778605566.1586524320-1750557363.1586524320.

  4. Masca S., G. and Vaidean, V. L. (2019). The Reliance on Budgets of EU Member States on VAT Revenues. Implications in Crisis and Post-Crisis Periods. Retrieved from: https://www.researchgate.net/publication/337558541_The_reliance_of_budgets_of_EU_member_states_on_vat_revenues_Implications_in_crisis_and_post-crisis_periods.

  5. VAT collection will play an important part in rebuilding the economy as on average 17.7 percent the revenue of EU Member States comes from VAT, Eurostat (2019). Main National Accounts Tax Aggregates. Retrieved from: https://appsso.eurostat.ec.europa.eu/nui/submitViewTableAction.do (Accessed 27-11-2019).

  6. A discussion on the way that cuts and increases of the VAT rate should be implemented falls outside the scope of this blogpost. The point here is that there is a rationale to do so and that this rise will probably come after the crisis as well.

  7. Masca S., G. and Vaidean, V. L. (2019). The Reliance on Budgets of EU Member States on VAT Revenues. Implications in Crisis and Post-Crisis Periods. Retrieved from: https://www.researchgate.net/publication/337558541_The_reliance_of_budgets_of_EU_member_states_on_vat_revenues_Implications_in_crisis_and_post-crisis_periods.

  8. Goodman, P. S. (2020). Why the Global Recession could last a Long Time. Retrieved from: https://www.nytimes.com/2020/04/01/business/economy/coronavirus-recession.html.

  9. IMF (2020). World Economic Outlook, April 2020. Retrieved from: https://www.imf.org/en/Publications/WEO/Issues/2020/04/14/weo-april-2020.

  10. Brandolo, J. (2009). Collecting Taxes during an Economic Crisis: Challenges and Policy Options. Retrieved from: https://www.imf.org/external/pubs/ft/spn/2009/spn0917.pdf.

  11. De Mooij, R. and Keen, M. (2013). Fiscal Policy after the Financial Crisis. Retrieved from: https://www.nber.org/chapters/c12646.pdf.

  12. CASE (2013). Study to quantify and analyse the VAT Gap in the EU 27-Member States. Retrieved from: http://ec.europa.eu/taxation_customs/sites/taxation/files/docs/body/vat-gap.pdf

    CASE (2014). Study to quantify and analyse the VAT Gap in the EU 27-Member States. Retrieved from https://ec.europa.eu/taxation_customs/sites/taxation/files/docs/body/vat_gap2012.pdf.

  13. Sanders, J. and Ahmed, I. (2020). Insight: Covid-19-Protecting your Business from VAT Fraud. Retrieved from: https://news.bloombergtax.com/daily-tax-report-international/insight-covid-19-protecting-your-business-from-vat-fraud.

  14. European Commission (2018). VAT: EU Member States still losing almost €150 billion in Revenues according to New Figures. Retrieved from: https://ec.europa.eu/commission/presscorner/detail/en/IP_18_5787.

  15. Deloitte (2018). VAT - Whose liability is it anyway. Retrieved from: https://www2.deloitte.com/ie/en/pages/tax/articles/VAT-whose-liability-is-it.html.

  16. 10% of the average 16,361 FTE which EU tax authorities use.
    OECD (2019). Tax Administration 2019: Comparative Information on OECD and other Advanced and Emerging Economies. Retrieved from: https://read.oecd-ilibrary.org/taxation/tax-administration-2019_311b3bab-en#page134.