Taxation of Financial Services under a VAT

Abstract

In simple economic models, it is relatively easy to describe how to impose a value-added tax at a uniform rate on all consumption goods, and to demonstrate that this tax is equivalent to a proportional labor income tax, plus a tax on existing assets. The equivalence involves little more than the national income identity relating the sources and uses of income. Once one attempts to incorporate the costs of financial intermediation, however, tax analysis becomes more complicated.In attempting to determine how a VAT should treat financial transactions, various authors have attempted to apply results from simpler models. Unfortunately, these results can lead to conflicting, ambiguous, and misleading prescriptions. In this paper, we argue that one needs to rely more on the fundamental objectives of a VAT to decide how it should treat financial transactions. Adopting this approach, we find that, in principle, the VAT should apply to resources devoted to financial transactions in the same manner that it does in other sectors. As discussed below, there are real problems, however, in implementing such a tax on the financial sector that we do not attempt to address in this paper.

Opting for Opting‐In? An Evaluation of the European Commission's Proposals for Reforming VAT on Financial Services*

“…Specifically, from a legal perspective, exemption for financial services gives rise to definitional and interpretative problems, creates difficulties in calculating the portion of deductible VAT, constitutes an incentive for engaging in aggressive tax planning, and has the additional problem of being conceptually incoherent with the general principles of the European VAT system. From an economic perspective, exempting financial services from VAT is regarded by most as a contravention to the principle of VAT as a general tax on consumption (Auerbach and Gordon (2002)). In particular, exempting any good or service results in a break of the VAT chain, tax cascading, bias towards self-supply, bias towards foreign suppliers, possible loss of potential tax revenue, and what is known as "creeping-exemptions" phenomenon (Ebrill et al(2001), Chapter 8, and de la Feria, (2007), pp.…”

The Collection Efficiency of the Value Added Tax: Theory and International Evidence

“…Alternatively, the variation in the political economy variable, among the high income countries, is not sizable enough to matter for explaining the tax efficiency. It is also possible that given the importance of, and difference in, the level of financial openness across countries, the actual implementation of VAT on financial services involves different problems in developing countries, than exist in high-income countries (on taxation of financial services under a VAT, see Auerbach and Gordon 2002). Table 4 reports cross-country OLS regressions, which, given data limitations, allow us to explore the association between VAT collection efficiency and income inequality.…”

Value Added Tax between Reality & Ambition

“…(2) The tax applies to all stages of production, but do not infect only the value added to the value of production, Tax levied on the difference between the price at which it sold goods and services produced and the cost of production employed by. Used in the production of these goods and services and in every stage of production.…”