Welfare Effects of Value-Added Tax Harmonization in Europe
A Computable General Equilibrium Analysis
With 17 Figures
Springer-Verlag Berlin Heidelberg New York London Paris Tokyo Hong Kong Barcelona Budapest
Dr. Hans Fehr University ofTübingen Department of Economics Mohlstraße 36 72074 Tübingen, FRG Dr. Christoph Rosenberg International Monetary Fund 700 19th Street NW Washington, DC 20431, USA Professor Dr. Wolfgang Wiegard University ofTübingen Department ofEconomics Mohlstraße 36 72074 Tübingen, FRG
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Introduction .......................... .......................... 1 Chapter I
An Introduction to Value-added Taxation . ......................................... 5
1. The Development of Value-added Taxation in the European Union ............................................... 6 1.1. From the Beginnings to the White Book ................... 6 1.1.1. The Development of Turnover Taxes in Europe ........................................... 6 1.1.2. The Treaty of Rome ................................ 9 1.1.3. Creating a European Value-added Tax ............. 11 1.2. The VAT Harmonization Debate Since 1985 .............. 14 1.2.1. The White Paper .................................. 14 1.2.2. The 1987/89 Harmonization Proposals ............. 16 1.2.3. A Tough Compromise: The Transitional System ............................................ 17 1.2.4. What Comes After 19967 .......................... 20 2. Principles of Value-added Taxation ............................ 21 2.1. Types of Value-added Taxes .............................. 22 2.2. The Rate Structure of a Value-added Tax ................. 24 2.3. Calculating Tax Liabilities ............................... 26 2.3.1. The Credit or Invoice Method ...................... 26 2.3.2. The Addition and the Subtraction Method ............................................ 28 2.4. International Taxation Principles for VAT ................ 30 2.5. One Further Issue in Value-added Taxation: Exemption Versus Zero Rating ........................... 36 3. Questions and Answers: The Plan of the Book ................ 37 3.1. The Questions ........................................... 37
VI
Contents
3.2. The Methodology: Computable General Equilibrium Analysis ..................................... 39 3.3. The Chapters to Come ................................... 40 3.4. Related Work ............................................ 41 Chapter II
VAT Policy Options for an Integrated Europe ............................. 45
1. Some Basic Elements of our Model ............................ 46 2. The 2.1. 2.2. 2.3.
Destination Principle ..................................... 50 Some Institutional Features .............................. 50 A Numerical Example .................................... 51 A More General Formulation ............................. 52
3. The Transitional System ...................................... 55 3.1. Main Institutional Features ............................... 56 3.1.1. Intra-community Supplies and Acquisitions ................................... 56 3.1.2. Means of Transport ................................ 57 3.1.3. Distance Sales ..................................... 58 3.2. A Numerical Example .................................... 61 3.3. A More General Formulation ............................. 63 3.3.1. The Switching Option .............................. 63 3.3.2. The Mixed System ................................. 65 4. The 4.1. 4.2. 4.3.
Origin Principle and the Credit Method .................. 65 Some Institutional Features .............................. 65 A Numerical Example .................................... 69 A More General Formulation ............................. 73 4.3.1. The Common Market Principle .................... 73 4.3.2. The Clearing System ............................... 75
5. The Origin Principle and the Subtraction Method ............. 78 Chapter III
Theoretical Foundations ..................... 81
1. The Command Optimum ..................................... 82 2. Tax Distortions ............................................... 85 2.1. Tariffs, Income Taxes, and Production Taxes ............. 85
Contents
VII
2.2. Destination-based VAT ................................... 87 2.3. Origin-based VAT under the Credit Method .............. 89 2.4. Origin-based VAT under the Subtraction Method .................................................. 93 3. Trade Neutrality and the Exchange Rate Argument ........... 95 3.1. Trade Neutrality ......................................... 96 3.2. The Exchange Rate Argument ............................ 98 4. Welfare Effects of VAT in Open Economies .................. 104 Chapter IV
From Theory to Application: A Computable General Equilibrium Model ....... 113
1. Operationalizing Walras with CGE Models ................... 114 2. The Theoretical Model ...................................... 117 2.1. The Production Sector .................................. 118 2.1.1. Value Added and Composite Intermediate Products ................................. 120 2.1.2. Primary Input Demand ........................... 120 2.1.3. Demand for Domestic and Imported Composite Inputs ................................. 121 2.1.4. Demand for Imported Inputs ...................... 123 2.1.5. Calculating Producer Prices Under the Tax Credit Method ........................... 123 2.2. The Household Sector ................................... 126 2.2.1. Calculating Price Indices .......................... 128 2.2.2. Demand for Leisure and Consumption ............ 129 2.2.3. Demand for Different Consumption Commodities ..................................... 130 2.2.4. Demand for Domestic and Imported Commodities ..................................... 131 2.2.5. Demand for Different Imported Commodities ...... 132 2.3. The Public Sector ....................................... 133 2.3.1. Public Revenues .................................. 133 2.3.2. Public Expenditure ............................... 134 2.4. The Foreign Sector ...................................... 135 2.4.1. Balance of Payments .............................. 135 2.4.2. Terms of Trade ................................... 136 2.5. Equilibrium Conditions of the Model .................... 137
VIII
Contents
3. A Micro-consistent Data Set for the EU ...................... 140 3.1. Consistency Requirements and Data Sources ............. 140 3.2. Data Adjustments ...................................... 143 3.2.1. Updating the Intermediate Transaction and Final Demand Tables ......................... 143 3.2.2. Value Added by Industry ......................... 146 3.2.3. Government Revenues and Expenditures .......... 147 3.3. Some Final Remarks .................................... 151 4. Model Calibration ........................................... 151 4.1. Specification of Exogenous Parameter Values ............ 152 4.2. Calibration ............................................. 153 4.2.1. Calibration in the Production Sector .............. 155 4.2.2. Calibration in the Household Sector ............... 156 Chapter V
Simulation Results and Economic Interpretations ................................ 161
1. Some Methodological Issues .................................. 162 1.1. Reliability of CGE Results .............................. 162 1.2. Measuring Welfare Changes from Tax Reforms .......... 164 2. The Transitional System ..................................... 166 2.1. The Switching Option ................................... 167 2.2. The Mixed System ...................................... 172 3. The Origin Principle and the Credit Method ................. 175 3.1. The Common Market Principle .......................... 175 3.2. The Clearing System .................................... 178 4. The Origin Principle and the Subtraction Method ............ 184 4.1. Welfare and Revenue Effects ............................ 184 4.2. Equivalence of Statutory Tax Rates on Value Added and Effective Tax Rates on Consumption ......... 186 4.3. Effective Consumption Tax Rates in General Equilibrium: An Example ............................... 191 4.4. Decomposing and Explaining Welfare Effects ............ 196
Contents
IX
5. Some Sensitivity Analysis .................................... 200 5.1. Varying Key Parameter Values .......................... 202 5.2. Varying the Data Set ................................... 207
Chapter VI
Summary and Conclusions .................. 211
List of Abbreviations ........................................ 217 Glossary of Notation ........................................ 219 The Debate about Value-added Taxation in the European Union: Timetable of Events since 1985 ........ 225 References .................................................... 227