Cut the VAT

It was ironic when last week in the European Parliament I found myself in the middle of a passionate debate during which we were making a strong case for the EU finance ministers to reach an agreement to extend an experiment allowing member states to impose a reduced Value Added Tax rate on labour-intensive services.

The current EU VAT regime, which is up for review, calls on member states to impose a VAT rate which is within the 15 per cent and 25 per cent bracket. The only cases where a reduced rate of not less than five per cent (even though there are exceptions to that) can be applied are on a limited category of goods and services (as negotiated individually by each member state) and on a series of labour-intensive services. The latter were introduced as an experiment in 1999. This experiment has already been extended twice and is now due to expire by year-end. Apart from this, there are a number of temporary derogations granted to particular member states.

The crux of our debate was the labour-intensive services experiment which is soon to expire. This experiment allows member states to apply a reduced VAT rate to up to three out of the following five categories: small repair services, renovation and repair of private housing, domestic cleaning, home help services and hairdressing. An extension of this experiment (which is the compromise position proposed by Parliament) or its formalisation as part of the system, as proposed by the Commission, is yet pending. Unless an agreement is found, the EU could be in for another fiasco since the thousands of jobs created by means of this experiment - especially within small and medium-sized enterprises - could be on the line.

The irony that struck me is that, while a number of European Union member states were experimenting with the idea of reducing VAT on an array of services, the Maltese government was increasing the standard rate by three percentage points to 18 per cent. Furthermore, nobody in the present administration seems to be of the opinion that a reduction in the tax burden can help increase the much-needed economic activity!

In Brussels, I put forward the argument that the reduced rate experiment should not only be retained but also made available to all member states, thus including Malta. I also made a point that more services, namely ecological ones and restaurant services, should be included in the list of labour-intensive services.

At present, only eight "old" member states - namely Austria, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain - are allowed to apply a reduced rate on restaurants. On the other hand, Cyprus, Hungary, Poland and Slovenia were granted permission to maintain reduced VAT on restaurant bills until 2007.

The Maltese government does not seem to be too keen on this. Currently, only seven EU member states - Sweden, Denmark, Finland, France, Belgium, the Czech Republic and Slovakia - have a higher VAT on restaurant services than ours. Those countries whose economy depends more heavily on tourism all charge a lower rate, for example Cyprus (five per cent), Spain (seven per cent), Greece (eight per cent) and Italy (10 per cent).

Apart from having an adverse indirect effect on the cost structure of our tourist product, this system also gives an unfair edge to package holiday operators (which are taxed at five per cent) over independent restaurant owners. The solution is to put both rates at par at the lower tax level.

As I already said, the problem is that the government does not seem to believe that less taxation can help give the necessary impetus to the economy. Once again, the government got it all wrong. In 2000, the Portuguese government, then led by Josè Manuel Barroso, asked for permission to reintroduce a reduced VAT rate on restaurant services "on the basis that maintaining the normal rate had adverse consequences, in particular job losses and an increase in undeclared employment, and that application of the normal rate increased the price of restaurant services for the final consumer" (Directive 2000/17/EC on transitional provisions granted to the Portuguese Republic).

Of course, I already hear those claiming that the state would be forfeiting a part of its income. Monetary and fiscal policy should not be seen as having solely a "cash register" function. They can be used as a tool to facilitate growth. I quote from a publication of the Hotels, Restaurants and Cafes in Europe (HOTREC), of which the Malta Hotels and Restaurants Association (MHRA) is a member: "In the beginning of the 1980s, VAT on hotel accommodation rose from 10 per cent to 23 per cent. This had a dramatic effect on the hotel industry in the country with more than 10 per cent of the hotels closing their doors. Then the authorities decided to reduce the VAT rate on accommodation and meals in March 1985 and July 1986 respectively. This cut greatly contributed to the growth of the hotel and catering industry in Ireland. The Irish example is very characteristic of a case where a cut in VAT (also) resulted in an increase of VAT receipts for the state. In fact, the tax intake from overseas tourism by the Irish government, which was IRP254 million when VAT was levied at the standard rate on tourism, rose to IRP818 million in 1996 when VAT had fallen to 12.5per cent".

Furthermore, such a move helps shrink the black economy, reduce illegal labour and bring people in legitimate employment.

This is a policy option that any government worth its name should actively consider. The Maltese government should have the guts to cut back the standard VAT rate it increased not so long ago and also introduce reduced rates wherever possible.

Tax rates review seems to be a regular issue on this government's agenda. The problem is that these reviews always end up with higher rather than lower tax rates.

Mr Muscat is a Labour member of the European Parliament.

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