The EU VAT Rate Reform 2022 from an Environmental Policy Perspective

Abstract

We live in a time of multiple crises. Some of them can be expected to have (hopefully) only a temporary impact on our economies, health, societal bonds and personal safety. In particular the effects of climate change, however, are likely to negatively affect our prosperity and well-being also in the medium and long term. In order to counteract these developments, we should make use of all tools available, including tax-related measures. Consumption taxes such as the European Union (EU) value added tax (VAT) are frequently featured in related discourses.

In April 2022, the Council of the European Union adopted the Amending Directive (EU) 2022/542 to reform the rules on tax rates in the EU VAT Directive. These actions are predominantly aimed at giving the Member States more flexibility in the setting of VAT rates. Another target of the recent EU VAT rate reform is to align the EU VAT Directive with other EU politics, such as the European Green Deal.

The environment-related measures in the reform package to deliver on the latter objective follow a two-pronged approach. On the one hand, the EU Member States have been authorized to apply zero, super reduced or reduced tax rates to certain environmentally friendly goods and services. On the other hand, preferential VAT treatment of certain environmentally harmful supplies is to be phased out. These combined measures are intended to incentivize eco-friendlier forms of consumption or, conversely, discourage environmentally harmful consumption patterns, thereby contributing to building a climate-neutral and green economy.

The good will of the EU legislator to make the EU VAT system fit for the green transition is undisputed. Nevertheless, it should be investigated whether and which of these VAT-related measures are actually (and entirely) capable of making a meaningful contribution to achieving the envisaged goals. Even if this should be the case, it further ought to be evaluated whether they can be considered an effective – or even the most effective – means for these purposes.

Against this background, this paper sets out to assess the environment-related measures of the EU VAT rate reform 2022 from an environmental policy perspective. An overview of the main characteristics of the EU VAT rate reform 2022, followed by a detailed description of the specific environmental measures, forms the basis for the subsequent analysis, which builds on the empirical evidence and scientific knowledge developed in the context of earlier VAT rate reforms. This body of research indicates the importance of a differentiated approach in assessing the green measures of the recent EU VAT rate reform. Accordingly, VAT increases for certain environmentally harmful supplies stemming from the phasing-out of preferential VAT regimes are likely to be passed on to the consumers, thereby sending the intended price signal. Nevertheless, the availability, accessibility and affordability of green alternatives, as well as the complementary use of other, more targeted instruments to accelerate the green transition, remain issues which need to be addressed. Conversely, it is questionable whether VAT reductions based on the options of the Amending Directive (EU) 2022/542 will be reflected at least partially in product prices. Even if this could be answered in the affirmative, there are several other aspects which national lawmakers should take into account. With regard to the intended effect of providing a financial incentive through a price signal, it should be noted that such VAT cuts constitute rather blunt policy instruments to achieve environmental goals, as they subsidize less-affluent and wealthier households alike. Furthermore, it is unclear whether simply lowering VAT rates will make relatively larger green investments more affordable for lower income and wealth groups, so that additional direct financial support is not required. Depending on the characteristics of the respective national economy, the effectiveness of environment-related rate decreases could be further hampered due to excessive price gaps and/or market saturation. As with all VAT rate differentiations, it is to be expected that these VAT reductions would additionally result in increased administrative and compliance burdens as well as new opportunities for VAT evasion and fraud. For all these reasons, VAT decreases may not be seen as an efficient means of achieving environmental goals. Even worse, they would add to existing financial constraints in times of great economic hardship, when the Member States need sufficient public funds to be able to, inter alia, make the necessary investments to achieve the EU climate targets. Based on these observations, the author argues that the Member States should be cautious when considering making use of the options offered by the EU VAT rate reform 2022. Instead of succumbing to pressure from lobby groups or the temptation to seek easy political gains, politicians should live up to their responsibility to create and maintain healthy and sustainable living environments in harmony with nature also for future generations. This requires that the intended benefits of environment-related VAT reductions are carefully weighed against the expected costs and risks, that science-based policies are pursued and that these strategies are communicated clearly and convincingly, in order to gain the trust and acceptance of the citizens for the chosen path. The paper closes with a summary of the main findings.