A European VAT on financial services?

Abstract:

EU financial services are exempted of VAT for technical reasons. This paper argues that the changed nature of bank-client relationships and advances in information technology have opened the door to a practical way of redressing this exemption. The proposed solution is to charge the regular VAT on services supplied to households, but no VAT on those supplied to businesses, while allowing financial institutions the normal VAT credit for all of their purchased inputs. Financial services would, as a result, be priced differently for households and businesses so banks would have to verify their customers' VAT status. While this may be burdensome, the OECD-wide fight against tax evasion and the international struggle against terrorism have forced financial institutions to know much more about their clients. Verifying clients' VAT status should thus be fairly simple. The paper also evaluates the economic impact of reform and finds that reform would significantly increase VAT revenues, while having little impact on overall welfare. Households would see an increase in the price of financial services but given the relatively high incomes of mortgage takers, the burden of the tax would be approximately proportional across income classes.