Ending VAT Exemptions : Towards a Post-Modern VAT

The proliferation of exempt supplies in VAT systems, particularly the traditional European VAT, undermines the integrity of the tax in many respects. Exempt supplies bear a tax burden equal to the input tax imposed along the supply chain up to the exempt supply. This leads to overtaxation of business customers and undertaxation of final consumers. The neutrality of a benchmark VAT is replaced by economically inefficient biases and distortions. Unclear borderlines between exempt and taxable supplies increase compliance costs and administration costs. This paper reviews the types of exempt supplies that fall into two broad categories -- merit or concessional exemptions such as those for education or health services, designed to reduce taxation to achieve social benefits, and those adopted for technical reasons including exemptions for immovable property and financial supplies. It explains the origins of the exemptions and explores reform options to bring exempt supplies within the ordinary system of taxable supplies with full input tax recovery for businesses