The European Union’s sales tax system was thrown into chaos on Tuesday night when three new EU members blocked a deal letting countries apply lower VAT rates to building work and other services.
Unless Poland, the Czech Republic and Cyprus lift their veto by the end of the week, the European Commission says it will take legal action against any country which continues to apply the reduced rates.
The details of the disagreement seem pretty straightforward...
European countries have to apply a minimum 15 per cent VAT rate under EU single market rules, but operate an experiment of reduced rates on a list of five “labour intensive services”. That experiment legally expired on December 31...
Poland, the Czech Republic and Cyprus all wanted to have permission to continue levying reduced VAT rates on a range of items after 2007, when transitional arrangements following their accession in 2004 end.
The list of items included construction work on new and old homes, children’s books and food.
But “old” member states, led by Germany, Sweden and Denmark, demanded the list of items eligible for reduced VAT rates stay as limited as possible, and refused to reopen the terms of the accession treaties of the new members.
... but the economics beneath the dispute may be a little less clear. From the Wall Street Journal:
In theory, the cuts are designed to stimulate consumption, and in particular increase jobs in labor-intensive fields. Without yesterday's accord, construction companies would have raised prices by 15%. UEAPME, a small-business association, estimated that the end of the exemptions would drive much business underground and cause as many as 200,000 job losses.
Economists question the figure and say the impact would have been minimal. Little evidence exists that low taxes lead to creation of jobs, says Silvia Pepino, an economist with J.P. Morgan in London.
Other economists also see a danger of hodgepodge exemptions, with some sectors receiving preference over others. "The more holes, the more distortions you create," says Susana Garcia-Cervero, an economist at Deutsche Bank in London.
Whatever any of this may mean about the balance of power in the EU, the sentiment of Ms. Garcia-Cervero seems about right to me.
UPDATE: Meanwhile, here's some good economic news from Old Europe.