Influence of Different Purposes of Value Added Tax and Personal Income Tax on an Effective and Efficient Use of Tax Incentives: Taking Tax Incentives for the Arts and Culture as an Example
VALUE ADDED TAX AND DIRECT TAXATION. SIMILARITIES AND DIFFERENCES, pp. 35-57, Michael Lang, Peter Melz and Eleonor Kristoffersson, eds., IBFD, 2009
16 Pages Posted: 15 Nov 2011
Date Written: April 1, 2009
The classical purpose of taxation is to raise revenue to meet government expenditure. At first sight one might argue that in this respect there is no difference between direct taxes and value added tax (VAT). However, within the European Union even in this respect there is a difference in purpose. Where direct taxes are raised to meet expenditures of national governments (including expenditures of local or regional governments, all within the borders and sovereignty of the state), part of VAT revenue is raised to fund expenditures of the European Union, at supranational level, and falls outside the sovereignty of the individual member states. Furthermore, in modern democratic states the ideal is that tax is raised in a fair and equitable way. In such states every citizen must contribute his or her fair share to government expenditures. However, ‘fair’ and ‘equitable’ are not fixed terms and may be defined differently, depending on the purpose of a tax.
Besides the classical function, tax legislation is also used for other auxiliary or subsidiary functions. Such auxiliary purposes include redistribution of wealth, influencing behaviour and producing specific effects. Not all tax academics are convinced that taxes should be used in an instrumental way. General complaints are that such special tax measures complicate tax legislation, that not enough information and democratic control is imposed on tax incentives, and that tax incentives are preferred by pressure groups as these are often perceived as free lunches. However, in some cases tax incentives may be a more effective and efficient means of achieving policy goals than direct subsidies, prohibitions or other policy instruments. And given the fact that most, if not all, countries take as a basic principle that some amount of government intervention (varying in degree between countries) in order to change perceived shortcomings in the economy and society is desirable, it is, in my view, not really constructive to take the position that tax laws may only be used for the budgetary function and not for other purposes. It is a political fact that taxes are used for other purposes than to raise money for the government. However, the basic principles or purposes of a tax law may make such a law less suitable for the attainment of certain policy goals.
The question is, whether a difference in purpose of VAT and direct taxes influences the potential for governments to make effective and efficient use of tax incentives in such tax legislation to reach certain policy goals. An effective and efficient use in this sense means that the government funds applied through the tax incentive (i.e. the forgone tax income because of the incentive, resulting in a smaller spending capacity of the government) are spent on the intended objects at the lowest cost. If part of the money is not spent in accordance with the policy goals, this causes waste of funds. If the purpose of the tax law causes such waste, a tax incentive in that tax legislation is not an effective or efficient way of pursuing a policy goal. In this paper I will focus on taxes levied in the member states of the European Union, as the EC Treaty and the supranational character of VAT influence the purpose of the legislation of the member states and set limits for the use of tax incentives.
As VAT is, in general, intended to tax consumption of individuals, in my view the most meaningful comparison in this respect is with the personal income tax and wealth tax, as these direct taxes are also aimed at private individuals. I will refer to these direct taxes with the abbreviation PIT, following the Dutch practice of including the wealth tax in the personal income tax. As a first step in testing the question whether a difference in purpose influences the effective use of tax incentives and in order to be able to remain within the limits of this paper, I will focus the comparison on cultural policy goals. This object of government policy has not been given much attention in tax literature, notwithstanding the fact that many countries use their tax laws to pursue such objects. For example, countries have included tax incentives for (the making of) films, preservation of cultural heritage and gifts to cultural institutions in their tax legislation. The EC VAT Directive explicitly allows for reduced rates for several cultural goods and services, for example, certain works of art, books and entry fees for cultural institutions and most member states make use of several of these possibilities. Another reason to focus on cultural policy goals is that these do not really fit in the main purpose of PIT or VAT. It is therefore interesting to examine the impact of the main purpose of these tax laws on the effectiveness of measures aimed at such goals alien to this main purpose.
The central question of this paper is, therefore, whether a difference in purpose of VAT and PIT influences the potential for governments to make effective and efficient use of tax incentives to pursue cultural policy goals. In paragraph 2 I will start with a discussion of the purposes and the equity principles underlying PIT and VAT and the consequences of these purposes for the potential to use the tax law to achieve policy goals other than raising revenue to meet government expenditure. Next, in paragraph 3 I discuss whether the purpose of PIT influences the effective use of tax incentives, also taking into account limitations set by EU legislation. In paragraph 4 I do the same for VAT, after which I come to a conclusion in paragraph 5.
Keywords: tax law, tax incentives, value added tax, personal income tax
JEL Classification: K34, H21
Suggested Citation: Suggested Citation