As the American statesman, diplomat, and scientist Benjamin Franklin said in 1789, “In this world, nothing is certain except death and taxes.” And he was right. Rest assured, this article is not about death or any such topic. Alas, this article is about taxes, specifically about value-added tax, or VAT. VAT is a tax that almost no European can escape. However, despite being a pan-European tax phenomenon, there are significant differences in its forms across Europe.
The origins of value-added tax can be found in France and Germany during the First World War. However, the current form of value-added tax was introduced some 30 years later, coincidentally again in France. In 1958, the French introduced the first value-added tax, which gradually spread throughout Europe and the rest of the world.
Nowadays, over 160 countries across the world have adopted and are using VAT. VAT accounts for most government revenue in some countries: France is one example, with 50% of its revenue coming from it. In the Czech Republic, value-added tax accounts for 20 % of government revenue.
“Hidden” tax and her American cousin
VAT is an indirect consumption tax. It is applied to goods and services and is a main hallmark of the European tax system. It is a hidden tax, even though it’s in plain sight. Yet, some people are absolutely unaware that they pay the tax on every purchase. When consumers go to a store in Czechia and want to buy bread, they look at a price tag of CZK 45 (EUR 1.90). The consumer subconsciously knows, but does not see at first glance, that VAT of 15% is already included in this price. In the case of the bread, it is around CZK 7 (30 euro cents).
In the United States, for example, there is a system of so-called sales tax. This tax is paid directly at the time of purchase by the consumer. Its amount varies from US state to US state. It is, therefore, different in Texas than in New York. But the most significant difference is that Sales Tax is not listed on the price tag in the store. The customer then buys the item for $5, and the 7% tax is added to the price at the checkout. Americans are thus reminded with every purchase how much tax they pay.
Three Seas and their VATs
As we said earlier, VAT is a very complicated and territorially distinct issue. It could also be described as “One tax, multiple rates.” Part of this complication comes from the European Union, which regulates and sets specific rules regarding VAT. For example, the EU requires member states to have a minimum standard rate of 15%. The second rule is to set a minimum threshold of 5% for the reduced rate. Thus, the standard rate must not be lower than 15%, and the reduced rate must not be lower than 5%. As the most straightforward summary, the following table shows the current status (June 2023) of value-added tax across the Three Seas Initiative countries.
The table shows that even the 12 countries of the Three Seas Initiative are very differentiated on VAT. People in Romania pay the lowest standard VAT at 19%. In contrast, Hungarians pay the most on standard VAT. Unfortunately, even this table does not show everything there is to know about VAT in the Three Seas Initiative Region.
Czechia, for example, is not a very flattering frontrunner in the taxation of essential foods. While all other countries tax food at the lower of the reduced VAT rates, the Czech Republic uses a 15% rate. This is the highest food taxation in both the Three Seas Initiative and the European Union.
The most radical changes in value-added tax are planned in the Czech Republic. The Czech Republic has used value-added tax since 1 January 1993. That is, since the establishment of independent Czechia and the dissolution of Czechoslovakia. These changes are part of the so-called consolidation package of the Czech government. This package aims to reduce the government’s record deficits, reduce the pace of borrowing and improve public finances.
From 1 January 2024, the current three VAT rates will be split into two: a standard rate of 21% and a reduced rate of 12%. The reduced rate is a political compromise between the current reduced rates of 15% and 10%. And even if this change does not seem very fundamental, it is the most significant change to the tax system in decades. Many people’s lives (and, more importantly, budgets) will change dramatically.
Many goods and services they got used to buying will get more expensive thanks to the proposed recategorization of products and their tax regimes. Even though the package and the tax reform are still work in progress, many wonders why should the same rate as sweet drinks tax infant water. The only major exception will now be made for books, which will move from the reduced rate of 10% to the tax-free regime: they will not be subject to VAT. However, the abolition of the two reduced rates makes it necessary to reconsider the taxation of certain vital goods and services.
Czechia as a rolemodel?
This is where the problem begins. As well as being an excellent tool for an easy and stable source of revenue across the countries that use it, VAT is an explosive political issue. Too many interest groups are trying to push their products into the lower tax rate. And the most influential interest group, the voters, are the most vocal. Yet, their voices are seldom heard.
Therefore, it is questionable whether the system’s realignment will succeed in Czechia without significant political and economic turbulence. And who knows? The Czech model may prove successful and will be followed by other countries of the Three Seas Initiative, Europe, and the world.