Freedom fighters
Reforms to VAT may lead to a more democratic but convoluted system
May 14th 2016
IN THE battle to smash the patriarchy, feminist campaigners have found an unlikely ally: the European Commission. Their gripe is with the tampon tax, the minimum 5% rate of value-added tax (VAT) on sanitary products imposed by European law. This is tantamount, in their eyes, to a tax on women—and worse, one which European governments have no power to undo. But new proposals on VAT reform from the commission may change that.
The European Union has no authority over income and payroll taxes, but great authority over VAT. Members must apply a standard VAT rate of no less than 15%; they can have up to two concessionary rates, of at least 5%, but these can only be applied to certain goods, including food, books and medical equipment. There are numerous exceptions to these rules (Ireland exempts tampons from all VAT, for instance), but they were negotiated by the countries concerned upon joining the EU.
This system of centrally imposed exceptions is an odd compromise between two sensible but incompatible goals. It is not very flexible or democratic, as governments have only limited scope to modify the system. But it is not simple or coherent either: rates on a single item can vary wildly (see chart). Moreover, the past 40 years have seen 750 court decisions interpreting VAT law. Surely the European Court of Justice has better things to do than mull Poland’s refusal to levy VAT on disinfectants or France’s low rate on early performances at theatres with bars?
The effort to minimise the variation in rates stems from a time when VAT was charged according to the rate in a product’s country of origin, rather than where it was bought. The commission did not want countries to give their manufacturers a leg-up (or to poach firms from other members) by setting lower VAT rates on their wares. But since it is now the VAT rate in the purchaser’s country that applies, there is no longer any risk of that. Consumers, after all, are relatively immobile, despite the odd cross-border shopping trip.
The commission has proposed two options for reform, both of which hand more VAT-setting power to national governments. The first would maintain a central list of items on which reduced rates are allowed, but expand it and review it more often. It would also rationalise the rules, by letting any country charge the lowest rate on a given item that applies anywhere else in the EU. Britain, for example, could exempt tampons from VAT, as Ireland does.
The second option is more radical: it would scrap the list, and transfer VAT-setting powers to national governments. There would be limits—if countries started applying sweeping carve-outs in an effort to entice shoppers over the border, the commission might intervene—but otherwise countries would be free to adopt as many rates and exemptions as they liked.
No country currently applies the minimum 15% standard rate (the average is 21%), so it seems unlikely that governments would take the opportunity to lower rates across the board. Rather, they would probably tinker: since the crisis there has been an increase in the number of countries using two reduced rates, from 14 out of 28 in 2007 to 19 this year. Analysis from the Centre for Social and Economic Research found that in 2013 countries sacrificed a median of 11.3% of potential VAT revenue via reduced rates. If the current restrictions were lifted, discounts and exemptions would presumably proliferate, to the delight of special interests.
Although such concessions may be good politics, they are sloppy economics. The more exemptions there are, the higher the standard rate has to be to raise the same amount of revenue. Different rates also distort people’s spending, penalising some industries and rewarding others. It is an inefficient way to redistribute: when Sir James Mirrlees, a Nobel-prize-winning economist, reviewed Britain’s tax system, he found that the government could scrap all concessionary rates, compensate the losers and still bring in £3 billion ($4.8 billion) more.
Grzegorz Poniatowski, an economist, notes that a proliferation of reduced rates provides more scope for tax dodging by misclassifying products as low-rate items. For Patrick Gibbels of the European Small Business Alliance, “there is too much fragmentation.” Encouraging a multitude of different systems could create an administrative burden, which would be particularly onerous for small businesses of the sort that Europeans are keen to cultivate. He prefers the first, more cautious option.
But Pierre Moscovici, the commissioner in charge of VAT, prefers the more radical option. Even if governments do not use the extra freedom wisely, there is a case for letting them make their own mistakes.
Beyond OPEC
The kingdom’s new oilman-in-chief will have less time for the cartel
May 14th 2016 |
KHALID AL-FALIH is a busy man. When he met The Economist in Riyadh in April, he was sitting in the sprawling office from which he was running the health ministry. But the subject was the part-privatisation of Saudi Aramco, the world’s biggest oil company, whose board he also chairs. And then there was the big football match—Manchester City v Real Madrid—to rush home to watch.
Since then his focus has narrowed a little. On May 7th the 55-year-old was moved from the health ministry to what had been known as the oil ministry, but is being renamed the Ministry of Energy, Industry and Mineral Resources. That gives him oversight of the kingdom’s ambitious drive to take its economy beyond oil. It also makes him the de facto head of OPEC, the oil cartel. He is only the fifth person to head the ministry, after legendary predecessors such as Ali al-Naimi, who kept prices from rocketing during the second Gulf war, and Zaki Yamani, who devised the Arab oil embargo of 1973. Those men were defined chiefly by their influence over OPEC, and hence over global oil markets. Mr Falih will hope for a different legacy.
Speculation is already rife that his appointment marks the start of a new Saudi push to pump more oil. The abrupt removal of Mr Naimi follows his effort last month to forge an agreement to freeze oil production between OPEC and non-OPEC producers such as Russia—an effort that was foiled by Muhammad bin Salman, the deputy crown prince. King Salman’s son, and the power behind the throne, saw no reason to freeze output unless Iran, the kingdom’s strategic rival, did likewise. Shortly afterwards Amin Nasser, Aramco’s chief executive, cheered oil-price bears by saying the company would raise output by 250,000 barrels a day from its Shaybah oilfield.
INTERACTIVE: Explore how oil prices affect OPEC and non-OPEC production and viability
But Mr Falih (pictured) comes across as too measured to create uproar. Although Prince Muhammad calls the shots, it is possible that he will listen to the soft-spoken, Texas-educated technocrat who has been in the oil industry longer than the 30-year-old prince has been alive. The new minister may want to expand Saudi Arabia’s output, but not so much to intensify the price war as to give himself the capacity to respond to seasonal surges in domestic demand and to fend off competition from Iran and Iraq to export to China and India. Mr Falih says Saudi Arabia will look at the “most responsive ways” to meet its customers’ needs. For instance, it typically sells oil through long-term contracts, but recently made its first spot sale in response to Asian demand.
What is more, shaping the global oil market may become less of a priority because Mr Falih has a huge new responsibility at home: preparing an initial public offering of Aramco. He is also in charge of plans to develop domestic refining, petrochemicals and other industries and to boost the production of renewable energy. This will require big improvements in the rule of law and corporate governance—not Saudi Arabia’s strengths. Prince Muhammad says he is agnostic about oil prices, because his aim is to move beyond oil. Whether or not he achieves that, Mr Falih’s focus will be beyond OPEC.
Triple whammy
Low interest rates, market turmoil and restructuring: it’s too much
May 14th 2016 |
IF YOU think America’s banks are having a rough year, take a look at Europe (see chart). American lenders’ share prices, having rallied from their trough in mid-February, are 6% lower than at the start of 2016; European ones are over 20% down. So miserable has the first quarter been that investors have applauded figures that beat dire expectations. On May 10th Credit Suisse, a Swiss giant, reported a second successive quarterly loss—and was rewarded with a 5% bounce in its shares.
Europe’s banks are struggling with a triple squeeze. First, ultra-low interest rates are thinning their staple diet, the margin between borrowing and lending. Monetary policymakers argue that by stimulating the economy and hence demand for loans, super-cheap money is also good for banks. For most, not yet. Commerzbank, which styles itself as German companies’ house bank, calls demand for loans “subdued”: the operating profit of itsMittelstand division fell by more than 40%, year on year, in the first quarter.
Second, other rations have also been short. The market turmoil of the first six weeks of the year walloped investment-banking revenues on both sides of the Atlantic. The Europeans broadly came off worse; Barclays’ 4% decline almost counts as a triumph. European banks lack the scale of the Americans, and that may be counting against them. Huw van Steenis, an analyst at Morgan Stanley, expects that this year their investment-banking revenues will tumble by 12%, twice as fast as those of their American rivals.
Market volatility dampened non-interest earnings in retail banking, too. With their savings earning zilch, Europeans should be keener to buy mutual funds in search of higher returns. That would mean more commission for banks, which in Europe are big sellers of investment products. But jumpy share prices have given savers pause. (American banks, by contrast, rely more on credit-card and account fees, so have not suffered in the same way.)
Rich customers have been as unadventurous as humbler ones. In the first quarter UBS, Switzerland’s biggest bank, which a few years ago scaled back its investment bank to concentrate on wealth management, attracted a staggering SFr29 billion ($29.3 billion) of net new money, the most for eight years, much of it from Asian clients. But because the wealthy too sought the safety of cash, UBS did not scoop the juicy transaction fees that come with shuffling portfolios. Pre-tax profit at its wealth-management divisions fell by 23%. That said, the squeeze on non-interest revenues should ease, now that markets are steadier.
The third cause of European banks’ pain is bad timing, often their own. With income tight—and with regulators demanding that they build up their capital ratios—control of costs matters all the more. More basically, so does choosing which businesses to be in and which to quit. Alas, only now are some of Europe’s biggest lenders, under new leaders, taking on the spring-cleaning American banks carried out within a few years of the financial crisis. For both investors and bankers, that is making 2016 extra-painful.
Deutsche Bank, Germany’s biggest, will slough off Postbank, a retail business it bought in 2008 and never fully integrated, and is cutting back its once-swaggering investment bank. It will not pay a dividend for 2016 and although it eked out a first-quarter profit of €236m ($260m) it expects only to break even this year.
Credit Suisse is hurting most. Its boss, Tidjane Thiam, an ex-insurer, is tilting it, like UBS, further from investment banking towards wealth management, with special emphasis on Asia. He has made an uncertain start. Having announced one strategic overhaul, he had a second crack in March, speeding up the disposal of investment bankers and ditching risky products he at first planned to keep. On his watch the share price has dived by more than 40%. It jumped this week partly because the cull is ahead of schedule. Parsimony used to be a dirty word in banking. It isn’t now.
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