Value-Added Tax

Value-added tax (VAT) is a key source of government revenue. However, the current system, with its numerous reduced VAT rates, has been widely criticized from both an economic and an administrative perspective. On behalf of the German Federal Ministry of Finance, a research team at ZEW conducted a criteria-based evaluation of the most important reduced-rate provisions. The study examined whether the existing tax concessions can be justified by robust arguments, such as relieving low-income households or safeguarding competitiveness. The assessment was based on several criteria, including policy objectives, instrumental suitability, distributional effects, administrative costs, positive externalities, and competition-related considerations.

The analysis shows that only a few exceptions are convincing. The largest reduced-rate subsidy in terms of fiscal volume — the reduced VAT rate on food — does provide relief for lower-income households. However, targeted transfer policies would generally be more efficient and less costly. By contrast, other tax concessions appear far less justifiable. In particular, reduced VAT rates for short-term accommodation services cannot be supported by evidence of substantial benefits for low-income households, relevant positive externalities, or significant international competitive pressure. A similarly unfavorable assessment applies to the reduced rate for selected agricultural and forestry supplies, whose business-to-business character and overlap with the food subsidy make meaningful redistributive effects unlikely.

The experts consulted in the study also emphasize that differentiated VAT rates create significant systemic problems. The large number of exceptions increases administrative complexity, creates legal uncertainty, and facilitates tax evasion. In addition, the system generates structural incentives for lobbying, contributing to what the study describes as a “spiral of tax concessions.”

ZEW therefore evaluates three revenue-neutral reform options. A complete abolition of all reduced VAT rates would lower the standard VAT rate to 16.74%, but would disproportionately burden the poorest households. Two alternative proposals show considerably more moderate effects. Retaining the reduced rate on food while abolishing all other reduced rates would lower the standard rate to 18.14%. The third option — abolishing reduced rates for restaurant, catering, and accommodation services — would result in a standard rate of 18.55%. Under this scenario, the additional burden on the lowest income decile would be close to zero, while higher-income households would bear a relatively larger share of the burden.

The report concludes by recommending a conceptual realignment of the VAT system. A leaner and more transparent system with only a few systematically justified exceptions would improve efficiency and simplify administration. The findings suggest refocusing VAT on its core function as a broad-based consumption tax, while replacing sector-specific special provisions with more targeted instruments within the transfer system. A gradual rollback of the numerous reduced VAT rates is therefore considered urgently necessary in order to reduce distortions and strengthen the coherence of the tax system.