Reduced VAT Rates and Exemptions: Is VAT Always the Tool for the Job?

Árni Sverrir Hafsteinsson

Student thesis: Master thesis


Most countries employ multi‐rate Value‐Added Taxes with generous exemptions as their commodity tax of choice. Using Iceland as an example, the effects of reduced rates and narrower than optimal tax base are examined on welfare loss, distributional equality and tax administration as well as on non‐specialized policy makers ability to maintain the tax systems. As can be seen on their divergence from the guidelines proposed by the OECD, IMF and EU, these tax systems are molded as much by political compromises as they are by expert advice from economic and legal scholars and technicians. Mostly misguided policy goals of achieving distributional effects and increasing equality through the wrong type of instrument are to blame for increased welfare losses, increased cost of administration and systems that is too complicated for non‐specialized policy makers. Attempts to create a progressive VAT system by subjecting necessities to reduced rates, increases lobbying for other products and services to also carry the reduced rate, even to the end that the VAT system becomes regressive. Exemptions should be used sparingly and be limited to businesses where prices are disconnected from production costs, for an example government services and charities.

EducationsMSc in Advanced Economics and Finance, (Graduate Programme) Final Thesis
Publication date2016
Number of pages77