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Spain’s Rajoy raises VAT even higher than expected

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Spanish Prime Minister Mariano Rajoy has confirmed expectations of a VAT rise, but it goes further than many thought.

Despite the Spanish government repeatedly denying that it would need to raise VAT rates, International Tax Review predicted in May that it was poised to make a u-turn after the Minister of Economy, Luis de Guindos, announced that indirect taxes will be raised next year to reduce the budget deficit.

Rajoy has now confirmed that a VAT rise will happen.

“I said I would cut taxes and I’m raising them,” the prime minister said. “But the circumstances have changed and I have to adapt to them.”

Advisers, however, had only predicted that the rates would go up two percentage points to 20%, as recommended by the IMF.

“Alternatively we were expecting an increase in the reduced rate and moving items from the reduced rate into the standard rate to extend the tax base,” said Ana Royuela of Baker & McKenzie.

It comes as a surprise, therefore, that the government now wants to raise the VAT rate three percentage points to 21%. The reduced rate of 10% will be increased by two percentage points, while the lower rate of 4% will remain the same.

The increase is part of a plan to cut €65 billion ($79 billion) from the budget.

The government has not yet indicated when the increase will come into effect, but when rates were last raised in July 2010, they were approved two months before. Royuela therefore predicts that the rise will come in before 2013.

On Friday the Council of Ministers is expected to approve the tax hike and, as the government has a majority in parliament, it is all but inevitable.

Royuela believes the measure will be tough for businesses.

“If customers do not accept the increase and demand for products falls, companies will have to absorb the cost and look for other ways of reducing costs,” she said.

In the short-term, there will be a boost to demand as people look to procure goods and services before the rise comes in. But in the medium and long-term, Royuela thinks this measure will be bad for the economy.

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