Spain's standard rate of VAT was raised on July 1 from 16% to 18% while the country's reduced rate went up by one percentage point 1% to 8%.
The government announced the changes at the end of 2009 in an effort to reduce Spain's budget deficit. The increases were delayed until this month to give the economy a chance to grow and consumption to increase before hitting retailers and consumers with a tax increase. When the measure was announced, the government expected the two percentage point increase in the standard rate to raise €5.15 billion ($6.4 billion) over 12 months.
"Currently, nobody dares to make an estimate," said Eduardo Gracia, head of tax at Ashurst in Spain. "In fact, many decisions to purchase items such as cars have been anticipated to avoid the VAT impact, while the retail sector has announced its decision to swallow the VAT increase by reducing their margins by those two points."
Gracia expects the measure to affect the retail sector, whether companies choose to absorb the VAT rise or pass the costs on to consumers, which may see sales fall.
"Consumption will probably decrease during the next few months," said Víctor Gómez de la Cruz, a tax partner at Ernst & Young in Spain. "Consumption, and the government VAT income, has increased during the months prior to the rise, maybe because some consumers have tried to avoid the new VAT rate."
Spain's new VAT rate is still below the EU average of 20%. However, its decision to increase rates follows a trend in many European countries where governments have found themselves trying to reduce their budget deficits without affecting their international competitiveness by raising corporate tax rates.
On the same day that Spain increased VAT, Portugal increased rates by one percentage point to 21%, Finland's went up from 22% to 23%, Greece's jumped from 21% to 23% and Romania's rose from 19% to 24%. Meanwhile the UK Finance Bill, which received its second reading last week, raises VAT rates from 17.5% to 20%.
"This is happening probably because governments are worried about cutting the budget deficit and VAT increases seem to be a fast way to obtain income," said de la Cruz. "Although it is not clear whether, in the long term, the net impact in the budget could be even negative. It will depend on the reaction of the consumers."
"We are very clearly seeing a trend towards more indirect taxes in Europe," said Gracia. "Particularly within the EU single market, member states need to compete to attract or retain capital and human talent which means offering attractive corporate and individual income tax rates."
Gracia points out that tax is one of the few areas where EU member states can still compete.
"As the social expenditure of the welfare state model run by all of them does not allow for significant cost reductions, the gap is offset by increases in the indirect taxes," he said.
