VAT-induced Distortions in the Passenger Transport System in the European Union: Assessment and Options for Reform

This paper is based on a study by the same authors recently published by the European Commission. It provides an economic assessment of the impact of current VAT regimes on passenger transport in the EU, and the likely effects of alternative regimes.After a review of the features of the passenger transport industry as they relate to VAT, the paper identifies and assesses a number of distortions arising from unequal VAT treatment of operators or passengers. Using a series of transport-related econometric models it then evaluates a number of changes in the VAT regime that could address those distortions.The main conclusion is that the distortions introduced by the rather byzantine current VAT system are small- or medium-sized.For the distortions on output (passenger demand), a large part of the explanation of their small impact is in the low ‘pass through’ of changes in costs to changes in fares, and the low system-wide elasticities of demand; for input distortions, the main explanation is in the ability of operators to reclaim VAT incurred on inputs, so the only cost distortion is that some operators incur additional financing costs between when VAT is paid and when it is rebated. These costs are small because of the short time between payment and reimbursement and the current low interest rates on that financing.The paper identifies one set of measures that addresses output distortions deriving from different VAT rates and place of supply rules and another addresses input distortions.The paper also provides valuable insights for tax administrations. It reveals an enormous potential of the application of VAT in the passenger transport sector with regard to generating revenue, and the small impact of applying simpler VAT rates.We can conclude that a simplified and harmonised application of VAT on all passenger modes, markets and all member states (aimed at elimination or reducing the distortions of the current VAT regime) would have only a small impact on both operators and passengers.