The most important global VAT questions, trends and challenges – Rita de La Feria

Welcome to the very first episode of the Vatvocate Podcast!

In my conversation with Professor Rita de la Feria, we focused on several key challenges shaping today’s VAT policy. We discussed why consumption taxes are becoming the backbone of global public finance and addressed the fundamental question of VAT’s perceived secondary status despite generating primary revenue streams. The episode also examines practical solutions to regressivity through progressive VAT design and real-time technology implementation.

The conversation further explores critical enforcement issues, including third-party liability in fraud cases and the balance between revenue protection and taxpayer rights. Rita shares insights from her groundbreaking research on taxation inequalities and explains why reduced rates often fail their intended targets.

A must-listen for VAT practitioners navigating cross-border compliance, policy implementation, and advisory work.

Taxation and Inequalities – book by Rita de la Feria – https://www.ibfd.org/shop/book/taxation-and-inequalities

Rita’s most important publications on topis discussed – https://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=2075359

And also Rita’s google scholar – https://scholar.google.com/citations?user=b1cx8gEAAAAJ&hl=en

Pawel’s article on What is VAT fraud – https://legalblogs.wolterskluwer.com/international-tax-law-blog/what-is-vat-fraud/

The Underappreciated Giant. Why and How the Future of Tax Systems Belongs to VAT? What Problems It Faces?

This article serves as an essential summary of the most critical issues and global trends discussed during my conversation with Professor Rita de la Feria, a prominent expert in the field of tax law and policy. It focuses on the Value Added Tax (VAT)—a fiscal tool of fundamental importance for state budgets that paradoxically remains undervalued and misunderstood in public and corporate debate. The insights gathered highlight not only why VAT is the future, but also how it must evolve to meet modern challenges.

Note: This article was written as a summary of the most important points discussed during the Vatvocate podcast. It is not an academic article and does not refer to relevant sources. The only source of information is the conversation between the podcast participants.

1. VAT in the Shadows: The Paradox of the Invisible Tax

Despite its status as a huge source of income, VAT (or its equivalent, such as GST) consistently operates in the shadow of income taxes. Let us delve into why this essential tax is so often overlooked.

The core of the problem lies in the consumer’s cognitive bias, which creates the illusion of not paying VAT. Studies, including notable surveys conducted in the UK, have repeatedly demonstrated that a significant majority of respondents mistakenly believe they do not pay VAT. This misconception is rooted in a failure to distinguish between two distinct concepts:

• The remittance of the tax to the government (which is the legal duty of the retailer).
• The bearing of the tax burden (which falls entirely on the consumer at the point of purchase).

Since consumers are not required to file any VAT documentation, the tax remains an „invisible” element of the final price. This contrasts sharply with Personal Income Tax (PIT), where the taxpayer is acutely aware of the deductions made from their salary. In reality, literally every individual in an economy with a VAT system is subject to its burden. In contrast, PIT is often only paid by a portion of the population (for example, roughly 50% in highly developed countries and far less—around 10–20%—in developing nations), making VAT the tax with the broadest possible base.

For the corporate world, the diminished interest in VAT stems from its fundamental design as a tax-neutral mechanism for businesses. In theory, VAT is fully deductible for registered entities, meaning it should not impact a company’s net profit. This is the key difference from Corporate Income Tax (CIT), which directly reduces corporate earnings and is thus treated as a primary boardroom concern. Consequently, VAT often receives less attention from financial management.

However, this dynamic changes dramatically where the principle of neutrality is compromised. Which sectors then become the most crucial for VAT expertise?

• The financial and insurance sectors, which often benefit from numerous VAT exemptions on their services, leading to a complex and costly inability to fully deduct input VAT.
• E-commerce and international supply chains, where the application of VAT and customs rules is intricate and constantly changing due to rapid cross-border transactions (e.g., the implementation of OSS/IOSS packages in the EU).
• The real estate sector, where the tax treatment can drastically change based on the nature of the transaction (e.g., land vs. building, first vs. subsequent sale), making it a high-risk area for compliance.

2. Global Trends: The Inevitable Rise of Consumption Taxes

In a world increasingly defined by globalization, financial mobility, and accelerating technological change, macroeconomic forces are converging to make consumption taxes, particularly VAT, the most reliable and robust fiscal response.

A clear historical erosion of income tax revenues is evident. We have observed a steady decline in the global average CIT rate, plummeting from approximately 40% in the 1960s to around 20% today. This reduction is a direct consequence of intense global tax competition, where mobile capital seeks out jurisdictions offering the lowest corporate burden. Furthermore, the rise of specialized talent and remote work has intensified competition for human capital, putting pressure on PIT rates. If these long-term trends persist, state treasuries face an inevitable shortfall in income tax revenue, necessitating an urgent shift toward alternative funding sources to maintain public services.

The solution lies in consumption taxes—VAT, excise duties, and others—which possess a crucial structural advantage: they are less susceptible to mobility. Unlike capital, which can be moved with a click, consumption fundamentally remains anchored to the territory where the goods or services are used. This „immobility” makes consumption taxes the most reliable and predictable source of budget revenue in a globalized economy.

In addition to revenue stability, the importance of non-fiscal goals within the tax system is rapidly growing. Excise duties, in particular, are becoming powerful instruments for implementing public policy. What are the main regulatory applications of these taxes?

• Public Health: The introduction of „sugar taxes” or excise on high-salt/high-fat foods to discourage unhealthy consumption habits and finance healthcare.
• Environmental Policy: Excise duties on fossil fuels, carbon taxes, or levies on single-use plastics designed to internalize external costs and promote sustainable behavior.
• Social Regulation: Taxes on tobacco and alcohol, which serve both as major revenue streams and tools for discouraging harmful consumption.

A final, yet critical, factor is automation and robotization. As human labor is increasingly replaced by machines, the tax base for labour taxes (both PIT and social contributions) will necessarily shrink. While the idea of a „robot tax” is sometimes proposed, experts largely dismiss it as impractical. Why is direct robot taxation unrealistic?

• Definition Problem: It is nearly impossible to create a legal definition that clearly distinguishes a „robot” from advanced automation software or efficient machinery.
• Economic Distortion: Such a tax could severely punish capital investment and hinder productivity growth, slowing the very technological progress it seeks to tax.

Since direct taxation of technology is a dead end, a greater reliance on VAT and excise duties becomes the essential, functional substitute solution for preserving government funding in the automated future.

3. The Challenges of VAT: Regressivity and the Single-Rate Approach

The most enduring and serious ethical and economic criticism levelled against VAT is its inherent regressivity—the disproportionate financial burden it places on individuals with lower incomes.

The mechanism of regressivity is straightforward: lower-income households must spend a much larger percentage of their total income (often near 100%) on immediate consumption, all of which is subject to VAT. In contrast, higher-income individuals save or invest a substantial portion of their earnings, and these saved amounts are not subject to VAT. Consequently, the effective VAT rate (when measured as a percentage of total income) decreases as income rises. While some economists argue that this effect disappears when viewed over a lifetime (since savings are eventually consumed), this argument fails for the extremely wealthy, whose capital is often transferred through inheritance without ever incurring a consumption tax, thus confirming the regressivity for the highest wealth brackets.

The traditional, politically palatable response to regressivity, especially prevalent in the European model, has been the use of reduced rates and exemptions for goods and services deemed „essential” (e.g., food, medicine). However, this approach is largely ineffective and costly. Why do reduced rates fail to achieve fairness?

• Absolute Consumption Effect: Wealthy families purchase more goods and services in absolute terms. They spend more on premium foods or multiple appliances. Therefore, the monetary value of the tax reduction they receive from a reduced rate is often many times greater than the saving achieved by a poor family.
• Subsidizing the Rich: Many „essential” exemptions, such as those for cultural events (opera, theatre) or high-quality private education, disproportionately benefit upper-income deciles who are the primary consumers of these services.
• Economic Cost: The patchwork of rates creates immense complexity, high administrative costs for businesses and tax authorities, and significant market distortions (deadweight loss), all without achieving the stated goal of equity.

This analysis brings us to the New Zealand Model (GST), implemented in 1986, which is often cited as the economically optimal approach. It is built on a revolutionary combination:

1. A single, unified rate for virtually all goods and services with zero exemptions (ensuring maximum neutrality and efficiency).
2. Direct, targeted social transfers to low-income households. Instead of complicating the tax system by manipulating rates on goods, the state simply provides direct monthly compensation equivalent to the extra tax burden. The benefits of this model are clear:

• Precision: Aid is provided exclusively to those who need it, avoiding subsidies for the wealthy.
• Efficiency: The tax base is broadened, and compliance is simplified.
• Transparency: The cost of social welfare is clearly separated from the cost of tax administration.

Despite its economic soundness, the New Zealand Model’s global adoption is hindered primarily by political risk and a crisis of social trust. Governments fear the political backlash of simultaneously raising a universal tax while only promising compensatory payments to a specific group.

4. The Technological Breakthrough: Progressive VAT in Real-Time

The political obstacle of social trust could potentially be overcome by deploying modern digital technology. This section outlines the innovative concept of Progressive VAT that operates in real-time, a solution recently put forward by the International Monetary Fund (IMF) in 2024.

This model achieves de facto progressivity while retaining the legal simplicity of a single rate. The mechanism leverages real-time transaction reporting and identity verification. At the point of sale, the consumer voluntarily provides their unique government ID (e.g., Social Security or Tax ID number). The system instantly interfaces with a central government database, verifies the individual’s eligibility for relief based on their known income or wealth status, and then immediately triggers a direct compensation payment to the consumer’s bank account.

This technological innovation manages to solve the core trade-off between efficiency and equity that has plagued tax policy for decades. What are the key advantages of this real-time progressive model?

• Immediate Cash-Flow: The consumer receives the financial benefit virtually instantaneously at the point of purchase, eliminating the need for complex tax refunds or waiting for annual settlements. This is crucial for low-income households.
• De-stigmatization: The seller only sees a single, universal rate transaction. The compensation is a direct transaction between the state and the citizen, maintaining the consumer’s privacy regarding their financial status.
• High Efficiency: Legally, the VAT remains simple and broad-based, maximizing revenue collection and minimizing compliance costs, while achieving the equity goals of a progressive income tax.

By using digital infrastructure to decouple the tax collection mechanism (single rate) from the compensation mechanism (targeted and instantaneous), this model could make VAT both the most efficient and the fairest consumption tax possible.

5. Legal and Operational Challenges of VAT

The final set of critical issues relates to the practical operation of VAT, including dealing with fraud, enforcing the law, and the future role of tax expertise. While VAT is often criticized for its susceptibility to fraud, particularly through complex schemes like carousel fraud, it is crucial to maintain perspective.

VAT is structurally less prone to wholesale fraud than the Retail Sales Tax (RST) models used in the United States. The difference lies in the enforcement mechanism:

• VAT is a multi-stage tax collected at every step of the supply chain. This distributed risk means that if a single entity commits fraud, only the tax relevant to that stage is lost.
• RST is a single-stage tax collected entirely at the final point of sale from retailer to consumer. Fraud at this single stage results in a 100% loss of the intended tax revenue.

Furthermore, in B2B transactions, VAT includes a powerful self-enforcement mechanism: a business buyer requires a valid tax invoice to exercise their right to deduct the input VAT. This necessity aligns the buyer’s incentive with the tax authority’s goal, encouraging the formalization and legality of transactions.

However, VAT systems face serious legal complexities, one of the most controversial being the „knew or should have known” doctrine concerning fraud liability. Developed by the European Court of Justice (CJEU), this principle allows tax authorities to deny a business the right to deduct input VAT if it can be proven that the business knew or should have known it was participating in a fraudulent chain, even if it did not directly commit the fraud itself. This construction is highly criticized because:

• It violates fundamental legal principles: Outside the tax sphere, holding an entity criminally or financially responsible for the past crime of an unrelated third party, based on a subjective standard of what they should have known, would be unacceptable in most democratic legal systems.
• It creates high uncertainty: The lack of clear, statutory guidelines on what constitutes „should have known” places an onerous burden of due diligence on honest businesses.
• It necessitates safeguards: For this doctrine to be minimally acceptable, legal safeguards must be robust, including placing the burden of proof unequivocally on the tax administration and ensuring the proportionality of the penalty applied.

Despite the automation of compliance through technologies like e-invoicing (such as Poland’s KSeF) and SAF-T files, the growing systemic importance of VAT confirms a rising, not falling, demand for specialized tax expertise. Which areas will drive consulting demand?

• Real-time Compliance Management: Expertise in managing continuous data streams, e-invoicing mandates, and integration of digital reporting into enterprise resource planning (ERP) systems.
• Complex International Structures: Navigating the intricacies of cross-border VAT on services, digital goods, and physical supply chains.
• Sector-Specific Issues: Deep specialization in areas where neutrality is compromised, particularly the financial, healthcare, and property sectors.

For entrepreneurs, investing in robust VAT compliance systems and specialized human capital is no longer a cost but a strategic necessity, providing a critical competitive advantage amidst digitalization and increasingly stringent information requirements.

6. Conclusion: VAT as the Foundation of the 21st Century Tax System

The evidence clearly suggests that VAT is destined to become the central pillar of modern tax systems. Its stability, broad base, and adaptability make it uniquely suited to address the macroeconomic challenges of the 21st century.

What is the synthesis of the trends driving this evolution?

• Globalization: VAT provides stability when traditional income tax bases (CIT/PIT) are highly mobile.
• Digitalization: Technology enables solutions (like Progressive VAT) that can resolve the long-standing equity problem of regressivity.
• Robotization: VAT serves as the necessary fiscal replacement for falling revenues from labour taxes.
• Non-Fiscal Goals: Consumption taxes are increasingly vital tools for effective climate, health, and environmental policies.

The core challenge now is not economic but political and communicative. The shift towards a VAT-centric system requires bold leaders to implement reforms like the single-rate model and Progressive VAT—reforms that are economically sound but depend entirely on winning public trust. The „boring” tax may well become the fiscal hero of tomorrow.

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