Simulations of global effects of VAT harmonization

This chapter presents a simulation analysis of the dynamic effects of international value-added tax (VAT) harmonization. The process of harmonization of the VAT systems started with the First Council Directive of April 1967 and has proceeded thereafter through consecutive directives. The process involved the adoption of VAT in various member countries and the continuous convergence of rates and structures among members of the community. The home country tax revenue stems from high income tax, while the foreign country revenue stems from high VAT. The harmonization of VAT entails a rise in the home country VAT rate and an equivalent reduction in the foreign VAT rate. Under the cash-flow income-tax system, the direction of changes in the world rate of interest and in the growth rates of consumption consequent on international VAT harmonization depend exclusively on the paths of the saving-investment gap. The chapter analyzes the global effects of such an international VAT harmonization.