Consequences of harmonization of indirect taxes for Luxembourg

Abstract

The European Commission has made several proposals and has implemented various measures to achieve a single European market. Some of these proposals concern the harmonization of value-added taxes (VAT) and excise duties. Despite the fact that the choice of the proposed level of the VAT and excise duty rates is based on the current situation in most of the EEC countries, there is much resistance against the proposals. Luxembourg fears that the proposals for indirect tax harmonization of the Commission will have a strong negative effect on its economy. Luxembourg resists the harmonization of indirect taxes mainly for fear of a deterioration of its price competitiveness (due to a wage-price spiral) and of the decline of nonresident consumption. In this article we try to quantify the effects of tax harmonization for Luxembourg with the use of a sectoral model. The first argument of Luxembourg against indirect tax harmonization seems to be unfounded. Even if the foreign price level declines, the substitution between Luxembourg goods and foreign goods are limited-at least in the short run. The second argument may be more convincing than the first. In the scenarios the increased excise duty rates on alcohol, petrol, and cigarettes are assumed to reduce the consumption of nonresidents of these products to nil and have, therefore, a clearly negative effect on the Luxembourg economy. However, the size of the decline in nonresident consumption is unknown and debatable. The consequences for the government receipts and the government budget are political. The indirect tax proceeds decrease, but the receipts from VAT and excise duties are not equal to these proceeds; for instance, the excise duties are levied jointly with Belgium.