Indirect taxes are levied on the production and consumption of goods and services. They influence the retail price, and hence affect patterns of trade and consumption. Indirect taxes are ultimately paid by the final consumer. Sales and turnover taxes, excise duties and tariffs are the basic indirect taxes. In contrast with direct taxes, indirect taxes are seldom progressive. The principles for the levying of these taxes will be considered before the analysis of indirect taxes.European Union; Indirect Taxes; Value-Added Tax; Excise Duties;

Ene, Sebastian

Micuda, Dan

English

Research Papers in Economics

315 
 
I IN ND DI IR RE EC CT T   T TA AX XA AT TI IO ON N   I IN N      T TH HE E   E EU UR RO OP PE EA AN N   U UN NI IO ON N   
Ene Sebastian 
Universitatea “Constatin Brancoveanu” Pitesti,Calea Bascov 2A, Tel 0721236051, Mail:  
george_sene@yahoo.com 
Micuda Dan 
Universitatea “Constatin Brancoveanu” Pitesti, Calea Bascov 2A, Tel. 0723387325, Mail: 
dan.micuda@gmail.com 
Indirect taxes are levied on the production and consumption of goods and services. They influence the retail 
price,  and  hence  affect  patterns  of  trade  and  consumption.  Indirect  taxes  are  ultimately  paid  by  the  final 
consumer.  Sales and turnover taxes, excise duties and tariffs are the basic indirect taxes. In contrast with direct 
taxes, indirect taxes are seldom progressive.  The principles for the levying of these taxes will be considered 
before the analysis of indirect taxes. 
European Union,  Indirect Taxes, Value-Added Tax, Excise Duties 
Principles Of Destination And Origin 
Tax  authorities  are  aware  of  the  possible  impact  that  indirect  taxes  have  on  trade  in  goods  and  services. 
Therefore, they introduced a safety device in the form of the destination and origin principle for taxation. This is 
of great importance to those countries that integrate. According to the principle of destination, taxes on goods 
are applied in the country of their consumption.  This is the norm accepted in the World Trade Organisation. 
However, according to the principle of origin, taxes apply in the country of their production.   
The destination principle states that consumption of all goods in one destination should be subject to the same 
tax, irrespective of the origin of their production. This principle removes tax distortions on competition between 
goods on the consuming country’s market. The goods compete on equal tax conditions. This principle does not 
interfere with the location of production. It is widely accepted in international trade relations even though it 
requires  the  existence  of  fiscal  frontiers  among  countries.  The  problem  is  that  this  principle  may  give  the 
illusion that it stimulates exports and acts as a quasi-tariff on imports. This issue will be discussed shortly. 
The  origin or  production  principle  asserts  that  all  goods  produced  in  one  country  should  be  taxed  in  that 
country, despite the possibility that these goods may be exported or consumed at home. If the production tax on 
good X in country A is lower than the same tax on the same good in country B, then if exported at zero transport 
and other costs, good X produced in country A will have a tax advantage in country B’s market over country B’s 
home-made good, X. This introduces a distortion that interferes with the spatial location of production between 
the countries. For allocational neutrality, a harmonised rate of tax, between countries, is a necessary condition. 
Even within a customs union or a common market, there may exist fiscal frontiers if the member countries 
accept the principle of destination. The fiscal authorities of each country should know where and when they are 
entitled to tax consumption of goods or services. The origin principle may have an advantage, for it does not 
require fiscal frontiers. This conserves scarce resources. 
Taxes levied according to the destination and origin principles differ regarding their revenue impact. These two 
principles  determine  to  which  government  the  proceeds  accrue.  A  full  economic  optimisation  cannot  be 
achieved if there are different tax rates levied on various goods. The principle of destination offers a chance for 
tax evasion that is unavailable (if the records are not faked) with the origin principle. If taxes differ, then a 
consumer may be tempted to purchase a good in the state in which the relative tax burden is lower and consume 
it in the country where the tax burden is relatively higher. Consumers may easily purchase goods in one country 
and send or bring them to another one, or order these goods from abroad. This tax evasion depends on the 
differences  in taxation, cost  of transport and cooperation of buyers and  sellers  who  do not inform the tax 
authorities if they know that the objective of certain purchases is tax evasion. The revenue effect of a standard 
tax at a rate of 40 per cent in a country where tax evasion is widespread (for example, the ‘olive-oil belt’ or Club 
Med countries of the EU) may be much smaller than the revenue impact of the same tax at a rate of 10 per cent 
in the country where tax evasion is not a common practice. 
Both the destination and the origin principles are imperfect. The destination principle for taxation is able to 
accomplish efficiency in the location of production, but not efficiency in trade. The origin principle has an 
inverse effect. If taxes are applied according to this principle, then trade may be efficient, but the location of 
production may not be efficient. 
Sales And Turnover Taxes 
Sales and turnover taxes are payments to the government that are applied to all taxable goods and services 
except those subject to excise duties.  Turnover tax is applied during the process of production, while if the tax 
is applied during sales to the final consumer it is called a sales tax. There are two methods for the collection of 
the sales tax. One is the cumulative multistage cascade method, while the other is called VAT. Apart from 
these two multiphase methods for the collection of the sales tax, there is also a one-stage method, applied only 316 
 
once, either at the stage of production or at the wholesale or retail sales phase. The following analysis will deal 
with the multiphase methods. 
Cumulative Multistage Cascade Method 
According to the cumulative multistage cascade method for the collection of sales tax, the tax is applied every 
time goods and services are transferred against payment. The tax base includes the aggregate value of goods that 
includes previously paid taxes on raw materials and inputs. The levying and collection of this tax are relatively 
simple, the tax burden may appear to be distributed over a larger number of taxpayers and the rate of sales tax 
applied by this method is relatively lower than the rate applied by the VAT method.  Firms may be stimulated 
by this method of collection of sales tax to integrate vertically in order to pay tax only at the last stage of the 
production process. This may have a favourable impact on the expansion of the business activities of firms 
(diversification). It may, however, cause a misallocation of resources. This artificial vertical integration may 
erode the advantages of specialisation and the efficiency of numerous SMEs if the vertically integrated firm 
ceases to use their output or if it absorbs them. 
Value-Added Tax 
This method of collection of sales tax is applied every time a good or  service is sold, but it applies only on the 
value that is added in the respective phase of production, which is the difference between the price paid for 
inputs and the price received for output (hence, value added). The application of VAT starts at the beginning of 
the production process and ends up in the retail sale to the final consumer. VAT avoids double or multiple 
taxation  in  the  previous  stages  of  production  (addition  of  value).  Every  taxpayer  has  to  prove  to  the  tax 
authorities, with an invoice, that the tax has been paid in the previous stages of production. Hence, there is a 
kind of self-regulating mechanism. 
VAT based on the principle of destination is accepted in the EU as the method for the collection of sales tax. 
The method is harmonised, but there is a wide range of differences in the rates of this tax among EU countries.  
If the objective is to have a single rate of this tax, then there is considerable room for improvement in the future. 
The elimination of fiscal frontiers in the EU in 1993 and the creation of the Single European Market placed a 
certain market pressure on tax authorities to ‘align’ national VAT rates and prices, otherwise firms would lose 
business, in particular in the frontier regions. The creation of the eurozone (1999) and the introduction of the 
euro in circulation in 2002 added to this pressure.  A White Paper (European Communities, 1985) proposed the 
setting up of the EU Clearing House System. Its role would be to ensure that the VAT collected in the exporting 
member country and deducted in the importing member country was reimbursed to the latter. The crucial feature 
in this system would play across EU bookkeeping and computerisation. This system would, in principle, create a 
situation for taxable persons within the EU identical to the one that prevails in the member countries. In spite of 
the potential benefits of such a tax system, it was criticised on the grounds that it would be bureaucratic and 
costly. 
In practice, however, the existence of widely diverging rates of tax and tax exemptions may expose the system 
to the risk of fraud and evasion. The EU was aware that some fraud and evasion already existed, but the scale of 
such distortions after the removal of fiscal frontiers and the introduction of the euro would increase without tax 
harmonisation.  Therefore,  a  minimum  standard  VAT  rate  of  15  per  cent  on  most  goods  became  a  legal 
obligation in the EU from October 1992. 
It is relatively understandable for Britain (as well as Ireland and Greece) to oppose this type of tax alignment 
since cross-border shopping is not a common feature in those countries as they have no common land frontier 
with the rest of the EU. However, for Austria, the Benelux countries, France and Germany, where cross-border 
shopping is common, it is easy to accept such arguments. 
A  move  towards  the  origin  principle  (collection  of  tax  during  production)  would  require  a  system  for 
redistribution of revenues (refunds) from the country where the goods were produced and taxed to the one where 
they  are  consumed.  The  effect  of  such  a  system  would  be  as  if  the  tax  had  been  levied  on  consumption. 
Although there were concerns in some member countries because of the need to find alternative employment for 
thousands of customs officers, the fiscal frontiers between EU countries were removed in 1993. This was the 
most visible benefit of the implementation of the Single European Market. Consumers are now free to purchase 
goods in any EU country and bring them home with very few restrictions, provided that the imported goods are 
only for their personal consumption. There are, of course, exceptions, but only two: the purchase of new cars is 
taxed in the country of registration, while mail-order purchases are taxed either at the rate applying in the 
country of destination or at the rate in the seller’s country (depending on the seller’s annual sales volume in the 
country of destination). 
Border tax adjustment without border controls was preserved in the EU.The former border controls were shifted 
by the interim system (introduced in 1993) to exporting and importing firms (centralised costs were replaced by 
decentralised costs in firms). The transitional system was extended in 1997 for an indefinite period, because EU 
countries were and still are unable to agree on the final shape of the VAT system based on the principle of 
origin.  This  system  replaced  time-consuming  tax  controls  and  payments  at  the  EU  internal  borders  with  a 
demanding centralised reporting system carried out by the companies themselves. The final system will allow 
firms to pay VAT in the country of origin, as if all EU member countries were a single country. The burden of 
redistribution of VAT revenue will then fall on the member states. This would be advantageous to businesses as 317 
 
they would not have to differentiate between domestic and intra-EU sales. None the less, there will be two 
problems. First, a clearing house system will have to redistribute revenue around the EU as countries that export 
a lot will benefit from the system, while those that import a lot will lose. Second, the origin-based tax system 
will enhance the need for a higher harmonisation of VAT rates. In the meantime, the current transitory system 
seems to be operating quite well. This will, of course, be taken into account during the reassessment of the tax 
system. 
This gradual approach was extremely difficult to implement. EU member states showed little enthusiasm in 
practice for the move towards the origin system. There is a reluctance to move towards a greater degree of 
harmonisation of VAT rates even though this is a precondition for the definitive system. Bearing in mind the 
potential and actual resistance concerning tax harmonisation, the European Commission has a patient long-term 
goal of origin-based taxation based on small steps, relating simplification, modernisation and administrative 
cooperation among member countries.  Table 1. illustrates differences in VAT rates in the EU countries.The 
lower rates apply to food, clothing and other essential items. Portugal has lower rates in its autonomous regions. 
Ireland and Britain use the zero rate for food, books and children’s clothing. The other countries generally apply 
an exception with credit (which comes down to the same thing as a zero rate) to exports and supplies assimilated 
to exports, such as supplies to embassies, to ships leaving the country and the like. In Ireland and Britain these 
supplies are also covered by the zero rate. 
The  EU  rules  assert  that  goods  should  be  taxed  at  between  15  and  25  per  cent,  except  for  a  series  of 
commodities  that  carry  reduced  rates.  In  order  to  simplify  the  EU’s  maze  of  VAT  rates,  the  European 
Commission proposed a plan (in 2003) that would require Britain and Ireland, which have zero VAT rate on 
children’s clothes and shoes, to apply VAT on these goods.  Otherwise, this would distort the Single European 
Market. The British Treasury declared that it would use the veto to block this plan if necessary as one of the 
election promises was to keep a zero rating on these goods.  A broad-based VAT can be criticised on the 
grounds that it is regressive.  The reason for the regressive impact of VAT in the EU can be found in the 
structure  of  national  demand.  Consumption  to  which  VAT  applies  usually  embraces  a  relatively  higher 
proportion of the GDP in the less-advanced member countries than in the richer ones. Other components of 
demand, such as investment, which is presumably higher in the more advanced countries, are not burdened by 
VAT.  
 
Table 1. VAT rates in the EU countries 
Member states 
Super reduced 
rate 
Reduced Rate  Standard Rate 
Belgium 
Bulgaria 
Czech Republic 
Denmark 
Germany 
Estonia 
Greece 
Spain 
France 
Ireland 
Italy 
Cyprus 
Latvia 
Lithuania 
Luxembourg 
Hungary 
Malta 
Netherlands 
Austria 
Poland 
Portugal 
Romania 
- 
- 
- 
- 
- 
- 
4.5 
4 
2.1 
4.4 
4 
- 
- 
- 
- 
- 
- 
- 
- 
- 
- 
- 
6 
7 
5 
- 
7 
5 
9 
7 
5.5 
13.5 
10 
5/8 
5 
5/9 
6 
5 
5 
6 
10 
7 
5/12 
9 
21 
20 
19 
25 
19 
18 
19 
16 
19.6 
21 
20 
15 
18 
18 
15 
20 
18 
19 
20 
22 
21 
19 318 
 
Slovenia 
Slovakia 
Finland 
Sweden 
United Kingdom 
- 
- 
- 
- 
- 
8.5 
10 
8/17 
6/12 
5 
20 
19 
22 
25 
17.5 
 
Excise Duties 
Excise duty is a type of indirect tax that is levied for the purpose of raising public revenue. It is applied in almost 
every country to tobacco, spirits and liquid fuels. While the VAT is proportional to the value of output, an excise 
duty may be based either on the ad valorem principle (retail or wholesale price) or it may be a specific tax.Within 
the EU, tobacco products are subject to both.  There is a specific tax per cigarette and an ad valorem tax based on 
the retail price of the cigarettes concerned. There is a wide variety in charges that come from excise duties among 
the countries. This difference is due to the various choices of fiscal and health authorities. If the difference in excise 
duties among countries exceeds the costs of the reallocation of resources or transport, it will have a distorting effect 
on the geographical location of resources or pattern of trade. The difference in the excise duty on 1000 litres of 
petrol of €210 between high-duty Germany and low-duty Austria is significant when one bears in mind that it costs 
just a few euros to transport this amount of fuel by pipeline.  The VAT is calculated on the price of a good that 
includes the excise duty. 
Any change  in the excise duty  will produce differences in the  VAT revenue.   Hence  the  need  for a certain 
harmonisation of excise duties too. In the US, each federal state has its own liquor duty. Liquor and cigarettes 
should bear the national tax authority stamp. Only the nationally stamped goods can be purchased legally within a 
state. Import for personal consumption is unlimited, while bulk intra-EU commercial transport and trade in these 
goods  without  the  proper  tax  clearance  is  forbidden  and  punishable.  The  harmonised  rates  proposed  by  the 
European Commission should be viewed only as a yardstick, as it would be  extremely difficult to try to unify 
excise duties throughout the EU member countries. 
BIBLIOGRAPHY 
1.  http://europa.eu.int/index_en.htm 
2.  DG Economic and Financial Affairs:  http://ec.europa.eu/dgs/economy_finance/index_en.htm 
3.   European  Commission  -  Taxation  and  Customs  Union: 
http://ec.europa.eu/taxation_customs/common/about/welcome/index_en.htm 
4.  Miron D. (colectiv) „Economia Integrarii Europene”, Editura A.S.E., Bucuresti, 2002. 
5.  Pfann,G. and H. van Kranenburg ‘Tax policy, location choices and market structure’, IZA Discussion  
6.  Paper No. 499, Institute for the Study of Labor, Bonn. 2002. 
7.  Serban R., „Extinderea Uniunii Europene. Componenta economica”, Editura „Tribuna Economica”, 
Bucuresti, 2004. 
8.  Sadiq, K. ‘Unitary taxation – the case for global formulary apportionment’, International Bureau of 
Fiscal Documentation Bulletin, 2001. 
 

(colectiv) „Economia Integrarii Europene”,

499, Institute for the Study of Labor,

European Commission - Taxation and Customs

Extinderea Uniunii Europene. Componenta economica”, Editura „Tribuna Economica”,

Kranenburg ‘Tax policy, location choices and market structure’,

Unitary taxation – the case for global formulary apportionment’,

Indirect taxation in the European Union

Indirect taxation in the European Union

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Research Papers in Economics