Edited by Paul Davidson
Chapter 12: VAT reduction for consumptionoriented, labor-intensive services in the European Union: a stimulus to employment? The case of Germany
Hubert Hieke INTRODUCTION Moonlighting and illegal employment have caused severe strains on the German economy. Some economists estimate that annual untaxed total revenue accumulated from these activities amounts to more than DM500 billion or 250 billion euros (Kornhardt 1998; Schneider and Ernste 2000). At the same time, the German economy has been facing persistent high levels of unemployment, and labor-intensive, consumption-oriented sectors in particular have been confronted with an increasing tax burden and labor costs, including those of fringe beneﬁts. Studies suggest that relative prices for services that are good substitutes for those oﬀered by the underground economy have risen considerably, and that demand for a wide range of products oﬀered by the formal sector has consequently declined (Haase and Alefs 1997). Although partial measures, such as a value-added tax (VAT) reduction for labor-intensive services, are usually considered ineﬃcient and rather inappropriate in stimulating overall employment, a VAT reduction might reduce the gap between prices charged to consumers by the formal sector relative to those charged for similar services by the underground economy. If this was the case, employment in the formal sector might increase due to substitution eﬀects between the two competing sectors. The current debate about the impact of a possible VAT reduction on speciﬁc labor-intensive goods and services that are primarily demanded by private consumers has been controversial, particularly because the potential net eﬀects on tax revenue and employment are hard to quantify, and no reliable data exist on either...
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