Learning from Europe and America’s Shared Gross Receipts Tax Experience

February 12, 2019

As states in America continue to consider gross receipts taxes (GRTs) as a source of tax revenue, Europe is also evaluating proposals to use GRTs to tax digital firms. Europe’s historical experience, like the experience of its American counterparts, shows that GRTs are bad tax policy with no place in debates over digital taxation and optimal sources of tax revenue.

Prior to 1970, western European countries other than France levied turnover taxes, also known as gross receipts taxes, including Germany, Italy and Belgium. These taxes are levied on total sales when goods “turn over” without any deduction for a firm’s costs. Turnover taxes have a long history in Europe. The first turnover tax, named the alcavala, was established in Spain in 1342. In The Wealth of Nations, Adam Smith in 1776 condemned turnover taxes as having caused “the ruin of the manufactures of Spain.”

Turnover taxes were a major source of revenue for European countries after World War I. By 1967, for example, revenue from turnover taxes made up about 15.4 percent of Germany’s total revenue. They were replaced by national value-added taxes (VAT) as part of a larger tax harmonization effort by the European Economic Community (EEC), a precursor to the European Union (EU).

Turnover and Value-Added Taxes in the European Common Market, Calendar Year 1967

*Note: This rate applied as a rebate for goods exported out of the country and as an equalization tax on goods imported into the country.

Source: Guenter Schindler, “Tax Harmonization in Europe and U.S. Business,” Tax Foundation, Aug. 1, 1968.

Country Tax Type Turnover Tax Rate Turnover Tax Rate for Luxury Goods Border Tax Adjustment Rate*
Belgium Turnover tax 7% Up to 23% 5% – 6%
Germany Turnover tax 4% 4% 5%
Italy Turnover tax 4% 6.4% – 23.3% 4% – 5%
Luxembourg Turnover tax 3% 3% 5% – 6%
Netherlands Turnover tax 6% 15% – 25% 5%
France Value-added tax 20% 25% 20%

Europe’s turnover taxes presented a challenge to international trade. Under the Bretton Woods system, which provided rules for the international financial system from 1944 to 1971, countries held their currencies at fixed exchange rates. This meant that currencies would not adjust when the proportion of imports to exports was altered. Domestic turnover taxes encourage imports, as imports are relatively cheaper without the turnover tax applied to them.

The General Agreement on Tariffs and Trade (GATT), an international trade agreement established in 1947, permitted equalization taxes on imports. Exported goods received a rebate to compensate for the turnover tax applied to domestic goods. While policymakers could have allowed prices between countries to adjust, they decided to use this system of rebates and taxes to equalize the tax treatment of imports and exports instead.

This arrangement suffered from a problem: it is difficult to determine the tax burden imposed by a turnover tax, as the tax is applied to the same value of a good’s inputs in each stage of production.  Known as tax pyramiding, this means that industries with supply chains of different lengths will have different effective turnover tax rates. Industries with a high degree of tax pyramiding may not receive the right rebate amount when the good is exported to offset the tax, while importers may be levied the wrong equalization tax rate.

The EEC resolved this problem by implementing a uniform value-added tax regime, as Tax Foundation’s Guenter Schindler documented in 1968. By 1970, EEC members replaced their turnover taxes with VAT, which can be harmonized between countries more easily. Firms can determine the VAT paid at each stage of production and receive a credit exactly offsetting the tax when goods are exported. Imported goods have the VAT applied to them, equalizing the tax treatment across countries.

Turnover taxes have been revived in the 21st century in the debate over how to tax digital firms in the EU. In 2018, the European Commission (EC) proposed a 3 percent turnover tax levied by individual countries on firms with worldwide revenues of €750 million (US $850 million) and total EU revenues of €50 million (US $56.67 million). Like other gross receipts taxes, this proposal threatened to harm firms with low profit margins, raise prices on consumers, and slow economic growth in Europe. While the European Commission failed to gather enough consensus to move forward, several individual countries are moving forward with unilateral proposals to tax certain digital companies on their turnover. A related debate is now going on at the Organisation for Co-operation and Development (OECD).

The comeback of turnover taxes in Europe mirrors the experience of American states, which eliminated gross receipts taxes as a revenue option by the mid-20th century, but these tax proposals have returned over the past decade. European and American policymakers should consider their shared historical experience on both sides of the Atlantic and identify other ways to raise revenue and avoid the negative economic consequences of turnover taxes.

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