A Poorly Targeted Subsidy? The Fiscal and Social Costs of EU VAT Expenditures

Value-added tax (VAT) systems in EU Member States deviate substantially from a uniform-rate benchmark through reduced rates and exemptions, typically motivated by distributional concerns. This paper provides microsimulation evidence on the fiscal and distributional effects of VAT expenditures in five major EU economies (Germany, France, Italy, Spain and Poland) using EUROMOD and its Indirect Tax Tool, drawing on EU-SILC 2022 microdata matched with EU-HBS 2015 expenditure data. Simulating a universal standard-rate VAT counterfactual, we find that abolishing all VAT expenditures would reduce post-consumption-tax disposable income by 8-15% for bottom-decile households versus 4-5% for the top decile, with Italy and Spain displaying the most regressive reform-cost profiles. The regressivity gap ranges from -6.3 percentage points in Poland to -16.3 in Italy. While VAT expenditures offer meaningful purchasing-power protection to lower-income households in proportional terms, this protection is poorly targeted in absolute terms and could be replicated more efficiently through targeted income transfers. We discuss implications for revenue-neutral VAT reform and the efficiency-equity trade-off in EU indirect taxation. JEL codes: H23, H25, D31, C15.