Contracting out: The Importance of a Solution for the VAT Distortion

In member states of the European Union, the current VAT treatment of activities of public authorities creates significant distortions in their decision-making between public provision and contracting out of public services. In several EU-member states, a refund of VAT to local governments eliminates this effect. Therefore, these VAT refund schemes facilitate contracting out. In member states with a refund scheme for the VAT costs of local governments or another solution to this distortion, in general refuse collection is contracted out to a relatively greater extent compared to member states without. Despite these solutions, the VAT distortion is still relevant for private suppliers of tax-exempt activities and public suppliers in other member-states. This distortion could be addressed by a change in the European VAT legislation. (JEL H 25; H 32)