Interaction of household income, consumption and wealth – statistics on taxation


Data extracted in October 2017

Planned article update: November 2019.

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Average VAT rate out of consumption

This article provides further elaboration on the experimental statistics on income, consumption and wealth published in 2017. In particular, the article takes advantage of the matching exercise making it possible to observe at the same time household income and household consumption. By observing the two simultaneously, it is possible to assess with the existing data what effect the value-added tax (VAT) has on different groups of households, and in particular on different income groups.

Full article

General overview

VAT rates for food products are generally lower than the rates for other products or services - in some countries such as the United Kingdom or Ireland the rates can even be zero - because it is a well-known fact that poor households devote a higher share of their budget to food than rich households. Therefore, the average rate of VAT on expenditure by poor households is lower than the rate paid by rich households. This statement does not account for the difference in behaviours for total consumption (or savings), given that the higher income group save a higher share of their income, and therefore pay less VAT rate as a share of their income. With the experimental statistics on income, consumption and wealth, it is now possible to estimate VAT as a share of gross income paid by different categories of households around 2010. It is possible also to observe that direct taxation mitigate the regressive pattern of VAT, as in most EU Member States the share of gross income paid for both VAT and direct taxation increases as income rises.

Indirect taxation as a share of expenditure

Figure 1: Average VAT rate for consumption
Source: Eurostat (hbs_exp_t111), (hbs_str_t211), (icw_tax_10), (gov_10a_taxag) and (nasa_10_nf_tr)
For information about the reference year see here


Figure 2: Average VAT rate for consumption by income quintile
Source: Eurostat (hbs_exp_t133), (hbs_str_t223) and (icw_tax_10)
For information about the reference year see here

Figure 1 shows the VAT rate that applies to average consumption, according to data obtained from household budget surveys (HBS) and the VAT rate according to data obtained from national accounts. According to the national accounts data, in 2010 the highest VAT rate was for Danish consumption (up to 25.9%) while expenditure were taxed on average at 10.6% in the United Kingdom. HBS data for the same year show a slightly different picture, as the tax rate is the lowest in Luxembourg (7.9%) and the highest in Hungary (18.8%, although Denmark is close at 18.1%). Such differences may be conceptual. The national accounts figure compares receipts made by the government from VAT paid by households in the country regardless of whether or not the households live in the country. By contrast, the HBS measures the VAT paid by households living in the country. In countries where cross-border consumption accounts for an important share of the economy, this may explain part of the difference. However, it may also be explained by the fact that the national accounts do not measure consumption in the same way as the HBS. The consumption basket [1] in the national accounts may differ from the consumption basket in HBSs; if the VAT rates differ for certain items, the average VAT rates will differ. Nevertheless, although the average VAT rate may differ between national accounts and HBSs, both sources show a great difference in rates between countries.

Figure 3: Average VAT rate for consumption by household type
Source: Eurostat (hbs_exp_t134), (hbs_str_t224) and (icw_tax_10)
For information about the reference year see here

In relation to income levels

We first focus on the share of VAT in the overall expenditure on consumption and how it relates to income levels. As shown in Figure 2, in almost all countries the more income households earn, the more VAT they will pay on their expenditure, in which food stand for a lower share. Thus, a common feature of VAT policies is to tax food at a lower rate. In the United Kingdom and Ireland, food items may benefit from a zero rate, meaning that no VAT is paid when purchasing those goods. Some other countries apply the standard rate to food items. But as a general rule, reduced, super-reduced or zero rates apply to items which on average represent a bigger proportion of the expenditure of lower income households. As a consequence, for low income households, VAT represents a smaller share of their overall expenditure. By taking into account the differences in the consumption basket across the population, it is possible to a certain extent to shift the VAT burden for specific groups of the population.

Figure 4: Average VAT rate for consumption by age of the reference person
Source: Eurostat (hbs_exp_t135), (hbs_str_t225) and (icw_tax_10)
For information about the reference year see here

Depending on the household type

We are also interested in the incidence of VAT across household types. In particular, we look at whether the different tax rates can be matched to specific types of households, and whether households with children are taxed more or less than those without children. As shown in Figure 3, the pattern across household types varies depending on the country. In general, the larger the household, the higher the VAT rate, although for some countries such as Hungary or Italy, the relationship is almost insignificant. Consumption behaviours are likely to differ widely within a given type of household (at least much more than within a given income quintile). Therefore, there is no clear-cut conclusion to be drawn from such data.

Over the life cycle

Another variable of interest, the age of the reference person, makes it possible to take into account changes in consumption habits over the life cycle. VAT rates tend to follow changes in income over a person's life cycle. In general, VAT is lower at the beginning of a person's working life and then goes up as the person grows older, reaching a maximum in midlife, and then decreasing, in particular upon retirement when income drops. Income drives consumption choices, at least in part: households with higher income tend to consume normal and even luxury goods, while households with lower income dedicate a significant proportion of their budget to the purchase of inferior goods (which in general have lower VAT rates, if any). Hence, we observe in Figure 4 this hump-shaped curve for VAT rates over the life cycle, whose pattern is most likely driven by income for the most part.

Indirect taxation as a share of gross income

Figure 5: Median indirect taxation out of gross income
Source: Eurostat (icw_tax_01)
For information about the reference year see here

Applying the VAT rates at the micro-level, we can derive indicators on VAT incidence, taking into account not only consumption but also income. With this it is possible to investigate how the burden of VAT is spread among the household population, not only in terms of expenditure but also in terms of income. From this viewpoint, it is possible to re-assess the progressive pattern of VAT observed previously in relation to income. As shown in Figure 5, the share of VAT in relation to (gross) income differs significantly from the share of VAT in relation to consumption, although the ranking across EU countries remains more or less the same. The country with the highest share of VAT in relation to gross income is Hungary, where VAT represents 14.2% of gross income (compared to 18.8% of consumption). The share of VAT is the lowest in Luxembourg with 4.9% of gross income (and 7.9% of consumption). By comparing VAT to income and not just consumption, it is possible to account for savings behaviours, as the average propensity to consume varies across countries and categories of households.

In relation to income levels

Figure 6: Median indirect taxation by income quintile
Source: Eurostat (icw_tax_02)
For information about the reference year see here

If we take into account savings behaviour, VAT is not progressive in relation to income levels. As shown in Figure 6, the median share of gross income that goes to pay VAT is much higher for the poorest 20% of households than for the richest 20% of households; in general, the VAT share decreases as income increases. The variation across the income distribution may be wider in some countries than in others; in 9 out of 27 countries, half of the poorest 20% of household pay more than 15% of their gross income for VAT, while in the vast majority of countries not more than 10 % of household gross income goes to pay VAT for half of the richest 20% of households. In Luxembourg, for instance, the variation across the income distribution is very low, ranging from 5.7% for the poorest 20% of households to 3.8% for the richest 20% of households. One of the drawbacks of this indicator is that gross income does not account for the difference in fiscal policies in the EU, in particular for direct taxation[2]. It is therefore necessary to also account for direct taxation in the assessment; this is done in the next section.

Figure 7: Median indirect taxation by household type
Source: Eurostat (icw_tax_03)
For information about the reference year see here

Depending on the household type

VAT as a share of gross income exhibits in general a higher variability across household types than VAT as a share of consumption (see Figure 7). Moreover, in several countries (Bulgaria, Croatia, Hungary, Latvia, Poland, Slovenia, Slovakia), people living alone turn out to be more heavily taxed in proportion to their income than the other household types. Here again, this mainly reflects particular savings behaviours, as the median savings rate is in general lower for adults living alone (see, for instance, experimental results available here).

Over the life cycle

Figure 8: Median indirect taxation by age of the reference person
Source: Eurostat (icw_tax_01)
For information about the reference year see here

In contrast to Figure 4, Figure 8 shows that the VAT rate as a share of income follows a U-shaped curve over the life cycle. In many EU countries, households whose reference person is under 30 years old face a high median VAT rate as a share of their income (sometimes even the maximum in relation to other age classes, like in Austria, Cyprus, Denmark, Greece, Spain, Finland, France, Ireland, Italy, Luxembourg, Romania, Sweden, Slovenia). This figure then usually decreases with age, and in many cases increases again for households with a reference person over 60 years old. Here again, it seems that the change in income over the life cycle drives the pattern, as households at the beginning and the end of the life cycle tend to have higher marginal propensities to consume.

Direct taxation

As mentioned, gross income used in a cross-country comparison may be misleading as it does not account for the national tax systems. Therefore, considering VAT as a share of gross income may not be accurate since it does not reflect the burden of VAT once direct taxes and social contributions have been paid. In this paper, direct taxation therefore refers to taxes on income and social contributions, as defined in EU statistics on income and living conditions (EU-SILC). However, we also include in direct taxes regular taxes on wealth, i.e. taxes that are payable on a periodic basis on the ownership of real-estate assets, and taxes on wealth as a whole net of indebtedness or any tax on valuables. As a sign of the differences in national tax systems in the EU, the median tax rate as a share of gross income varies widely across countries, ranging from 3.7% in Ireland up to 30.5% in Denmark in 2010. The changes over time in most of the countries turn out to be insubstantial; however, the Irish tax rate has steadily grown over the period, reaching 7.6% in 2015.

Moreover, direct taxation across European countries turns out to be progressive, which means that the share of gross income paid for direct taxes increases with income. The progressivity of taxation is generally preferred, as it has the advantage of lowering the tax burden of low-income households for the same global amount of collected taxes. This fiscal policy also affects the tax incidence over the life cycle; hence, the tax rate follows a humped-shaped curve, reaching its maximum in the middle of the life cycle.

Direct and indirect taxation

Figure 9: Median and aggregate direct and VAT taxation out of gross income
Source: Eurostat (icw_tax_07), (gov_10a_taxag) and (nasa_10_nf_tr)
For information about the reference year see here

Once direct taxation and VAT are totalled, it is possible to obtain a broader picture of taxation in Europe which encompasses the main aspects of household taxation. Taxation continues to vary widely across EU countries: the median ratio of VAT and direct taxes out of gross income ranges from 15.6% in Cyprus to 42.3% in Denmark. It is possible to compare this figure with data from national accounts, and in particular taxes collected by the authorities for personal income taxes, social contributions and current wealth taxes compared to an ad hoc gross income derived from disposable income and taxes paid by households. According to national accounts, aggregate VAT and direct taxes out of household gross income is the lowest in Spain (12.3%) and the highest in Denmark (48.3%). The differences may be explained by differences in concepts; on the one hand, the median is a distributional indicator splitting the population into two equal shares, while aggregates consider the population of households as a whole. The differences may reflect differences in the allocation of the tax burden across the population. It may also reflect differences in concepts (for the definition of income, for instance) and in measurement; in the case of the median ratio, VAT is estimated based on the expenditure reported by households (whether the VAT has actually been paid or not), and direct taxes are reported by the households (and in many cases obtained from fiscal sources). In the case of the aggregate ratio, VAT and direct taxes are the amounts collected by the authorities.

Figure 10: Median direct and VAT taxation by income quintile
Source: Eurostat (icw_tax_09)
For information about the reference year see here

In relation to income levels

When accounting for direct taxation, the combination of VAT and direct taxes turns out to be progressive, as shown in Figure 10: the tax rate out of gross income increases with income in almost all EU. Hence, in most countries, the regressive pattern observed for VAT is largely mitigated by direct taxes that are generally designed to precisely target the high-income households and to shift the fiscal burden to the top of the income (and possibly wealth) distribution. The data also suggest that it is not entirely the case for some countries (Italy, and partially Bulgaria, Denmark, Croatia, Ireland, Luxembourg, Latvia, Poland, Romania, the United Kingdom); in these countries, VAT and direct taxes do not increase as income rises. However, this observation has to be mitigated by at least two points. First, even though the tax system is quite comprehensively described with direct taxes and social contributions, there are still some taxes that are not accounted for, such as excise taxes for indirect taxation, or local taxes for direct taxation. Second, the matching performed for the computation of the indicators presented in this article may be of lower quality for some of these countries: in particular, since the HBS data for Italy do not include any proxy for income, the data may be more questionable than the data for the other countries.

Figure 11: Median direct and VAT taxation by household type
Source: Eurostat (icw_tax_08)
For information about the reference year see here

Depending on the household type

As shown in Figure 11, there is no clear pattern for the incidence of VAT and direct taxation across household types. Where the taxation burden seems to increase in relation to household size in some countries, in other countries it remains fairly stable. The incidence of taxation across household types depends on several factors, such as the differences in income across household types, the demographic structure of the population but also the birth policy of the country and its implementation in the tax system. The mixed results obtained here probably also reflect the different birth policies across countries.

Figure 12: Median direct and VAT taxation by age of the reference person
Source: Eurostat (icw_tax_07)
For information about the reference year see here

Over the life cycle

Following the earlier observation that the fiscal incidence across the life cycle of the different taxes analysed here is very much driven by income, the pattern of the tax rate depending on the age of the reference person follows a hump-shaped curve that is consistent with the change in income over the life cycle. In particular, the households whose reference person is 60 or older are much less taxed in relation to their gross income than other households in most of the countries (except Sweden). This is the consequence of both a drop in income due to retirement (and therefore a drop in the direct taxation rate) and a change in the consumption structure (as shown in Figure 4).

Data sources

EU statistics on income and living conditions (EU-SILC) were launched in 2003 and data collection is governed by Regulation (EC) No 1177/2003 of the European Parliament and of the Council. EU-SILC collects information on income and comprises a cross-sectional dimension and a longitudinal dimension. The Household Budget Survey (HBS) is a survey conducted every 5 years on the basis of a gentlemen's agreement between Eurostat, the Member States and the EFTA countries. Data are collected using national questionnaires and, in most cases, expenditure diaries that respondents are asked to keep over a certain period of time. The wave used for this article is the 2010 wave, although the reference year may vary across countries.

Household disposable income is established by adding up all monetary incomes received from any source by all members of the household (including income from work, investment and social benefits) — plus income received at household level — and deducting taxes and social contributions paid. In order to reflect differences in household size and composition, this total is divided by the number of ‘equivalent adults’ using a standard equivalence scale, known as the ‘modified OECD’ scale, which attributes a weight of 1.0 to the first adult in the household, 0.5 to each subsequent member of the household aged 14 and over, and 0.3 to household members aged less than 14. The resulting figure ('equivalised disposable income') is attributed to each member of the household.

Consumption is described according to the Classification of individual consumption by purpose (COICOP) for each household. Total consumption is obtained by adding up all COICOP items and (as with income) this total is divided by the number of 'equivalent adults' using the same modified OECD scale. The resulting figures are used to compute equivalised expenditure, which are attributed to each member of the household, in order to compute the 'low levels of expenditure' indicator.

Direct taxation is estimated through variables collected in EU-SILC. There are two variables giving respectively the regular taxes on wealth paid by households and the taxes on income and social contributions. Regular taxes on wealth refers to taxes that are payable on a regular basis on the ownership or use of land/buildings by their owners. It also includes taxes on net wealth or on valuables. Direct taxation designates taxes on income, profits and capital gains, as well as social insurance contributions paid by employees, self-employed and if applicable unemployed and retired individuals.

Value-added tax (VAT) is a tax paid by consumers on top of what they spend for consumption. Even if VAT collection may involve many parts of the economy (in particular firms, and in general the seller of the good or service being taxed), the households that consume in the country are the ones that end up paying the tax, whether they live in the country or not. VAT applies to goods and services sold in the European Union, including between Member States; goods and services sold outside the EU are not subject to VAT. In the EU, all countries have a ‘multi-rate’ system, with a ‘standard’ rate as a general rule and reduced/super-reduced/zero rates as exceptions for specific goods and services. In accordance with European tax rules[3], the standard rate should not be below 15%, while the reduced rates (one or two reduced rates may apply to a specific list of goods and services defined by the rules) should not be below 5%. For further information, the reader may refer to the European Commission's documentation on VAT.

Value-added tax is estimated through the consumption structure of the household. Based on data provided by theEuropean Commission's Directorate-General for Taxation and Customs Union, a VAT rate is applied for every COICOP item. This makes it possible to compute the VAT that is paid by the household, assuming that every expense reported by the household has been made on the national territory and that none of the reported expenses have been made in the black economy. Scripts performing the computations on the HBS data are made available in annex.

EU-SILC and HBS data are matched according to the year of reference for HBS, so as to obtain a fused dataset containing household-level information on both income and consumption. The results are considered valid "around 2010". For more details on the statistical matching of EU-SILC and HBS, see another Statistics Explained article describing the methodology used.

Context

In order to support its agenda for social fairness and strike a good balance between economic and social goals, the European Commission has stressed the need to bring social indicators up to a par with macroeconomic indicators within the EU's reinforced macroeconomic governance. To this end, it is important to ensure the availability of harmonised statistics at EU level that cover the distributional aspects of households' income, consumption and wealth (ICW).

In September 2016, the Directorates General of the National Statistical Institutes (DGINS) conference[4] in Vienna stressed the importance of ICW statistics shedding light on people's material well-being and on inequality. The conference concluded that there was a need for a harmonised statistical framework on ICW based on a multi-source approach integrating existing sources of data (EU-SILC, Household Budget Survey (HBS) and the Household Finance and Consumption Survey (HFCS). These data are the first outcome of an effort to integrate data that will be pursued and improved in the coming years.

In the meantime, Eurostat has launched a section on its website dedicated to the dissemination of experimental statistics. These statistics use new data sources and methods in an effort to expand and improve Eurostat's response to its users' needs. Since the statistics presented in this article come from experimental data processing and are based on statistical assumptions, they belong to this section until they reach a sufficient level of maturity.

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Notes

  1. with respect to the COICOP - the Classification of Individual Consumption according to Purpose.
  2. Direct taxation refers here to taxation applied on income and wealth, as well as social contributions.
  3. See the regulation for VAT in the EU Regulation (EC) No 112/2006.
  4. The DGINS conference is held once a year and aimed at gathering the Directors General of the National Statistical Institutes to discuss topics related to the statistical programme. For more details, see here.