Will We Overcome the Lawyers This Time? Svetla Kostadinova July 2006

Discussions on VAT draft law are the time when certain “privileged groups” are to loose their preferences and who will keep theirs for once more.

VAT draft law foresees that legal services be exclude d from the list of goods and service that are exempted from VAT. Lawyers’ reactions are not unexpected. Nevertheless, we are surprised to hear statements such as “we will sue the state in front of international institutions because of the violated right of defense” (good approach from lawyers) and “we are ready for a strike” (unexplainable action from people who should rely strongly on words and arguments in their favor).

How is in Europe?

The table below shows the currents state of affairs in the EU regarding VAT taxation. Out of all 25 member – states, only in two legal services are exempted from VAT and another three have reduced VAT rate in specially defined cases regarding legal profession.

Why there should be no reduced VAT rate for legal services?

The reduced rate has several negative side effects. Often, introduction of reduced rate is justified by no-fiscal motives as in the case of legal services – the access to basic human right of defense. Some say that lower rate leads to lower prices, easier access to legal services for low-income people. Despite this, there are proofs that call in question whether reduced rate really have those effects taking into consideration the distortions they cause.

The arguments in favor of standard VAT rate and elimination of reduced rate for legal services are the following:

- Introduction of single standard rate will make taxation more equal and fare across all sectors of economy;

- At the moment, lawyers pay only income tax and monthly fee in the local bar association ;

- Standard VAT rate will not have significant effect on people with lowest incomes since they have certain rights in the current Law on legal aid, such as (1) consultation for reaching an agreement before starting a trial or filing a lawsuit; (2) preparation of documents for filing a lawsuit; (3) procedural representation; and (4) representation in case of arrest. Additionally, VAT taxation will not affect lawyers with annual turnover up to 50 000 leva (VAT registration threshold). For comparison we can present the following data. According to National statistical institute, the average annual expenditures for a household for court and legal services are as follow:

What is should be done?

It is interesting to notice, that opponents of standard VAT rate use the same arguments to defend their thesis, as we will use now.

Reducing the VAT rate for all

The current 20% rate can and should be reduced. The first step is to make it 18% as recent proposals, and later it is possible to reach the minimum required rate from EU – 15%. The accusations that the government did not managed to negotiate for preferential VAT rates for certain goods and services sounds cynical – whatever the reasons (ignorance and indifference, or just sound economic logic), we all should be grateful for that.

Reducing the VAT rate for all will:

1. Reduce the size of the informal economy ;
2. Increase economic growth ;
3. Reduce the overall tax burden on end consumers.

Abolishing of all exceptions and reduced rates ( introducing of flat VAT rate )

Different rates violate the principle of neutrality and lead to efficiency losses because they distort the incentives for investments in certain sectors of economy.

Abolishing of reduced rates will make tax system simpler and will reduce the need of hiring lawyers, accountants and tax advisors. In other words, administration costs will be less.

On the other hand, this will reduce significantly the possibility of income misreporting by lawyers and those with biggest clients and highest turnover will “go out of dark”. They, in turn, will not be affected from standard VAT introduction since in almost all cases they will have the opportunity to transfer the payment of the tax to their clients.

We should not forget that if reduced VAT rate is introduced now, later any other sector or profession will ask fro preferential treatment, will put many efforts and funds into this, and will find some “friend of the people” to tell as how we can not go on like this any more.

It is interesting to know that EU is maintaining policy towards gradual cutting of reduced VAT rates and encourages using of one standard rate.

Finally, reduced rates for legal services mean lower prices not only for low-income people, but also for those consumers with higher than average incomes. Such “social policy” leads to additional expenditures for the budget that, by our estimations, are greater that the achieved social effect from reduced VAT rate.