Paolo Falcioni, European affairs manager, IndesitCo.
Value added tax (VAT) revision is in the news in Europe. Labor-intensive services such as restaurants and catering services, as well as cleaning and maintenance services, could be subject to reduced VAT rates, according to proposals unveiled by the European Commission in July.
More politically relevant for the household appliance industry is the fact that both French President Sarkozy and British Prime Minister Brown have stated their interest in reducing VAT on top energy-efficient products such as refrigerators, clothes washers, and other large household appliances as a way to encourage consumer buying. They are also asking for a revision of the European VAT Directive in order to create some harmonization in the field. It should be noted that fiscal policies in the European Union are dealt with at national level, unless there is unanimity in all 27 member states.
Lowering taxes looks good at first glance, but a second glance reveals a “snake in the grass.” Lower VAT could actually be detrimental to the development and uptake of energy-efficient innovation in the household appliance industry.
Replacement of outdated, inefficient household appliances by state-of-the-art models makes sense from an environmental and competitive point of view. For the past 10 years, the household appliance industry has invested heavily in developing improved energy- and water-efficient appliances, such as refrigerators and clothes washers. These appliances are ready to positively contribute to the EU’s climate and energy-efficiency goals, but product uptake by consumers is slow.
The market reality is that appliances with higher energy efficiency cost more than their less-energy-efficient counterparts. The initial purchase price constitutes a considerable financial barrier for many consumers. While technology offers energy and water savings in the long run, the payback to the consumer is not immediate. Europe’s climate change mitigation programs require an acceleration of the diffusion of super-efficient products. Because consumers are not ready to pay for them, the commission is responding with incentives and the proposal of lowering VAT.
An Inefficient Plan
The European Commission’s energy efficiency action plan outlines a framework of policies to realize the over-20% estimated savings potential in EU annual primary energy consumption by 2020. The plan encourages citizens to use energy in the most rational manner possible and calls for a dynamic revision of the seven-class European energy label at least every five years, once the top class represents 20% market share.
Contrary to catering and restaurant services, where a lower VAT would be permanent, the proposal calls for a temporary lower VAT to be applied to super-efficient appliances to jump-start the uptake of these products, thereby giving them a lower overall purchase price and causing them to appear more attractive and affordable to the consumer.
This scheme actually creates problems instead of solutions. In Europe, VAT is automatically included in the product price tag, and there is no differentiation made between the cost of the product and the amount of VAT that is included in the overall price. Therefore, a lower VAT would send an incorrect message since the price on display is the end-price of the product. Lowering the consumer’s perception of the product value is contrary to the signal that we are trying to get across—that energy efficiency has a value.
The household appliance industry views a dynamic lower VAT proposal as a serious threat to innovation and competition. If a lower VAT is applied to the best energy-efficient product, it will only remain in effect until the energy label is updated to identify a new top class. Once this happens, the VAT would increase on the now-second-best product, theoretically making the end price increase for the consumer. While the price perception of the lower-quality product would not be influenced by the change, the second-best products would definitely be influenced.
In practice, the consumer market adapts to a lower price and would not accept a price increase. As a result, retailers would be unable to pass on a higher price to consumers. Both retailers and manufacturers would be unable to internalize the tax increase and maintain the final price for consumers.
The end result is that the second-best product either would not be sold (because it would no longer be profitable) or would not be purchased (because it was too expensive). Consumer choice would then focus on the lower-quality offer. If product sales drop toward the lower range, it would discourage industry’s investment in R&D funding and, thus, slow down technological advancements for products that are even more energy-efficient.
In addition to all this, the European marketplace is complex. The establishment of a harmonized VAT reduction approach would put less-advanced national marketplaces at a disadvantage. They would be prevented from exploiting the fiscal policy since it would apply to products that are far too expensive for their consumers. At the same time, setting the upgrade of the fiscal regime on the less-advanced markets would imply massive spending of public money in the most advanced national marketplaces for sales that would have occurred anyway.
The household industry supports incentive schemes that do not alter the consumer’s perception of the true value of the product as a way to encourage uptake of the most efficient product. This also helps keep the consumer aware of the value of the top appliance.
Revenue tax credits that are granted directly to the consumer do not alter the consumer’s price perception. Besides, they are advantageous for governments, as the tax credit is in fact compensated by increased VAT revenues that come from increased sales of the higher-value appliances. Rebates for consumer purchase or cash-back schemes also work if they are carefully designed and managed.
Some incentive schemes are working. The Plan Renove in Spain, for example, allows consumers to receive a subsidy between €50 and €125 if they replace an old household appliance with a new, efficient machine. In Brussels, Belgium, buyers can receive up to €200 for purchasing an A++ refrigerator, refrigerator/freezer, or an electric/gas tumble dryer. Italy offers a tax credit of up to €200 when users upgrade to the more efficient appliances.
Energy-efficient technology and energy labels are not enough. Governments must be active if we hope to achieve societal change. The household appliance industry needs incentive schemes to promote early replacement and higher energy efficiency. We need the support tools now that will help us continue to bring innovation to the market. Incentive schemes implemented at the member-state level can be operational now, while discussion about a differentiated VAT at the European level could continue for years, with possibly no resolution.