VAT Vs FAT Model

The first instrument that is commonly cited as an alternative to the FTT proposed by the European Commission is the tax on financial activities, or FAT. The key principle of the FAT is to “tax the sum of profits and remunerations of the financial sector”. It is important to distinguish between the tax on financial transactions and the tax on financial activities as the first one taxes complete transactions while the latter only taxes the net proceeds generated by those transactions.

There are in fact several underlying motives in introducing a FAT: First of all, raise funds for either past or future bailouts, to hold the banking sector responsible for the considerable cost it has imposed on the governments and thus also on the taxpayers. Secondly,

We will briefly explain these different models in order to assess the advantages and inconvenients of the different models separately.

• FAT 1 is the broadest model and is a substitute for the VAT. In brief, its purpose is to tackle the distortions caused by the VAT exemption of financial services, i.e. an overconsumption of financial services by final consumers, an underutilization of financial services as inputs in the production process, as well as too much self-supply of financial services. In practice, FAT 1 implies a tax base composed of wages and profits, which is the equivalent of value added in this sector. For practical reasons, the easiest way of implementation is an origin-based tax without tax credits for input VAT or business

These rents may be the result of reduced competition in the financial sector caused by barriers to entry or of low interest rates for central bank lending. In the case of supernormal taxes, this approach could be implemented by either using a cash flow tax or a corporate income tax in combination with an allowance for corporate equity (financial institutions with low returns will benefit proportionally more than institutions with high returns). Taxing supernormal wages directly is more complicated, but just taxing bonuses as a proxy is not sufficient. The most important advantage of FAT 2 is that it is neutral with respect to input and financing choices, but not with respect to taxation, which may lead to strong tax competition. However, its main drawback is high administrative and compliance costs. Moreover, FAT 2 faces most of the problems regular corporate taxation is struggling with as well, for example the treatment of losses and group taxation regimes.

• FAT 3 taxes “very high” wages and profits in the financial sector and is mainly aimed at reducing excessive risk-taking. The wages and profits targeted by this tax are substantially higher than those in FAT 2. The objective is to compensate for the incentives to take excessive risks created by the implicit government guarantees to rescue banks that are “too big to fail”. The inconvenients of FAT 3 are similar to those of FAT 2, but one key issue