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

In member states of the European Union, the current VAT treatmentof activities of public authorities creates significant distortionsin their decision-making between public provision and contractingout of public services. In several EU-member states, a refundof VAT to local governments eliminates this effect. Therefore,these VAT refund schemes facilitate contracting out. In memberstates with a refund scheme for the VAT costs of local governmentsor another solution to this distortion, in general refuse collectionis contracted out to a relatively greater extent compared tomember states without. Despite these solutions, the VAT distortionis still relevant for private suppliers of tax-exempt activitiesand public suppliers in other member-states. This distortioncould be addressed by a change in the European VAT legislation.(JEL H25; H32)