Make the VAT threshold progressive

Every year, all the people I know who work part-time freelance seem to land in roughly the same dilemma. It gets to October or November, and their income from freelance work for the year is just creeping towards the VAT threshold — which here in Germany is a rather stingy €22,000 per year (as of writing).

At that point they have to make a decision. If they take on work that will push them just over the threshold, the tax office will suddenly want to take 19% of all their income for the year in VAT payments (or 7%, if the work they do qualifies for the reduced rate — or whatever the equivalent rate is in their own countries). This means, at the end of the year, in order to come out ahead (with more net pay for more work), they’ll have to do 19% more work for effectively nothing until they start making real take-home money again.

Unsurprisingly, everyone seems to decide that the risk of losing money — especially, for those with families, in the run-up to Christmas — is not worth it. They start turning down work which, if they took it, would literally cost them money to do.

This is stupid, and there’s an obvious fix.

For independent freelancers, VAT is effectively another form of income taxation. This problem was solved for income tax with progressive taxation thresholds: instead of paying more tax on all your money when you earn more than a particular amount, you only pay more on the amount exceeding that threshold.

VAT should work this way, too! VAT is seen by consumers as taxation on goods and services, but in fact an equivalent way to look at it is to see it as a tax on turnover. In fact, in German, one of its names is Umsatzsteuer (USt), which means ‘turnover tax’. Seen this way, it doesn’t seem too difficult to implement a system where only the turnover above a threshold gets taxed, and not all of your turnover the moment you go over the threshold. (And yes, this could work with the different-tiered rates of VAT for different goods and services too — you just need to measure the turnover on each category separately.)

You could probably even lower the VAT threshold to compensate for the lost VAT on the turnover below it and come out basically even, and it would still take a huge load off the minds of independent freelancers and other small businesses. I’m pretty sure that not having to worry about whether or not they can make the tax under the VAT threshold back within the year would encourage more people with small side businesses to focus more on their business and eventually grow it into their main occupation. Entrepreneurship! Economic growth! Job creation! Innovation!