| Summary: | EXECUTIVE SUMMARY Iceland’s government, elected in 2013, is conducting a general review of its tax policy with a view toward making it more efficient and less distortionary.1 To this end, it has targeted VAT reform as a priority to become more reliant on consumption rather than income taxation. The narrow base and wide gap between the very high 25.5 percent main VAT rate and lower rate of 7 percent distort economic behavior and encourage tax arbitrage, evasion and lobbying. The efficiency of the Icelandic VAT is thus currently well below the European and OECD averages. To address this situation, the government plans in the near term to broaden the base by eliminating exemptions, raising the lower rate, and reducing the top rate. In the medium term, the government targets a single-rate system. To offset the potentially inflationary effects of VAT reform and reduce price distortions, the government is considering repealing the commodity tax and reviewing the trade regime for agriculture. It may also seek to increase social benefits for low-income households most affected by the VAT increases. These measures are all in accord with recommendations made by two previous IMF missions in 2010 and 2011. This mission reiterates its previous recommendations that Iceland should in the near term: (1) eliminate exemptions at least for tourism, transport, sports and culture; (2) limit VAT refunds to local government to services that could be outsourced; (3) double the lower rate to 14 percent; (4) reduce the top rate as revenue permits, depending on base broadening; and (5) in the longer term, move to a single VAT rate of about 21 percent. In addition, this report makes the following major recommendations: • Consider at least doubling the VAT threshold to ISK 2,000,000 (about USD 17,850 or EUR 12,900). A higher threshold will ease administration, allowing limited RSK resources to be focused on the large taxpayers who generate most VAT revenue. • Fully tax all sales and leasing of commercial buildings, as well as first sales of ...
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