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Although the single market was designed to promote fiscal alignment, the data shows that national governments are shaping an increasingly fragmented system—one where the logic of harmonisation often gives way to local interests, political priorities, and long-standing tax privileges.

A System Designed for Unity, Now Driving Fragmentation

According to the Commission, 75% of all 64 existing VAT derogations are concentrated in just three countries: Luxembourg, Ireland, and Italy. Seven other countries—Malta, Cyprus, Greece, France, Portugal, Spain, and Austria—account for the remaining 25%.

This imbalance raises fundamental questions:
Are businesses really treated equally in the single market? And are some governments using VAT flexibility to pursue domestic economic gains at the expense of EU-wide cohesion?

For companies operating cross-border, this patchwork creates extra administrative costs. For consumers, it means uneven prices depending on where they shop. While differences in economic development justify a degree of flexibility, today’s level of variation no longer seems compatible with the spirit of a unified market.

Which Sectors Benefit Most?

The sector with the highest number of derogations is housing and construction, representing nearly 30% of all exceptions. Next come culture and tourism, public services, hospitality, and financial services, which together account for around 40%.

Even more telling is the structure of the exemptions themselves:

  • Super-reduced rates

  • Parking rates (intermediate, protected rates)

Together, they make up over 90% of all derogations.

This suggests that most exceptions aren’t temporary measures, but rather entrenched tax privileges maintained by member states for years. Instead of simplifying VAT—one of the EU’s central goals—the system becomes more opaque, undermining the principle of neutrality.

National Tax Strategies in Focus

Luxembourg: A Champion of Annex III Derogations

Luxembourg leads when it comes to exempting goods and services from Annex III of the VAT Directive, particularly books and pharmaceuticals. This strategy keeps the country attractive for publishers and the pharmaceutical sector, but fuels debates about internal tax competition within the EU.

Ireland: Zero Rates and Maximum Flexibility

Ireland is the only country applying a zero VAT rate on children’s clothing and maritime services. Half of its 28 derogations concern goods outside Annex III. This makes Ireland’s VAT system one of the most flexible in the EU, though critics argue it destabilises the broader European framework.

Italy: Housing at the Centre

Italy directs its derogations mainly toward the housing sector, applying a 10% rate to construction and renovation projects tied to social housing. While this supports the domestic property market, it may also deepen inequalities between countries with different fiscal capacities.

Derogations Without Borders… but Few Takers

Since 2021, EU countries have been allowed to adopt derogations used by other member states. In practice, almost nobody does. Only Cyprus, Greece, and Malta have taken up nine of these options, citing “lack of domestic compatibility”.

This highlights a deeper issue: although EU rules allow for harmonisation, governments rarely use these tools, preferring to maintain their own national tax strategies. The result is a layered system where shared legal frameworks coexist with increasingly divergent national practices.

Shared Rules, National Realities

The VAT Directive gives governments broad freedom to set rates, as long as they respect basic limits. The standard rate must be at least 15%, and states can apply up to two reduced rates, no lower than 5%, to goods and services listed in Annex III (including books, medicines, and public transport).

The 2022 VAT reform expanded this flexibility even further. EU states can now introduce:

  • Super-reduced rates below 5%

  • Zero rates for up to seven categories of essential goods (e.g., food, pharmaceuticals)

The reform also allowed the use of parking rates (minimum 12%) to maintain reduced taxation on goods not listed in Annex III.

In theory, this was meant to support social goals and help governments respond to crises. In practice, it has increased divergence and complexity. Some countries still apply reduced rates to environmentally harmful products, despite EU goals for a greener fiscal system.

Fragmentation or Healthy Fiscal Diversity?

The Commission’s report leaves little doubt: Europe’s VAT system is becoming more fragmented, even though it operates under one legal umbrella. To some, this reflects healthy fiscal pluralism. To others, it signals a weakening of the EU’s ability to shape a coherent economic policy.

The key question is no longer whether harmonisation is needed, but how to achieve it without undermining the principle of subsidiarity, and while restoring clarity to a system meant to be unified.

Because if a tax designed to be common no longer looks common across the Union, the problem isn’t just technical—it touches on the very foundations of European economic integration.

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