The European Commission Directive 1999/85/EC allowed an experiment where the participant countries may apply one or two reduced VAT rates to specific labor-intensive services for a period of three years to study the impact of these reduced rates on job creation as well as combating the black economy. In Finland the chosen services were hairdressing services and minor repairing relating to bicycles, shoes, leather goods, clothing and household linen including alteration of clothing and household linen. The VAT rate was reduced from the general 22% rate to 8% from the beginning of 2007, and was meant to be in place until the end of 2010. In September 2010 it was decided that the experimental VAT reform would continue until the end of 2011.
In this thesis I look into the European Commission's experiment of whether the reduced rates of value added tax did enhance employment in the specific labor-intensive services. The empirical part of the study is carried out by performing a difference-in-differences regression on the number of openings, number of closures and the stock of enterprises of both hairdressers and beauty salons, which were considered as the control group for hairdressing businesses. The results gotten from these regressions described how the reform affected hairdressing businesses when compared to beauty salons, for which the reduced VAT rates were not applied.
The results of the study provide evidence that the reform did not increase demand or employment in the hairdressing sector. The demand for hairdressing businesses can thus be concluded to be inelastic, which suggests that it is not optimal or efficient to apply reduced VAT rates on this kind of labor-intensive services.