European leaders know they need to increase their defence spending to meet threats in the post-Ukraine-invasion, post-Trump world. Most discussions turn on conventional financing methods: Tax hikes, spending cuts or borrowing. Leaders should instead think outside the box and consider dramatic cuts to their value-added tax (VAT) rates in order to turbocharge economic growth.
Large welfare states, high tax rates and massive debt hamper most European nations’ efforts to dramatically boost defence spending. Some nations with more favourable balance sheets, such as Poland and Germany, are nonetheless able to pay for their defence hikes with increased borrowing. Most other nations, including heavyweights like France and Italy, cannot.
That means they will need to either turn to collective borrowing in the form of Eurobonds or find ways to increase economic growth if they are to pay for defence without politically unpopular spending cuts or tax increases. Defence Eurobonds are being predictably resisted by wealthier nations unwilling to underwrite spending by historically fiscally undisciplined nations. That leaves growth, and conventional efforts to boost growth have largely failed over the past 15 years.
This failure is in part due to European reliance on exports. Most nations within the European Union run trade surpluses, and the EU as a whole has run surpluses for most of the past decade other than the period during and immediately following the Covid-19 pandemic.
Europe’s export-driven models, though, run into many nearly insuperable challenges. America’s deep private financial markets and China’s State-driven financial subsidy models allow technology leaders to obtain the financing they need to grow and invest rapidly. European companies still have to rely largely on national financial markets and cannot rely on support from the EU itself to make up the difference. The fact that the EU remains a collection of nations rather than a nation itself is a significant barrier to creating the large, innovative firms needed to win the global trade war.
Then there’s the problem of geopolitics. Chinese and American leaders often view the global economic battle through the lens of their geopolitical rivalry. This means they will use legal means to help their national champions and hamper their adversaries. Neither nation views European companies as loyal friends, which means their actions inevitably disadvantage European firms.
Geopolitics also rears its head in terms of European access to these behemoths’ home markets. The US under President Donald Trump has moved to bring production back to its borders by use of tariffs, while China’s model of favouring domestic producers for its home market means European sales to Chinese consumers are dropping. China’s subsidies to its exporting industries, such as automobile companies, mean its exports to European consumers are rising quickly. The result: Germany’s longstanding surplus in high-end machinery and factory equipment sold to China, which supported many jobs, has now turned into a deficit. The EU’s overall goods trade deficit with China reached €359.9 billion in 2025, more than double the level of a decade earlier.
The combination of these factors means that European growth remains sluggish precisely at the moment it needs to rise.
Europe has a secret weapon, though: Its consumers. High VAT rates, ranging as high as Hungary’s 27 per cent, suppress domestic consumption. This, in turn, leads to some of the world’s highest personal savings rates, 14.3 per cent of disposable income in the euro area in the first quarter of 2026, according to Eurostat, as Europeans who find buying things too expensive save instead. Cutting VAT rates should unlock some of those savings, leading to jobs and growth. EU law sets a floor of 15 per cent for standard VAT rates, which caps how far any member state can go, though the EU average of about 21.8 per cent leaves most governments room to move.
Cutting the VAT could lead to short-term increases in budget deficits, but the dynamic effects would likely be much smaller. Research shows that temporary VAT cuts have largely been passed through to the consumer in lower prices, with about 70 per cent of Germany’s 2020 cut reaching supermarket shelves, according to the ifo Institute, thereby lowering inflation. They also have the desired effect of increasing spending and consumption.
Lower inflation means lower interest rates, which lower government borrowing costs. Higher spending means more employment, which leads to lower government social spending and higher income tax revenue. Both factors would offset some of the static revenue loss from the tax cuts.
Coupling this with tariffs on many Chinese goods could further heighten the positive economic impact. Revenue from the tariffs would again bolster government budgets, while the increased prices for Chinese goods could lead to increased demand for European substitutes. The EU already applies duties of up to 35.3 per cent on Chinese electric vehicles, though Chinese models still passed 10 per cent of total EU car sales for the first time in May 2026. If Chinese electric cars, for example, were closer to European-produced models on price, many Europeans would likely choose the domestic champion over the foreign import. That would increase employment and profitability at domestic firms, which increases tax revenue.
It’s clear that Europe’s post-Cold War political and economic models are broken. They relied on American subsidy, through shouldering the defence burden and its free trade, consumer-driven economic model. They also relied on China remaining a supplicant rather than a large competitor and on Russia’s closer integration into Western European norms. All of these factors are gone. Europe’s leaders must then choose new models, quickly.
Cutting VAT sharply would be out of character for the hidebound consensus politics that have typified European nations for decades. Those leaders might just find, though, that their populist competitors have few qualms about such a drastic move. The current crop of leaders should therefore take a leap and try to jump-start the growth and robust sovereignty their voters crave lest their adversaries come to power and do exactly that.
