18 What Next for the VAT?
- Liam Ebrill, Michael Keen, and Victoria Perry
- Published Date:
- November 2001
The VAT is now a commonplace of tax systems around the world. What of its future? Will this also be commonplace—or are its scope, nature, and role set for further major change?
The safest prediction is that the spread of the VAT will continue. Indeed, several countries have already announced their intention to introduce a VAT and are in the process of doing so. While the United States remains the most prominent outlier, with no immediate prospect of a federal VAT being introduced there, there also remain many countries in Africa and the Middle East with no VAT. The particular issues associated with small and often island economies—the central question (discussed in Chapter 16) being whether a VAT extended to retail level offers much advantage over a mix of tariffs and excises—is likely to arise with increasing frequency.
One lesson of experience, however, is that, to a greater extent than has often been recognized, the work needed to put an effective VAT in place does not stop with its formal introduction. The difficulties in establishing proper audit capacity and effective refund systems (Chapters 14 and 15), for instance, may only become apparent after some months of operation of the tax (indeed it is not unknown for a strong initial revenue performance to reflect in part underpayment of refunds). These are deep-seated difficulties, and can require a sustained effort to overcome.
The nature of “best-practice” within the VAT is also likely to change, reflecting wider developments in the structure of economic activity and policy, and intellectual advances. As the trends toward decentralization within nation states and the formation of regional trading blocs continue, for instance, so the search for ways of implementing lower-level VATs without zero-rating interstate trade (Chapter 17) will intensify. And as the financial sector continues to grow in importance, so pressure will increase to find a better way of taxing financial services than by the exemption now normal (Chapter 8).
More generally, indeed, the damage done by current widespread exemptions—both the commonplace exemptions generally prescribed and nonstandard ones adopted in particular countries—is likely to become increasingly apparent: they take the VAT away from being a broad-based tax on consumption just as much as does outright rate differentiation; indeed exemptions are in a sense even more damaging, being far less transparent in their design and effects. Thus the battle against exemptions is likely to intensify. This will require improvements in administrative capacity, whose weakness in some cases underlies the choice to exempt. It requires new thinking, as described here in relation to both financial services and the treatment of the public sector (Chapter 8). It touches too, moreover, on deeper questions as to the proper role of the state in providing below market value (perhaps free) what are essentially private goods (ones, that is, for which a price could be charged)—notably health care and education—and doing so whilst essentially the same items are provided by private enterprises. For the proper tax treatment of such items is intimately tied to the competitive relation between public and private sector in the provision of such services.
A still deeper set of issues, likely to loom more prominently in the years ahead, concern the relationship between the VAT and income tax. These arise at a variety of levels.
In terms of tax administration, the VAT has often been seen as a catalyst for wider reform, laying a groundwork that can subsequently be used, in particular, for the development of a more effective income tax. Restructured organizations (Chapter 12), the development of self-assessment (Chapter 13), and the enhancement of audit capacity (Chapter 14) are all prerequisites for income tax systems, especially at personal level, that overcome the severe limitations which many developing countries encounter in this area.
In structural terms too, the links between the VAT and income tax raise deep issues, and ones that have as yet received very little attention. For in its basic structure the VAT is, after all, essentially equivalent to a tax on wages and pure profits (Chapter 2); and seen in that light it clearly has many similarities to an income tax. Indeed it is some respects a superior form of income tax. Some would find merit, in particular, in its exclusion from tax of the return to savings (being ultimately a tax on consumption). Moreover, the component of the VAT that bears on business income has some advantage relative to the corporation taxes commonly observed, having the strengths that many see—in the avoidance of distortions to the level and composition of investment—in the cash-flow form of corporate tax. As corporate taxes come under increasing pressure from international tax competition, so this role of the VAT as, in part, an implicit corporate tax may come to be both more clearly apparent and more valued. Where these resonances will lead is far from clear: the treatment of international trade under the VAT, for instance, is an important source of difference from a residence-based corporate tax (a point which perhaps underlies a lingering concern in the United States that European firms enjoy a competitive advantage in world markets from the zero-rating of exports under the VAT). At lower levels of government, there are already signs that income-type accounts-based VATs may have a role to play as a form of local income tax, the recent Italian IRAP being a prominent example. Bird and Mintz (1999) make a general case for such taxes at lower-levels of government.
The future of the VAT could hardly be as dramatic as its recent past, but the power of its inner logic is likely to be felt even more strongly.