Chapter

chapter 2 VAT Rates

Author(s):
Alan Tait
Published Date:
June 1988
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And though each spring doe adde to love new heate,

As princes doe in times of action get

New taxes, and remit them not in peace,

No winter shall abate the springs encrease.

—John Donne, “Loves Growth”

The rate or rates at which VAT is levied is an important consideration in the operation of VAT. Table 2-1 shows the VAT rates in effect on January 1, 1991 in 55 countries. It also shows 8 countries that are actively considering a VAT (Algeria, Burkina Faso, Cyprus, Jamaica, Malaysia, Poland, South Africa, and Venezuela). Twenty-one countries use a single rate (ignoring the zero rate used by nearly all for exports and by some to exempt domestic purchases—see Chapter 4). The highest single rate in use is in Sweden (25 percent), and the lowest (5 percent) is in Panama. The principal costs of administering a single rate VAT are the same whatever the rate chosen; given the widely perceived high costs of administration and compliance (see 12 and 16), it might be considered a poor allocation of resources to levy a VAT at a low rate. For most countries, a VAT is probably not worth introducing at less than 10 percent (a point that becomes crucial in discussing a VAT in the United States). At that rate, the administrative costs as a proportion of revenue should fall to 1-2 percent. Also, at that rate, the deficiencies of the retail sales tax start to emerge more strongly (see Chapter 1), and the VAT, with its fractionated collection at importation and subsequent stages, begins to look more attractive.

The highest selective vat rates appear in Kenya (250 percent), Malawi (85 percent), Senegal (50 percent), Italy (38 percent), and Greece (36 percent). The lowest rates—more or less theoretical—are in Belgium and Turkey (1 percent) and Korea (2 percent). Generally, reduced rates applied to food are levied at 5 percent or 6 percent. The highest standard rate is 35 percent in Malawi and the lowest (3 percent) is in Japan.

Table 2-1.Percentage VAT Rates Throughout the World
Date VAT

Introduced

or Proposed
VAT Rates1
At introductionOn Jan. 1, 1991
Algeria2Jan. 1992
ArgentinaJan. 19751613
AustriaJan. 19738,1610,20,32
BelgiumJan. 19716,14,181,6,17,19,25,33
BoliviaOct. 19735,10,1510
Brazil3Jan. 1967159,11
Brazil4Jan. 19671517
Burkina Faso2
CanadaJan. 199177
ChileMar. 19758,2018
ColombiaJan. 19754,6,104,6,10,15,20,35
Costa RicaJan. 1975108
Cyprus2
Côte d’IvoireJan. 1960811.11,25,35.13
DenmarkJuly 19671022
Dominican Rep.Jan. 198366
EcuadorJuly 19704,106
El Salvador2
FinlandOct. 19901717
FranceJan. 19686.4,13.6,20,252.1,4,5.5,18.6,22
GermanyJan. 19685,107,14
GreeceJan. 19876,18,363,8,18,36
GuatemalaAug. 198377
HaitiNov. 1982710
HondurasJan. 197636,7
HungaryJan. 198815,2515,25
Iceland5Jan. 199014,24.514,24.5
IndonesiaApr. 19851010
IrelandNov. 19725.26,16.37,30.262.2,3.3,12.5,21
IsraelJuly 197686.5,16
ItalyJan. 19736,12,184,9,19,38
Jamaica2
JapanApr. 19893,63,6
KenyaJan. 199017,20,40,50,27017,20,40,50,270
KoreaJuly 1977102,3.5,10
LuxembourgJan. 19702,4,83,6,12
MadagascarJan. 19696,1215
MalawiMay 198910,35,55,8510,35,55,85
Malaysia2
MaliJan. 199110,1710,17
MexicoJan. 1980106,15,203,4
MoroccoApr. 19867,12,14,19,307,12,14,19,30
NetherlandsJan. 19694,126,18.5
New ZealandMay 19861012.5
NicaraguaJan. 197566,10,25
NigerJan. 19868,12,1815,25,35
NorwayJan. 19702011.11,20
PakistanJuly 199012.512.5
PanamaMar. 197755
ParaguayJan. 19911212
PeruJuly 19763,20,4018
PhilippinesJan. 19881010
Poland2
PortugalJan. 19868,16,308,17,30
SenegalMar. 1961–8067,20,34,50
South Africa2Oct. 1991
SpainJan. 19866,12,336,12,337
Sweden5Jan. 19692.04,6.38,11.125
Taiwan Province of ChinaApr. 198655,15,25
Trinidad and TobagoJan. 19901515
TunisiaJuly 19886,17,296,17,29
TurkeyJan. 1985101,6,8,12,20
United KingdomApr. 19731015
UruguayJan. 19685,1412,218
Venezuela2July 1991
Yugoslavia2
Source: Various reports.

Rates shown in bold type are the so-called standard rates applied to goods and services not covered by other especially high or low rates. Most countries use a zero rate for a few goods, and Ireland, Portugal, and the United Kingdom use it extensively to ensure that substantial amounts of goods and services are free of vat.

Discussed.

On interstate transactions depending on region.

On intrastate transactions.

Effective rates.

Senegal’s vat evolved from a limited manufacturers turnover tax with credits, and no precise date of introduction is given.

The standard rate to increase to 14 percent in 1991.

To increase to 22 percent on April 1, 1991.

Source: Various reports.

Rates shown in bold type are the so-called standard rates applied to goods and services not covered by other especially high or low rates. Most countries use a zero rate for a few goods, and Ireland, Portugal, and the United Kingdom use it extensively to ensure that substantial amounts of goods and services are free of vat.

Discussed.

On interstate transactions depending on region.

On intrastate transactions.

Effective rates.

Senegal’s vat evolved from a limited manufacturers turnover tax with credits, and no precise date of introduction is given.

The standard rate to increase to 14 percent in 1991.

To increase to 22 percent on April 1, 1991.

The experience of changing rates has been nearly all one way—upward. Only four countries, Argentina, Chile, Costa Rica, and Peru (and Brazil on interstate transactions), have a lower standard rate of vat in 1991 than when vat was introduced. Other countries have watched vat rates climb. Some have moved from a single rate to double rates and back to a single rate again (United Kingdom), while others have made an effort to reduce the number of rates used (Italy and Belgium). The EC has proposed that countries should use only two bands of rates, a standard rate and a reduced rate—see discussion in Chapter 8, section on “Customs Unions.”

There are contentious issues relating to effective vat rates, the relationship between vat and excises, and tax harmonization. However, the most persistent and important problems all relate to the choice of single or multiple rates and how many multiple rates.

A Single Rate or Multiple Rates?

The basic rule is simple: use as few tax rates as will satisfy the preferences of politicians. All tax administrators prefer to use a single rate of vat (once again, ignoring the zero rate on exports). Politicians nearly always think the public will acquiesce to a vat more easily if products consumed by lower-income households are taxed at lower rates than products consumed by the better off. The temptation is to introduce a rate lower than the standard rate, and another higher rate, thus ending up with three rates. It cannot be emphasized too strongly that both official administrative costs and traders’ compliance costs rise dramatically as the number of rates multiply and nothing much is gained in terms of revenue (see Chapters 6 and 16).

To run the simplest practical vat (one positive rate, a zero rate, and some exemptions) requires at least 9 pieces of information from each taxpayer (the value of supplies at the two rates and the value of exempt supplies, the value of purchases at the two rates, two liabilities to vat on output, and two liabilities to vat on inputs). A vat with three positive rates, a zero rate, and exemptions needs at least 17 pieces of information. The Irish tax return form, using only two rates, still requires 38 entries.1 As the number of rates increases, tax forms become much more complicated and not only the chance of error, on the part of both taxpayer and tax officials, becomes much greater but the potential for evasion rises rapidly as well.

Apart from administrative and compliance costs, there are numerous doubts about the rationale for using multiple rates at all.

(1) Multiple rates distort both consumer and producer choices.

(2) Low rates of vat, as the Irish Commission on Taxation noted, do not “necessarily benefit the final consumer. In reality, traders [are] faced with recouping a certain amount of vat from consumers. They [adjust] their prices in line with what the market would bear regardless of the rate of tax prescribed for individual items.”2 That is, given multiple rates, traders will juggle their prices to what the market will bear and items with low vat rates could end up cross-subsidizing the higher-rated items.

(3) Of course, not just low-income households benefit from the lower tax rate; such differential rates are a very blunt instrument for favoring particular households. Clearly, income tax adjustments, transfers, income supplements, or coupon schemes can be better targeted to help the poor.

(4) Many countries subsidize “essential” goods and services such as food, electricity, or fuel. It makes little sense to levy a special low rate vat on an already adjusted price rather than the standard vat rate.

(5) Favorable treatment creates dissatisfied traders and consumers who argue that their products are at the dividing line of definition; if fresh vegetables are taxed at a low rate, why not frozen vegetables, if frozen, why not canned, and so on.

(6) A glance at any of the vat regulations defining differential categories should quickly convince any sensible person how ill advised it is to multiply rates and create the attendant problems of definition. It is not only that vat staff time is taken up defining the various categories of goods, assessing the borderline cases, and explaining decisions to traders and public interest groups, but that, typically, these decisions require the attention of highly qualified, intelligent staff, whose decisions will stand up to debate and argument. Such a staff can be employed much more fruitfully on administering the vat. Settling hardline definitions therefore becomes an expensive exercise.

(7) Successful arguments for lower vat rates erode the tax base.

(8) High vat rates typically (except for automobiles) apply to goods that account for a relatively small proportion of total consumption. The revenue at issue is small, and the administrative cost is high. Frequently, consumers avoid sumptuary rates by adjusting their consumption. Given the small segment of the population involved, the effect on distributive burden cannot be much. Excises and user charges are the best complements to vat to levy higher taxes on a few goods (see below).

(9) Whatever multiple rates are chosen and whatever the subsequent changes, they rarely reflect genuine changes in consumer or government preferences. As Cnossen remarked, “At the beginning of 1979, music and stage performances became taxable at the general rate; admissions to zoos, pleasure fairs, and circuses, however, continued to be taxed at 4 per cent. Presumably, this change did not signify a shift in the cultural taste of the Dutch.”3

(10) Finally, using a general equilibrium model, it has been shown that rate differentiation leads to significant reductions (about 60 percent for sales tax) in the welfare gains of adopting equalized tax rates.4

To get a new tax off the ground smoothly requires the cooperation of the traders who must bear the compliance costs (see Chapter 6). As Roger Douglas, the Minister of Finance of New Zealand, pointed out, “Traders who would be collecting gst [goods and services tax—the New Zealand vat] had to be assured they could cope with the new tax. Simplicity for them was, in fact, one of the key reasons for setting the tax at a single rate and without exemptions… I believe now this … was one of the principal reasons why the tax reform package was so well accepted when it was finally introduced.”5

The arguments are overwhelming in favor of using a single rate vat with a zero rate for exports and very few exemptions. Should multiple rates be necessary, the fewer the better.6

Effective Rates

A powerful additional reason against multiple rates (were one needed) is that with “any complication in rate structure … the pattern of uniformity flies apart completely.”7 Even with a simple single rate of 15 percent and a zero rate with some exemptions, Hemming and Kay were able to show that the effective rates on value added in the United Kingdom ranged from –24 percent (on food) to 37 percent (on leather goods and furs). Of course, these effective rates of vat, like effective rates of protection from customs tariffs, are not apparent to the consumer or, usually, to the trader. They occur because traders are unable to claim full credit for some inputs, yet the vat is applied to the full value of their sale. Therefore, the actual value added in that particular trade is taxed effectively at a much higher rate. (For example, a vat of 10 percent on a restaurant meal, where inputs represent 40 percent of the final value with no credit because they are exempt, is transformed into an effective rate of over 16 percent.)

A more pedestrian point about effective rates is that only one country (Sweden) quotes its vat rates on a price inclusive of tax, and traders in most countries have to work from tax-inclusive prices backward to calculate their vat liability. The obvious case would be a 10 percent vat, quoted at 10110, requiring the trader to use either the fraction 111 or 9.091 to calculate his vat liability at 10 percent net of tax. When numerous rates or rate changes are made, some peculiar (and to some, confusing) fractions are created. If the rate is reduced from 10 percent to 8 percent, the relatively easy fraction of 111 is transformed into 227 or a coefficient of 7.41. The fewer such changes, and the simpler the fractions and coefficients sought, the better.

Another minor point is that some countries have altered their effective rate of tax by adjusting the value of the good charged. Sweden used this mechanism to lower the vat on housing (effectively halving the tax rate). Tunisia proposed a 50 percent reduction in value for a range of commodities, and Grenada adjusts the base for all domestic goods to make the effective rate 8 percent (instead of 20 percent). Finland overadjusts for the value of inputs to “subsidize” essential goods. Such adjustments discriminate for or against inputs and would not be acceptable on traded goods under GATT. Moreover, the tax shown on invoices to purchasers will have to be at the effective rate to avoid overgenerous credit claims for inputs. Naturally, such adjusted bases are discriminatory, distorting, and undesirable.

VAT Rates and Excise Duties

A vat is levied on a price inclusive of customs duties and excises. It could be levied on a price excluding both but, given that these taxes are levied early in the production process and that levying them on a base including vat would be administratively cumbersome, it is easier to levy the vat on the all-inclusive base and then adjust the excise rates if necessary. Usually when a vat is started, the excise rates are adjusted so that the retail price of excisable commodities, including vat and excises, does not change. Excises typically are levied on four traditional goods: alcohol, tobacco, petroleum products, and automobiles; two of these (alcohol and tobacco) are usually regressive and the other two contribute to progressivity. If countries wish to try to create progressivity through indirect taxes, then it is preferable, especially in developing countries, to use a few extra excises than to complicate the vat structure (see above) by introducing multiple rates.

The range of commodities over and above the usual goods subject to excises, even in OECD countries, is remarkably large (Table 2-2). However, realistically, in terms of significant revenue, the goods that might be considered for excises to complement the vat, aside from those already mentioned, are electricity, telecommunications, nonalcoholic beverages, household electric appliances, records, and tapes. Each of these has some possibility of adding to progressively. The consumption of most rises sharply with increasing household income. Certainly the extraordinary range of goods on which excises are levied, for instance, in Japan (Table 2-2), with rates from 1.6 percent on golf clubs to 7.6 percent on small television sets and 32.1 percent on small passenger automobiles,8 is almost a classic example of the desirability of a single rate vat to replace such distortions of consumer choice.

Table 2-2.Examples of Nonsumptuary Excised Goods for Selected OECD Countries, 1981
BelgiumCanadaDenmarkFranceGermany, Fed. Rep. ofIrelandItalyJapanLuxembourgNetherlandsNorwayUnited

Kingdom
United States

(Federal)
JewelryAV(r)AV(r)AV1
MatchesS(u)S(u)S(u)S(u)S(u)AV1S(u)
Playing cardsS(u)S(u)S(u)S(u)
Watches, clocksAV(w)AV1
Motor vehiclesAV2AV(w)AV1AV(w)AV(w)S(u)2
Electric powerSSAV(r)
Nonalcoholic beveragesS(v)S(v)S(v)AV(r)AV1S(v)S(v)S(v)
Tea, coffeeS(w)S(w)S(w)S(w)S(w)AV1S(w)
Candy, chocolateS(w)S(w)
Perfume, cosmeticsAV1AV(w)
Television setsS(u)AV1
Electric appliancesAV1
SugarS(w)S(w)S(w)S(w)S(w)S(w)S(w)
Light bulbsAV1
Spices, cocoaS(w)S(w)AV1
Food oilsS(w)S(w)
SaltFM
LampsS(u)AV1
TiresS(w)
Phonograph recordsAV(w)AV1
Sporting goodsAV1AV(w)
FirearmsS(u)AV1AV(w)
Sources: Commission of the European Communities and individual country budget documents for 1981.
Note:AV= ad valorem rate.S(w)= specific rate according to weight.
AV(r)= ad valorem rate on retail sale.S(v)= specific rate according to volume.
AV(w)= ad valorem rate on wholesale value.S(u)= specific rate according to unit.
S= specific rate.FM= fiscal monopoly.

Part of the Japanese commodity tax.

Automobile excise rate levied according to size and/or fuel efficiency.

Sources: Commission of the European Communities and individual country budget documents for 1981.
Note:AV= ad valorem rate.S(w)= specific rate according to weight.
AV(r)= ad valorem rate on retail sale.S(v)= specific rate according to volume.
AV(w)= ad valorem rate on wholesale value.S(u)= specific rate according to unit.
S= specific rate.FM= fiscal monopoly.

Part of the Japanese commodity tax.

Automobile excise rate levied according to size and/or fuel efficiency.

The advantage of using excises instead of multiple vat rates is that the mechanisms of tax collection are kept separate. Typically, excises are collected at the manufacturing stage from a few large producers. The tax is monitored by both physical and accounting controls. Revenue is secure and easy to collect. Instead of involving vat and its attendant complicated collection mechanism, it is better to keep the two taxes separate, vat with its uniform rate and the clearly recognized excises levied separately on quite independently justified grounds. However, it is quite possible to use vat audits to supplement audits for excises.

Geographical Rates

At least one Latin American country (Brazil) uses different vat rates in different parts of the country. Mexico has a standard rate of 15 percent, but uses 6 percent in the areas bordering the United States. The arguments in favor of this are powerful. The state retail sales taxes across the border in Arizona, New Mexico, and Texas are much lower than the 15 percent standard Mexican vat; border residents in Mexico would make all their purchases in the United States and decimate trade in the Mexican border towns.

Despite the understandable reasons for the differential rate, it creates a potential for substantial evasion. It is a fairly simple matter to make operations transacted outside the areas where the lower rate is applied appear as if they had been performed within them, especially in the case of sales to final consumers. The temptation to do so increased sharply when the original difference of 4 percent (a standard rate of 10 percent and the geographic rate of 6 percent) widened in 1983 to 9 percent (15 percent standard rate and 6 percent geographic rate). Of course, revenue is also affected as consumers living near the lower rate areas will make their purchases in favored zones.

Argentina does not use rates differentiated by region for its federal vat; however, the states are allowed to give investment incentives that rebate the vat in full or in part. The result is that the effective rates of vat are varied by region and indeed by activity. Of course, this erodes the federal revenue and in a way that is uncertain both in amount and in timing. Clearly, from the Federal Government’s point of view, such a development is undesirable. If regional incentives are to be given, they should be given in some other way that does not endanger federal revenue.

Portugal, to try to offset the transport costs to the Azores and Madeira, uses reduced rates of 6, 12, and 21 percent (instead of 8, 16, and 30 percent). Of course, direct transport subsidies would be preferred.

Such geographic vat rate differences cannot be recommended as a tool of regional policy or as an expansion of local democracy. Differential rates undermine the neutrality of the vat (which is its major virtue), encourage evasion, and erode revenues.

Rate Harmonization

Countries forming a customs union and working to achieve a true internal market need to harmonize their vat and excise rates. The EC is the only agency to have issued proposed rules on this, and even those seem optimistic to reach the harmonized rates by the desired date of 1992.9

The proposal is that EC members should not make any moves that would exacerbate their rate differentials and, if possible, should move toward a common number of rates and then toward the same rates. What this means, in practice, is that countries using more than three rates should reduce their rates to three, and those using one rate “be allowed to increase that number to two.”10 For instance, Belgium, with the largest number of rates in the EC, has suggested (in a Royal Commission Report of February 1987) that five rates (6, 17, 19, 25, and 33 percent) should be reduced to three (6, 20, and 25 percent).11

Overall, the message as far as rates are concerned is straightforward: the fewer the better, levied on full unadjusted prices, and inclusive of customs duties and excises.

Ireland, Commission on Taxation (1984, p. 63).

Ireland, Commission on Taxation (1984, p. 66).

Cnossen (1981, p. 229).

Ballard, Shoven, and Whalley (1982, pp. 35–36).

Douglas (1987, p. 210).

For a further discussion see Cnossen (1982).

Hemming and Kay (1981, p. 80).

See an excellent description in Ferron (1984).

European Community, “Proposed Standstill on vat and Excise Duties,” reproduced in Intertax (February 1986, p. 45).

European Community, “Proposed Standstill on vat and Excise Duties,” reproduced in Intertax (February 1986, p. 45).

“Belgium: Income Tax Changes Ahead.” World Tax Report (1987, p. 9).

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