Chapter

chapter 8 Federal VAT and Sales Tax Harmonization

Author(s):
Alan Tait
Published Date:
June 1988
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Differences in tax systems did not come about at random, but rather reflect social and political preferences that should not be ignored. . . . efficiency losses … may be an acceptable price to pay for retaining national diversity and autonomy.

—Sijbren Cnossen,Tax Coordination in the European Community (Deventer, Netherlands: Kluwer Law and Taxation Publishers, 1987), p. 49

The vat is levied as a national government tax (except in Brazil). Sometimes, in a federal system, it can clash with existing state taxes. Even without a federal system, the central government vat may not be easy to reconcile with existing local, municipal, and other sales taxes. However, some federal systems—such as in the Federal Republic of Germany, Brazil, Mexico, and Argentina—levy a vat and short discussions of those systems follow. (India has introduced the “modvat,” which is not a vat but a federal excise to get around the powerful interests of the states and their state sales taxes, see Chapter 1, section on “Tax Evolution and Efficiency.”) Next, there is a brief discussion of the vat harmonization issues of customs unions, especially the EC. Finally, general federal-state issues are dealt with in the context of the United States and Canada.

VAT Used in Federal Systems

Federal Republic of Germany

In the Federal Republic of Germany, the states (Länder) actually collect the federally legislated vat at common rates on a common base. The actual operation of the vat is in the hands of each state, and uniformity of application is achieved throughout the country by court rulings on vat. The total vat revenue is split between the Federal Government and the states (roughly 70/30 percent), with some redistribution to help the economically weaker states.

As a model for other federal countries, the German vat illustrates the need for agreed federal and state legislation on base, structure, and rates. Once established, the formula for splitting the proceeds may be the most clear and least contentious method of revenue distribution. However, it should be pointed out that even the limited flexibility in recent years of the federal/state split from 68/32 to about 70/30 was not achieved without considerable disagreement. In a federal system where the states tried to retain more discretion over their own exemptions, rates, and revenues, the system could not work.

Brazil

In 1988, a number of changes were proposed for the Brazilian vat system (see below). Before that it was somewhat similar to the German system in that the Federal Government determined the base and rates. However, in all other respects it differed from the German vat. The vat base was much smaller as fresh food, agricultural inputs, fuels, minerals, and many services were excluded (and from time to time the federal authorities have granted other exemptions to try to stimulate economic expansion). In Brazil, the tax rates are different for interstate sales (11 percent) and for intrastate sales (17 percent). Moreover, the Federal Government levies the vat on manufacturers’ interstate trade (impôsto valor agregadoiva), whereas the states themselves levy the intrastate vats through to and including the retail sale. This creates a much more complicated structure than the German system and introduces some peculiar twists. For instance, a final consumer will be tempted to buy out of state because of tax at 11 percent instead of in state where the tax is 17 percent. (This is much the same as the present U.S. failure to collect from certain mail order firms the out-of-state retail sales tax—see discussion below.) Again, a firm buying any of the many tax-exempt inputs will have less credit to offset against its vat liability on sales than it ought, and the vat on its value added will be higher. Of course, this simply represents “catch up” on the vat paid by the final consumer, and the tax collected by the government will be appropriate. However, there is continuous wrangling over “producer” versus “consumer” states. To try to pacify the consumer states, the agreement is to tax out-of-state sales at a lower rate; in turn, this leads to administrative complications and, possibly, to tax evasion.

Proposals for a new constitution (1988) transfer more tax authority and revenues to the states and the municipalities. The state vats (impôsto sôbre circulação de mercadoriasicms) will have a wider base including services such as communications, consumer credit charges, electricity, and transport; it will also include fuels and minerals. Most important of all, however, the states are to have the right to set the state vat rates themselves and to graduate them according to their individual assessment of “essentiality” of the goods and services. Thus, while in other countries there seems to be a general movement toward reducing divergences in tax rates between sectors and between countries to reduce distortions, Brazil seems to be moving in the opposite direction. The states are to get 75 percent of the new icms revenue and the municipalities are to get 25 percent. With multiple rates different in each state and a federal vat on trade between states, the challenges to tax administration are obvious (see also Chapters 12, 13 and 14).

Mexico

Mexico has 31 states and a federal district. The collection and most administration of vat is in the hands of the states. They remit the entire revenue to the Federal Government and get back only 19 percent. Although the situation is similar to that in the Federal Republic of Germany, the even lower payment ratio to the states seems to affect the efficiency of collection. The Mexican revenue-sharing formula is complicated and based on economic conditions in the different states. It does include a weight for the “effort” made by the state to collect the VAT; effort is defined as the ratio of change in the particular state to the total change in collection. Unfortunately, the reward for effort is small, probably less than a cent for a dollar’s worth of effort. Second, the comparison with the revenue-sharing system under the 4 percent cascade tax the vat replaced shows that previously the states kept 50 percent of the revenue they collected. The introduction of the vat left the states feeling less enthusiastic about sales tax collection for the benefit of the Federal Government. Third, the federal district, despite having 50 percent of the taxpayers, collects only 20 percent of the revenue. Finally, the collection efficiency of the different states varies substantially; some states have much more sophisticated revenue departments than others and some more cohesive, perhaps federal, effort might be more efficient. These problems are recognized by the authorities, but clearly have deep institutional and political roots that are not connected to the vat per se, but are an integral part of any federal structure of government.

Argentina

Argentina has opted for a federal vat administered by the Federal Government. Revenue is shared with the states, using a revenue-sharing formula. Again, fiscal federalism creates problems; the Argentine states have the power to grant exemptions from vat, which erodes the federal tax base, distorts economic policy and management, and creates administrative complexities.

Review of Issues

These examples illustrate that vat can work in a federal system, but the states have to have an interest in making the collection system work and perceive that the formula for revenue distribution is fair. The vat and fiscal federalism constitute an uneasy compromise. The worst alternative is probably that which gives the state administrative power for a federal tax; the best is that which relies on an agreed revenue-sharing formula, changed infrequently, and then only in response to agreed, objectively measured criteria. It should also be noted that in these examples there are no state level sales taxes independent of the vat (as would be the case, at present, in the United States); this clearly complicates the issue and is discussed later.

Customs Unions

The usual country vat is levied on a destination principle in that the tax is levied according to the rate levied on the final consumption of the good or service. The vat is deducted from exports so exports are tax free. Imports are taxed at the full rate of vat, equivalent to that levied on similar domestic goods.

This structure, in a customs union, still requires all the border vat adjustments to be made despite the abolition of customs duties. The whole paraphernalia of border posts, customs officials, examinations, documentation, and so on are still needed. In recognition of these problems, the original designers of the EC looked toward a time when the EC vat could be levied according to the origin principle.1

The origin principle implies that vat is levied where the value added originates and not according to where final consumption occurs. Of course, for this to happen, the tax bases in the different jurisdictions should be the same and the rates should be identical, otherwise the “catching up” mechanisms of vat would transfer vat liabilities across borders. Recent proposals2 have tried to limit countries to a standard rate, a low and a high rate of vat, and to encourage a narrowing of the differentials between rates (no more than a 2.5 percent range of each other). Even more recently, the Commission has proposed only two rates, a standard rate between 14 and 20 percent and a reduced rate between 4 and 9 percent. The reduced rate would apply to foodstuffs, energy, water, pharmaceuticals, books and newspapers, and passenger transport.3 It is recommended that member states fix their rates in the lower half of the band for the reduced rates.

It must also be recognized that it makes little sense to remove border controls for vat if they remain for excises. Therefore, trade adjustment for such taxes might be shifted to “factory gates and retail outlets following agreement on uniform bases of assessment.”4 Of course, such agreements continue to be elusive and must suggest even further delays in EC tax harmonization.

As far as vat is concerned, any customs union proposal should ensure that (1) traders are inconvenienced as little as possible; (2) the clearing system places as little additional burden as possible on the national fiscal administrations; and (3) the clearing system is self-financing.5

Traders are inconvenienced as little as possible by not having to distinguish between domestic and foreign sales. If traders simply apply the same rate of vat to sales regardless of their destination, their task is made as simple as possible. Moreover, consider a trader who might consign goods to be trucked from the Netherlands to Italy; then, when the truck is in Paris, he changes his mind and diverts the goods to Germany. Imagine the complications if invoices must be changed (and checked at borders) for the change from zero rating at the Netherlands border to Italy and now altered to Germany. It is easier for the domestic Netherlands exporter to consider all his production as one, regardless of destination. Where it goes after dispatch, as far as vat is concerned, is no concern of his.

What happens under the Commission’s present (1988) proposal is that each member state calculates its total vat sales and purchases for intra-Community trade for the month by aggregating all vat charged and claimed by registered traders on sales and purchases to EC members. The net position is calculated vis-à-vis the EC as a whole and not against separate states. So each country creates a monthly statement showing its total vat input and output figures for intra-Community trade. The statement establishes a claim or payment. Under this system, there will never be “a final balancing of the vat accounts, but must be seen as part of a perpetually on-going process.”6 Countries have different accounting dates, different rolling programs, different payments on account, and different seasonal trades.

A customs union clearing house will net out the national claims. “Large flows of revenue are at stake and Member States must have reasonable assurances that these revenues, important for their national budgets, are safeguarded.”7Table 8-1 gives an idea of the size of these flows.

Table 8-1.EC Countries: Estimated Revenue Flows Resulting from Operation of the Clearing Mechanism1
Net Amount

to Be Paid

or Received

(In millions of ECU)2
Percent

of GDP
Belgium/Luxembourg3–747–0.62
Denmark6800.82
France2,4210.34
Germany, Fed. Rep. of–3,534–0.38
Greece4371.08
Ireland520.21
Italy1470.03
Netherlands–1,509–0.86
Portugal770.26
Spain1320.06
United Kingdom1,8450.33
Source: Commission of the European Communities, Completing the Internal Market—The Introduction of a vat Clearing Mechanism for Intra-Community Sales, Annex A (COM(87)323 final, Brussels, August 25, 1987); reproduced in Intertax (Deventer, Netherlands), January 1988, p. 26.

Based on 1986 figures and assuming vat rates of 16.5 percent (standard) and 6.5 percent (reduced).

Positive figures indicate amounts to be received by member states from the clearing account and negative figures indicate amounts to be paid by member states into the clearing account (in both cases for the year as a whole).

For technical reasons it has not been possible to distinguish between the constituent components of the Belgian-Luxembourg Economic Union.

Source: Commission of the European Communities, Completing the Internal Market—The Introduction of a vat Clearing Mechanism for Intra-Community Sales, Annex A (COM(87)323 final, Brussels, August 25, 1987); reproduced in Intertax (Deventer, Netherlands), January 1988, p. 26.

Based on 1986 figures and assuming vat rates of 16.5 percent (standard) and 6.5 percent (reduced).

Positive figures indicate amounts to be received by member states from the clearing account and negative figures indicate amounts to be paid by member states into the clearing account (in both cases for the year as a whole).

For technical reasons it has not been possible to distinguish between the constituent components of the Belgian-Luxembourg Economic Union.

While it is relatively easy to recognize the benefits of such a simple system, it is also easy to anticipate the doubts that may rise about the accuracy of the claims involved in such large flows of money between countries with very different judgments about each other’s accounting practices and efficiency. The Commission proposes four elements as means of control. First, the abolition of zero rating, which will extend the self-policing nature of vat, and changes in the net surplus, which can help identify error trends. (There should be a surplus because vat on exempt traders will be collected in exporting countries, but not credited in the importing country.) Second, the creation of standardized audit trails. Third, improved control and cooperation at the national administration level. Finally, better coordination at the Community level. All of these are desirable, but whether they are of sufficient substance in practice to persuade member countries to put at risk such large sums may be in doubt. “It would not be surprising if the national revenue authorities were more concerned to check that vat had been paid on exports (for which they would have to pay money into the clearing system), rather than to scrutinise claims for input vat (which they can, in turn, pass on to the Clearing-House).”8

The scheme leaves member states free to set their own vat rates within the proposed limits. It is persuasively argued that this flexibility is especially needed in a full monetary union where national monetary policies are phased out and discretionary economic policy devolves to fiscal policy.9 Whether such a clearinghouse scheme could work in federal systems may be debatable. Clearly, Canada with 11 provinces might well be dealt with in a similar manner to the proposed EC clearinghouse system. It is much less certain that such a system could be applied to the 50 states of the United States.

United States

Discussions on the possibility of introducing a vat in the United States have recognized the crucial problem of the relationship of any federal sales tax to the state sales taxes.10 As shown below, there are four basic options.

United States: Possible Combinations of Federal and State Sales Taxes
Retail Sales TaxVAT
Stateac
Federalbd
Source: See text.
Source: See text.

State and Federal Retail Sales Taxes (a + b)

The first possibility would be to run the existing state retail sales taxes in tandem with a federal retail sales tax (options a and b, above). This is a perfectly feasible alternative subject to one overriding criticism: most present state sales taxes use rates of about 5–7 percent; therefore, it would not be worth instituting the mechanism to collect a federal retail sales tax unless the rate was at least 5 percent. So the combined federal and state retail sales tax would be above 10 percent and, as already discussed in Chapter 1, that rate is one that has already proved too high for the retail sales tax, which has weaker collection and enforcement capabilities compared with the vat. Quite apart from this fundamental problem, there are some additional problems about the precise method by which the piggybacking would be organized and the cost of administration borne between the two recipients of the revenue. Traders might well face increased compliance costs unless exemptions, tax periods, returns, audits, and penalties were identical in both the state and federal VATs. If they are to be identical, why bother to have separate taxes?

Federal VAT and State Retail Sales Tax (a + d)

The next possibility is to accept the existing state retail sales taxes and combine them with a federal vat (options a and d, above). The principal problem is that compliance costs could rise sharply. Traders would be faced with two quite separate tax systems, probably taxing different goods and services with differing exemptions. There would be different, but frequently duplicated, systems for registration. The calculation of tax liability would be different under each system and would involve quite separate forms and returns. Traders might have to tax some goods only under the state retail sales tax, some only under the federal vat, and presumably most under both. If there were differential rates of vat, the problems for traders would be multiplied. Presumably, audits and penalty structures would be different too; The treatment of retail state sales to out-of-state purchases might be complicated; a particular difficulty in the United States is the National Bellas Hess (v. Illinois Department of Revenue, Case 386 U.S. 753) decision that frees mail order traders from any obligation to collect taxes from a customer in a state and remit the revenue to that state unless the trader has a business presence in that state. This gives the mail order houses a competitive advantage over other traders.

The combination of options a and d, although possible, would likely be opposed by commercial interests and would certainly be a complex set of taxes, quite probably involving some cascading (insofar as the present state sales taxes create some cascading).

However, if the states could agree to zero rate and exempt exactly the same goods and services as the federal vat and simply piggyback their retail sales taxes on the federal vat, this could be a simpler option. Traders with no retail sales would pay only the federal vat. Traders with in-state retail sales would have to calculate their state retail sales tax liability from the same figures, and probably a duplicate of the federal vat form; payment would be made directly to the state. Traders making retail out-of-state sales (the mail order problem again) would have to tax at the rate appropriate to the destination state and remit the revenue to that state. Common sense (which does not always triumph in federal-state relations) suggests there should be joint agreement on audit and enforcement.

Both traders’ compliance costs and potential evasion increase if multiple rates are used and increase even further if the rates are different for different regions. The desirable solution is to use a vat as the way to collect revenue and then use a revenue-sharing formula to divide the resources between the different authorities. This can be arranged to allow each region to have its own rate (including zero if they wish); however, the differences between rates should not be too large otherwise interjurisdictional smuggling becomes a problem.11

Federal Retail Sales Tax and State VAT (b + c)

The other cross-combination of state vats with a federal retail sales tax is improbable. It is certainly highly implausible that the states in the United States would shift from their present retail sales taxes to a vat. Different state vats with different bases and different rates would involve some peculiar “catching up”; the paperwork to ensure that interstate “exports and imports” were made fully vat free would be considerable and would constitute a sizable impediment to trade, equivalent to breaking down the United States to the present different vats of the EC with the added complication of a federal retail sales tax on top.

Actually, this parallel suggests a way in which federal revenue equivalent to a vat could be collected. After all, the countries of the EC run their independent country vats alongside a federal EC “VAT” to finance the Commission’s expenses and programs. Currently, this “federal VAT” is levied at a maximum of 1.4 percent. It is, however, not really a vat at all and is assessed only on a theoretical base. To ensure that all the EC members are treated equally, the Commission defines precisely how the theoretical tax base should be calculated from national income figures (see Chapter 7, section on “Problems with the Flat Rate Compensation”). The base is equivalent to that defined in the various EC vat directives; all the various exemptions and deviations that can be used are ignored. It is on this broadest base that the “federal” EC Commission vat is levied. Countries that prefer to exempt and zero rate many goods and apply their domestic vat to a much smaller base (for example, Ireland, Portugal, and the United Kingdom), end up having to pay the federal vat at 1.4 percent on a base they do not use and equivalent to a much higher effective vat rate on their smaller base.

The practical problem with this method as a way to collect federal revenue is that each subnational unit (the states in the United States or the provinces in Canada) would have to compute, in an acceptably accurate manner, the household consumption for the state, broken down by various broad headings of goods and services consumed. The advantage is that as the traders are not involved at all in this tax collection, there are no compliance costs; the states can keep their own tax bases and rates but simply have to meet this federal charge, calculated on the basis of estimated value added, from their state revenues, however collected.

Naturally, this federal revenue collection on a theoretical vat base could be used either in the example above (a federal retail sales tax and a state VAT), or with the final alternative, vat used by both the federal and state authorities (options c and d, above).

Federal and State VATs (c + d)

If the federal vat is levied on the principle of origin, it seems sensible to review the possibility of running the state schemes on the same principle. The mechanics appear straightforward. The vat liability is assessed in the usual way. Then, either the revenue is collected by a federal agency and the states’ share reapportioned from the federal government to the states on the basis of trader location and the state vat rate, or the traders themselves could make separate returns to federal and state governments.

In practice, it is unlikely to be so simple. If states decided to levy different rates of vat, then when commodities crossed state boundaries the vat content of the good would be different, depending on which state the good came from12; this means that the tax credit on each invoice could be different for identical goods if they had originated in different states. It would be impossible for traders simply to apply the joint federal and state vat rate to inputs to obtain their credit against vat liability on sales, as their state vat rate could differ from the vat rate of the exporting state. There is no way out of this dilemma unless full harmonization of rates and coverage is obtained. It is recognition of this dilemma that has finally persuaded the EC to change its intention and not pursue the origin principle.

Even if complete rate and exemption harmonization was agreed, a further problem arises where group returns are allowed. To circumvent this problem, as described elsewhere, the usual practice in the EC is to allow companies with many subsidiaries to consolidate their return to eliminate all intracompany sales and purchases and to make only one return to the authorities. Such an arrangement is convenient and also ensures the allocation of federally collected revenues to the state where the group headquarters is located, unless the group returns specify the retail sales of companies in the group state by state.

Preferred Option

The simplest practical way to run a federal-state sales tax system (including VAT) is to adopt a form of revenue sharing (similar to that in the Federal Republic of Germany). This means the states hand over the sales tax to the federal authorities and, in return, get a portion of the revenue. There might be some slight advantage in the states’ transferring the odium of levying sales taxes to the federal government, yet retaining the political kudos of spending, say, 50 percent of the revenue. However, the arguments weigh heavily against this suggestion. The first problem is to agree to the appropriate revenue-sharing system. If the proportions of revenue in force before the new scheme is introduced are accepted, this fossilizes the allocation despite likely changing tax bases. Experience shows that the most contentious and difficult points in a revenue-sharing scheme involve any change in the formula, since what one participant gains can only be at the expense of another.

Second, states would have no latitude to use different rates or different bases. All in all, “this does not seem to be an appropriate or politically viable solution to the issues of intergovernmental relations.”13

If this solution is unacceptable on grounds of state sovereignty, then the second-best solution is to use federal and state vats on the same base, with the same definition and treatment of goods and services. Traders would register only once, complete the same forms, and make a single return. Presumably, audit and enforcement procedures could be the same for both federal and state vats. In practice, this means that the states would give up most of their sovereignty over sales taxation and the solution may, therefore, be impractical. If differential rates were allowed, the invoice method breaks down. States with low tax rates would find their traders importing inputs from high-tax states offsetting their input liability and effectively reducing their vat liability and the state revenue. Collections by states would become arbitrary.

A possible solution to this problem is to switch to a direct-subtractive method of calculating vat. That is, each trader in each state would calculate his actual value added from his accounts, and the federal and state vats could be levied at whatever rates were wanted. The vat would probably be best calculated by the income tax authorities from the same accounts as the corporate income tax. If a flow of revenue were needed, interim payments related to the last year’s figures could be made on account, subject to an annual reconciliation. This is a most attractive option and leaves the states with independence in their rate structures (and, possibly, in their bases) but, of course, it transforms the tax from a sales tax to a direct tax on business.14

As the tax content of invoices no longer matters, the intrastate and interstate trade could take place without invoices having to show any tax content. On the other hand, insuperable difficulties appear in compensating traders for the vat content on international exports if states maintain differential rates of vat on the origin principle, even using the direct-subtractive method. As McLure commented, “Imports would be diverted through the states with the lowest tva rates and exports through the states with the highest rates.”15 Attempts to calculate average vat compensation for exports would certainly contravene GATT rules. However, if a single rate vat, common to federal and state jurisdictions, is used, then appropriate accurate rebates on exports and taxes on imports can be made. Whether these would be allowed under GATT, as indirect sales taxes, is another question.

Hybrid Options

Apart from these “pure” options, there are possible hybrids. For instance, the federal government could levy a vat on manufacturing and wholesale sales and leave the states to tax the retail sales separately. This would be the innovation least invasive of state rights. The states could continue to tax retail sales as they do now. Only manufacturers and wholesalers would deal with the federal vat.

While this sounds an easy way out of the problems discussed above, it has its own drawbacks. As discussed in Chapter 1, all wholesale taxes suffer from the problem of defining a wholesale price. Many manufacturers are also wholesalers; this should not cause a problem unless they come to an agreement with the retailer to allot most of the value added to the retail sale (if the retail vat rate were lower than the federal vat rate) or, alternatively, to put the value added into the earlier stages if their federal vat rate were lower. However, frequently retailers are also wholesalers and their internal transfer price becomes crucial in allocating value added between the federal and state vats. Even if the rates were the same for both federal and state VATs, the different value of the tax base (depending on the internal transfer price) could distort the apportionment of revenue between the federal and state authorities.

Trying to levy any sales tax at the wholesale level has always led to complex regulations to determine standardized discounts on retail prices to get back to the wholesale price. Alternatively, markups can be specified on factory gate prices to get at the wholesale value from the production end. In either case, the problems are difficult and any standard solution creates its own inequities as clearly not all producers conform to the average. This option should not be ruled out but ii does introduce its own undesirable elements.

Without using the federal manufacturer or wholesale vat or the innovative direct-accounts method of calculating vat (with a single common rate), the only really viable option seems to be a federal-state agreement on a common vat base, with either a revenue-sharing agreement or, much less desirable, differential rates and cross-state border transactions subject to zero rating and import taxes as practiced in some customs unions; the administrative implications of this make it a poor option. Table 8-2 summarizes a series of options similar to those just discussed. McLure favors options (2) and (6), and if the retail sales tax is ruled out because of possible widespread evasion at rates over 10 percent, then this leaves only option (6), “an approach that entails considerable loss of state fiscal sovereignty.”16

Table 8-2.Advantages and Disadvantages of Alternative Tax Coordination Schemes
Tax OptionsAdvantagesDisadvantagesAssessment
1.RST/RST (uncoordinated)Familiarity of RST:1 state control of tax base and rateCascading of RST, difficulty of BTAs, vulnerability to evasion at high rates;2 severe compliance problems;3 no gain in National Bellas Hess area4Not practicable
2.RST/RST (coordinated)Familiarity of RST;1 unification of bases; facilitates solving National Bellas Hess problem:4 retains state control of tax rateCascading of RST; difficulty of BTAs; vulnerability to evasion at high rates;2 loss of state control of tax baseMay be feasible
3.RST/credit VATFamiliarity of state RST; federal tax avoids cascading; accurate BTA for federal tax; administrative advantages of credit-method VAT; state control of tax base and rateSevere compliance problems;3 no gain in National Bellas Hess area;4 cascading of state RST; inaccurate BTAs for State RSTNot practicable
4.RST/subtraction VATSimplified compliance on sales; familiarity of state RST; state control of tax base and rateDefects of subtraction-method VAT;3 standard problems of RST (cascading, BTAs); no gain in National Bellas Hess area4Not practicable
5.VAT surcharge/VATVAT avoids cascading; accurate BTAs; state control of tax rateNot administratively feasible;3 loss of state control of tax baseNot feasible
6.VAT/VAT (federalcollection)Simplified compliance;1 saving in administrative cost; general advantages of vat (no cascading, BTAs); state control of tax rate; implies solution to National Bellas Hess4Loss of state control of tax base; appearance of complexityMay be feasible
7.Tax sharingSimple compliance; saving in administrative costLoss of fiscal autonomy3Probably not acceptable to states
8.Revenue sharingSimple compliance; saving in administrative costLoss of fiscal autonomy3Probably not acceptable to states
Note: RST = retail sales tax and BTA = border tax adjustment.Source: Charles E. McLure, Jr., State and Local Implications of a Federal Value-Added Tax (Washington: Academy for State and Local Government, 1987), p. 18.

Indicates important advantages.

Indicates potentially deciding disadvantages.

Indicates overwhelming disadvantages.

National Bellas Hess decision frees mail-order houses from obligation to collect sales tax on out-of-state sales—see text.

Note: RST = retail sales tax and BTA = border tax adjustment.Source: Charles E. McLure, Jr., State and Local Implications of a Federal Value-Added Tax (Washington: Academy for State and Local Government, 1987), p. 18.

Indicates important advantages.

Indicates potentially deciding disadvantages.

Indicates overwhelming disadvantages.

National Bellas Hess decision frees mail-order houses from obligation to collect sales tax on out-of-state sales—see text.

Whatever form of federal vat is chosen, it should be pointed out that substantial administrative problems are likely. Present state retail sales taxes are made easier to administer by the exclusion of many services. The U.S. Internal Revenue Service (IRS) is used to administering withholding taxes (about 70 percent of receipts) but “in a vat there is no such thing as withholding. The entire amounts that are due to the government must be paid by the registered taxpayers voluntarily at the end of each taxable period.”17 The suggestion is that compared with the taxes the IRS is used to dealing with, the vat would require higher staffing ratios and more audit (see Chapter 13).

Canada

In 1987, the Canadian authorities published a proposal for sales tax reform.18 Three possible sales taxes were suggested. First (and apparently preferred), a national sales tax. Although never exactly specified in the text, this represents a direct-subtractive-accounts-based vat (see Chapter 1). The tax would have to be at a single federal rate on a uniform base for all provinces. However, provinces would be able to levy their own local variants on the rate. Thus, for example, the federal rate might be 10 percent, but Ontario might supplement this with a provincial rate of 3 percent, while Quebec might opt for 5 percent. Businesses engaged in interprovincial trade would apply the rate to goods at the combined rate (13 percent or 15 percent) in the province to which the goods were shipped (the destination principle). Provinces that decided to have no truck with the sales tax would be taxed at a zero rate. The tax would be federally administered on an accounts basis probably by the Income Tax Commissioners. The authorities maintained, “even though different businesses at different trade levels may have collected taxes at different rates, the national system ensures that the final tax collected on a product is the same as it would be under a combined retail sales tax of [X] percent in the province in which the goods are consumed.”19

All this is possible. Taxpayers would be faced with a tax return that would have to show 11 columns (10 for other provinces and 1 for exports) for both inputs and outputs. This certainly sounds complicated. However, statistics on interprovincial trade indicate that the vast majority of businesses would only have to fill three or four columns, and interprovincial trade is not all-encompassing for all trades. (However, consider the problem applied to the 50 states in the United States.) Special rules would be needed for the cross-border flow of services, such as transportation and telecommunications. A computerized central clearinghouse would ensure that provinces were credited with the revenue appropriate to the value added originating in their province.

If the provinces cannot be co-opted to agree to the joint tax, then the federal authorities are prepared to go it alone with either a federally administered direct-subtractive vat (called, as in New Zealand, a “goods and services” tax) or a straightforward vat. The main difference between the two is that the direct-accounts-based tax necessarily implies a uniform base and a single rate vat, whereas the second option could involve exemptions and multiple rates. It would require retailers to “keep track of their sales in four categories: sales subject to both federal and provincial taxes; sales subject to federal tax only; sales subject to provincial tax only; and sales exempt from both taxes.”20

The national sales tax involves both federal and provincial agreement on the base but allows different rates. The federal only goods and services vat is simple to operate but cannot accommodate exemptions and multiple rates. The federal vat would be more flexible but also more costly to administer. However, “Each option is far better than the current federal sales tax and would be a major improvement in Canada’s tax system.”21

Municipal Sales Taxes

Not only do central governments and states levy sales taxes, so do cities and metropolitan areas. It is certainly undesirable to have yet another tier of vat or retail sales tax imposed on traders. Many of these local taxes are undesirable in themselves. They can use numerous, extremely low rates (such as, 0.25 percent or 1 percent). They frequently list particular commodities or trades to be taxed; discriminations and distortions abound.

The obvious solution is to abolish such minor taxes at the time the vat is introduced and settle with the local authorities to share in the vat revenue by a formula or straight percentage. Other tax bases might be transferred to the localities (for example, property and vehicle licenses) to give an independent revenue source. However, the reality is that it may be easier, although still very difficult, to get states to agree on a common vat with some revenue-sharing formula than it would be to get municipalities to do the same.

See European Community, Commission of the European Economic Community, The EEC Reports on Tax Harmonization: The Report of the Fiscal and Financial Committee (1963).

See European Community, Report on Behalf of the Committee on Economic and Monetary Affain and Industrial Policy on the Removal of Tax Barriers Within the European Community (1987, pp. 57–17).

European Community, Completion of the Internal Market: Approximation of Indirect Tax Rates and Harmonization of Indirect Tax Structure (1987, pp. 8–12).

Cnossen and Shoup (1987, p. 82).

European Community, Completing the Internal Market—The Introduction of a vat Clearing Mechanism for Intra-Community Sales (1987, pp. 4—5).

European Community. Completing the Internal Market—The Introduction of a vat Clearing Mechanism for Intra-Community Sales (1987, p. 7).

European Community, Completing the Internal Market—The Introduction of a vat Clearing Mechanism for Intra-Community Sales (1987, p. 9).

Lee, Pearson, and Smith (1988, p. 23).

Cnossen and Shoup (1987, pp. 74–82).

See, for instance, United States, Congress (1972, pp. 1–48), and McLure (1987b, Chap. 9).

The problem occurs with vat within the EC. The most recent example is that of the Republic of Ireland and Northern Ireland. It is estimated that 25–30 percent of color television sets in the Republic have been imported illegally from the north, because vat and excises make them so dear in the south. See Ireland, Commission on Taxation, Third Report (1984, pp. 153–55).

See McLure (1972, pp. 28–29).

McLure (1987b, p. 157).

A variant of this approach is given in Poddar (1986).

McLure (1972, pp. 29–30).

McLure (1987a, p. 23).

Casanegra de Jantscher (1987, pp. 303–304).

Canada, Department of Finance, Tax Reform 1987: Sales Tax Reform (1987, p. 50).

Canada, Department of Finance, Tax Reform 1981: Sales Tax Reform (1987, p. 58).

Canada, Department of Finance, Tax Reform 1987: Sales Tax Reform (1987, p. 58).

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