chapter 18 Concluding Remarks
- Alan Tait
- Published Date:
- June 1988
In general, no field of taxation has seen so much nonsensical discussion than the value-added tax.
—John F. Due, Hearings Before the Joint Economic Committee,
U.S. Congress (92nd Congress, 2nd Session, March 21, 1972), p. 19
The economic and technological changes of the second half of the century … have made vat the quintessential modern tax.
—“vat Takes the Strain,” Financial Times (London), February 15, 1988, p. 44
In its centennial review, The Financial Times referred to vat as the quintessential modern tax and anticipated that if the trend toward higher vat rates and fewer exemptions continues, the vat will supplant the income tax as the most important single source of revenue for several governments by the end of the century. It is this fashionable tax this book has tried to review, warts and all. It may have been of interest to those already grappling with the vat and it should be useful to those (politicians, administrators, or academics) thinking about a country adopting a vat. A brief review of some of the highlights follows.
Part I: VAT Structure
Chapter 1 showed that the particular form of vat that evolved in Europe had a profound influence on the countries that subsequently adopted vat. All use the European invoice or credit method of levying vat despite quite extensive debates about the alternatives. The desire to have at least the option (even if not exercised) to levy more than one positive rate of vat is a powerful inducement to use the invoice method. This method also straightforwardly attaches the tax liability to the transaction and creates a good audit trail.
However, it is quite clear that some might see an alternative form of vat—for example, the business transfer tax or the “X tax”—that required the use of only a single rate as a significant advantage in itself. Once enacted, the authorities would find it difficult, if not impossible, to give in to the normal inclination of politicians to pander to sectional interests by adjusting differential rates and creating numerous exemptions.
Countries introduce the vat because of dissatisfaction with their existing sales taxes (cascading turnover taxes, manufacturer and wholesale taxes, or insecure retail sales taxes), because a customs union needs border taxes abolished, or because a buoyant source of new revenue is needed. In Europe, Latin America, and the Caribbean the vat extends, usually, through the retail stage. In Africa the tax has tended to evolve in a way similar to the original French vat; at first applied to only a limited number of manufacturers, then others, gradually extended (for example, Senegal). It is perhaps noteworthy how Middle Eastern countries do not adopt general sales taxes, least of all vat. (In this region only Israel has a vat.)
More interesting is why countries have not adopted a vat despite (sometimes prolonged) discussion. A review of the debates in the United States, Australia, Canada, Japan, and Iceland indicated that fears about regressivity, possible high administrative costs, potential evasion, high compliance costs, and the effects on inflation, all made countries wary of the vat. In addition, some saw the buoyant revenue potential of vat not as an advantage but permitting the public sector to grow larger. It is true that in many developing countries the vat has enabled indirect tax revenues to be at least half as high again as the sales taxes replaced. However, other evidence suggests that the causation is reversed. Countries with large public expenditures look around for a buoyant revenue source and vat becomes that fountain. While vat is not necessarily a “money machine,” it does finance those who have already decided to spend (as also discussed in Chapter 11). Finally, it was shown how federal governments have difficulty in reconciling a new federal vat with existing state and local sales taxes.
The highest standard rate of vat (25 percent) is levied in Côte d’Ivoire, Ireland, and Niger. The highest rate of all is levied in Senegal (50 percent). Many countries apply a reduced rate to food of 5 percent or 6 percent. Some, for instance, the United Kingdom, exempt food entirely by using a zero rate. The experience of changing rates has been one way—upward, and standard rates are commonly between 15 percent and 25 percent. Overall, the basic message of Chapter 2 was simple: the fewer vat rates used the better, and these should be levied on full, unadjusted prices, inclusive of customs duties, import fees and charges, and excises.
Similarly, the general message of Chapters 3, 4, and 5 on exemptions and zero ratings was also straightforward. Adopt a vat with as wide a base as is practical and resist arguments for special cases and exemptions. The New Zealand vat is frequently quoted as an excellent example of a base that includes food, new housing, public utilities, all clothing, government purchases and sales, leasing, and even some financial services such as life insurance; the New Zealand authorities resisted the arguments for zero rating or exemptions on grounds of regressivity, “merit,” or special pleading. As a result, they got a clean, efficient, no-nonsense vat that won high marks in terms of introduction and administration and, more interestingly, from the public and traders in terms of acceptability. Services should be taxed. Even in developing countries income elastic services such as electricity, telecommunications, gasoline, garage repairs, restaurants, hotels, and barber and beauty shops should be taxed. Although financial services should be taxed (why tax food and not banks?), the “bundle” of services they provide are difficult to disentangle and easy to drive offshore.
As discussed in Chapter 6, special schemes for small traders should not be looked upon as a regrettable departure from the principles of vat but rather as being so obviously necessary as to be intrinsic to any vat system. Such schemes help administrators by removing large numbers of traders from the register and hence saving administrative costs. They help the trader by saving him from the compliance costs of dealing with the tax authorities. A generous threshold based on turnover is recommended with little or no reliance on a forfait; cash accounting should be allowed, but small traders should be encouraged to file returns as frequently as the usual vat taxpayer.
A farmer is a special sort of small trader. In Chapter 7 it was explained how in developed countries, for the purposes of the vat, the farmer may be treated the same as any other business. If farmers’ sales are small, they will be exempt under the small business exemptions. Over the limit, they can register for vat as full taxpayers. If this is considered impractical, then the method used in many developing countries (especially in Latin America) can be adopted; principal farm inputs, such as seeds, fertilizer, and insecticides, can be zero rated. The third option is to apply the rough justice of the global credit offset as is done in most EC countries.
Some federal governments levy a vat (Argentina, Brazil, the Federal Republic of Germany, and Mexico) but some of those considering a vat (Canada and the United States) find the relationship between a federal vat and state and local sales taxes to be one of the most difficult issues. Chapter 8 looked at the vat in federal systems and considered the options. The simplest solution is to give the administration and collection of vat either to the states or to the federal government and then use a formula to share the revenue between the central government and the states. If this is unacceptable because of the loss of fiscal autonomy, then a federal vat might have a state vat “piggybacked” on it. This, of course, is more complex for both traders and administrators. The Canadian suggestion of an accounts-based vat that would enable the provinces to levy their own varieties of rates is an interesting possibility but it would be even more difficult to operate in the United States with 50 states (as opposed to 11 provinces).
The vat is introduced into an already existing tax structure. It may supplement existing taxes or replace old taxes, but the smooth changeover requires a careful appreciation of the transitional problems. Chapter 9 emphasized the need to ensure early registration of vat taxpayers, the importance of educational visits to traders, and the importance of adequate compensation for taxes paid on stocks. As the usual vat ensures that all capital goods are free of tax, some prior planning is needed if existing taxes on capital are not to cause a bunching of capital goods orders.
Part II: Economic Aspects and Consequences
Most governments and the public anticipate with trepidation the effect on prices of introducing a vat. However, the evidence (Chapter 10) shows that in most countries the introduction of vat, or a change in vat rates, is not inflationary; the change might lead to a once and for all shift in prices, but not to an acceleration of price changes.
The most trenchant case against vat is that it is regressive. The evidence shows (Chapter 11) that a broad-based vat is likely to be regressive and that making it progressive by extensive use of the zero rate (for example, the United Kingdom) is undesirable on administrative and revenue grounds. Moreover, such use of zero rating does not ensure that the underprivileged groups who are supposed to be helped actually are helped. As an Irish report points out, tax revenues from applying the vat to expenditures exempted on grounds of regressivity would raise a sum far in excess of that needed to compensale the poor for the diminution of their household consumption due to vat. Given that exemptions, zero rating, and multiple rates are inefficient ways to reduce the potential regressivity of vat, can low-income households be compensated? New Zealand used a wage supplement and changes in social security to ensure a compensation to low-income families following the vat introduction. Suggestions for progressive vat rates on payrolls under the “X tax” might achieve something similar. But the crucial problem remains as to whether or not compensation can reach those with small rural incomes, the urban informal sector poor, or the old, if there is no or only a rudimentary social security system. These problems become even more important in developing countries where such groups are likely to be targe and all the more difficult to reach and compensate.
A similar argument holds when, in developed economies, the potential regressiveness of a vat may be offset by strongly progressive income, capital gains, and wealth taxes, but in developing countries such progressive taxes, even though draconian in legislation, may be paper tigers in application. Therefore, the presumed correction to the vat’s regressiveness through progressive direct taxation may not take place.
The vat is an efficient and neutral tax (Chapter 10) and does not distort savings and investment behavior. Any favorable effect of vat on foreign trade is likely to be small and temporary; usually arguments in favor of vat on these grounds exaggerate its virtues.
Finally, vat is not meant to be used as a weapon for short-term demand management and fine tuning. It is designed to be neutral and to build in nonneutrality erodes the basic virtues of the tax.
Part III: Administration and Compliance
As quoted at the beginning of Chapter 12, in developing countries tax administration frequently is tax policy. Indeed, in most countries the crucial importance of the effectiveness of tax administration is too often overlooked when ambitious statements are made about efficiency, equality, neutrality, and effects of alternative taxes on savings, work effort, and risk taking. Tax administration is often waved to one side in academic discussions, but Chapters 12 to 15 try to emphasize its importance. Although some governments run their vat through the customs and excise department (for example, Denmark, Israel, and the United Kingdom), it is usually better to give the responsibility for vat to the income tax authorities. Each country has to evaluate its own preferences whether or not to centralize the vat administration, and the arguments were reviewed in Chapter 12.
Staffing is affected by decisions on the threshold for exemptions, goods and services taxed or exempted, the inclusion or exclusion of the agricultural sector, the treatment of groups of companies, the collection of vat by other agencies such as customs, the staff transferred from taxes replaced, the frequency of vat returns, the number of vat rates, the extent of computerization, and the quality and standard of administration desired. Ratios of staff to registered traders can vary from 1:21 up to 1:726 or, as suggested for the United States, 1:1,000. Chapter 12 examined staffing both by assessing the numbers of staff at different functional levels and by comparing the figures derived to the broad staffing ratios.
Chapter 12 also outlined ways of planning staff changes during the transition to a vat and the different ways planning committees could be organized. The costs of administering a vat should be 1 percent to 2 percent of revenue; of course, the lower the rate of vat, the higher are likely to be the costs as ratio to revenue. Given the likely complexity of changing to a vat, the costs can only be justified if the vat is a major revenue source, and this suggests a standard rate of 10 percent and above. Chapter 12 also indicated that 18–24 months are needed to prepare and introduce a vat. The experience of countries as diverse as Belgium, Greece, Hungary, Korea, Mexico, and Portugal suggests the need for gradual but sustained administrative effort to introduce a vat.
The importance of the vat register of taxpayers was emphasized in Chapter 13. The register must be comprehensive and must be kept up to date (which involves a large amount of “churning,” that is, registering and deregistering taxpayers).
The introduction of a vat can be used as the justification for a major overhaul of tax identification numbers (tins). These numbers are crucial for computer-held records and for audit. Similarly, the invoice is the crucial control document for the usual credit-method vat. Some developing countries have tried to standardize the form the invoice should take, while some other countries dictate the serial numbers, but most allow the invoices to take any form the trader wishes, as long as it contains all the information required for the vat. Chapter 13 described the most ambitious attempts to cross-check invoices (Korea) and the means countries have used to try to check on the weakest link in the chain—the retail sale. However, basically, vat is a self-assessed tax, and hence the control of vat payments and refunds (where revenue is most at risk) and audit, as discussed in Chapter 13, is important.
Much has been made of the self-checking mechanism of vat but, of course, vat is evaded, as the discussion of 15 different methods of evasion in Chapter 14 showed. At the same time, the public and courts in most countries appear to view tax evasion in a different light to most other crimes. Rightly or wrongly, it makes sense for the vat authorities to rely on sanctions other than criminal prosecution. Financial penalties should be, as far as possible, automatic.
The development of powerful, versatile, economic, and most important of all, reliable personal computers and their software packages has revolutionized tax administration, for both officials and traders, especially in developing countries. Chapter 15 discussed the options, planning, potential outputs, systems design, personnel, and training needed to use computers in administering a vat. Although some vat officers caution about relying too much on computers, the tide is one way and computers have a central role in administering vat.
A vat depends for its success on the taxpayer’s willing compliance as much as (indeed probably more than) on efficient administration. Chapter 16 dealt with this often neglected topic. Traders must anticipate their obligations under vat and take decisions involving their pricing, margins, and bookkeeping. They must also cope with the visits of vat officials. All this has a cost. The chapter also reviewed the debate on the trader’s compliance costs and, while it is difficult to put a monetary value on such costs, clearly they exist; vat administrators are well advised to keep them constantly in mind and do as much as possible to mitigate them.
The vat, like any tax, is based on an Act that ought to include precise definitions; Chapter 17 looked at the possible definitions about the taxpayer, his business, the place and time of supply, the value of goods and services, and the treatment of exports and imports. There are, of course, numerous detailed legal debates in every country about these matters but the intent of this chapter was to give the flavor of the debate on some of the more important definitional issues.
This book started out to try to illustrate how, using one tax as an example, practical considerations influence the form, shape, and structure of a tax; how theory influences the choice of particular forms of tax, but also how important the practical considerations of both tax officials and taxpayers are in modifying tax structures. If the text has weighed too heavily on the side of practice, perhaps that is because practical considerations do dominate the real world of taxation.
One reader of the manuscript of this book wrote that it could become the Baedeker of vat. A memory the author has of using a Baedeker was in Capri, where the guidebook informed the visitor that the phosphorescence in the Blue Grotto could be seen by throwing a small coin to a local boy who would dive into the water; the same effect, the book continued, could be achieved more cheaply by trailing one’s hand through the water. This illustrates the virtues of Baedeker; not only does it tell the reader what is important, it also discusses different ways to achieve results, and then recommends efficiency and economy. If this book can even remind a reader of Baedeker, it will have been worth the effort.