Abstract

Value-Added Tax or VAT, first introduced less than 50 years ago, remained confined to a handful of countries until the late 1960s. Today, however, most countries have a VAT, which raises, on average, about 25 percent of their tax revenue.2 This chapter defines what is meant by a VAT; documents both the remarkable spread and the current reach of the tax; considers the differences between countries with and without the tax; and develops some stylized facts on the typical experience of countries that have adopted a VAT.

Value-Added Tax or VAT, first introduced less than 50 years ago, remained confined to a handful of countries until the late 1960s. Today, however, most countries have a VAT, which raises, on average, about 25 percent of their tax revenue.2 This chapter defines what is meant by a VAT; documents both the remarkable spread and the current reach of the tax; considers the differences between countries with and without the tax; and develops some stylized facts on the typical experience of countries that have adopted a VAT.

What Is a VAT?

Despite its name, the VAT is not generally intended to be a tax on value added as such: rather it is usually intended as a tax on consumption. Its essence is that it is charged at all stages of production, but with the provision of some mechanism enabling firms to offset the tax they have paid on their own purchases of goods and services against the tax they charge on their sales of goods and services.

Although this characteristic feature is very clear-cut, the VATs observed in practice show considerable diversity as regards, among other things, the range of inputs for which tax offsetting is available and the range of economic activity to which the tax applies (that is, the base of the tax). Some major countries (such as China) currently do not grant credits for taxes on capital goods purchases; moreover, of those that allow credits in respect of such purchases, some do not refund excess credits (any excess of tax paid on inputs over tax chargeable on outputs). Most countries exclude exports from the VAT, in the sense that tax is not charged on sales for export but tax paid on inputs is recoverable, although some (in the BRO3 region, at least until recently) have systematically levied VAT on some exports. Some countries extend the VAT only to the manufacturing stage; others do not levy it on services.4 Practice also varies in how tax offsetting is implemented: by far the most common method is through the use of invoices, but the same effect can be achieved on the basis of books of account, as elaborated later.

As a result of the diversity of practice, there can be disagreement as to whether a given tax is properly called a VAT or not.5 For definiteness, though at the risk of creating the impression of an overly sharp dichotomy, we take a VAT to be:

A broad-based tax levied on commodity sales up to and including, at least, the manufacturing stage, with systematic offsetting of tax charged on commodities purchased as inputsexcept perhaps on capital goodsagainst that due on outputs.

This leaves scope for dispute, but does highlight what is taken here to be the key feature of the VAT: the tax is charged and collected throughout the production process, with provision for tax payable to be reduced by the tax paid in respect of purchases.

This definition is broad enough, for example, to encompass not only the dominant “invoice-credit” form of VAT (under which tax paid on inputs is offset by a means of a credit against tax due on output, tax paid being recorded in invoices issued by seller to buyer) but also the subtraction method (under which the offsetting is achieved implicitly, by charging tax on the difference between the values of output and inputs). These methods of implementing the VAT, and other technicalities touched on in this overview, are discussed further in the next chapter.

The definition excludes, on the other hand, any scheme that allows crediting only in particular sectors of the economy, as well as sales taxes that grant credits only for inputs deemed to be physically incorporated into the output. “Ring” systems—under which tax that would otherwise be charged by one firm on sales to another is suspended for sales to a subset of firms within the “ring”—are also excluded, on the ground that it is an intrinsic feature of a VAT that tax is actually collected at intermediate stages of production. There is of course an issue of judgment as to when the exclusions from tax become so widespread that the tax ceases to be a VAT: the exclusion of services in some countries, for instance, is not taken to prevent a tax being labeled a VAT; the former Indian MODVAT, on the other hand, which offered crediting only of central excise taxes (rather than a broad-based output tax) is not regarded here as being a VAT. More generally, it is immediately clear that VATs come in many quite different shapes and forms.

A Primer on the VAT

The key features of the Value-Added Tax are that it is a broad-based tax levied at multiple stages of production, with—crucially—taxes on inputs credited against taxes on output. That is, while sellers are required to charge the tax on all their sales, they can also claim a credit for taxes that they have been charged on their inputs. The advantage of such a system is that revenue is secured by being collected throughout the process of production—unlike a retail sales tax—but without distorting production decisions, as, in particular, a turnover tax does.

Suppose, for example, that firm A sells its output (assumed, for simplicity, to be produced using no material inputs) for a price of $100 (excluding tax) to firm B, which in turn sells its output for $400 (again excluding tax) to final consumers. Assume now that there is a VAT with a 10 percent rate. Firm A will then charge firm B $110, remitting $10 to the government in tax. Firm B will charge final consumers $440, remitting tax of $30: output tax of $40 less a credit for the $10 of tax charged on its inputs. The government thus collects a total of $40 in revenue. In its economic effects, the tax is thus equivalent to a 10 percent tax on final sales (there is no tax incentive, in particular, for B to change its production methods or for the two firms to merge), but the method of its collection secures the revenue more effectively.

“Zero-rating”1 refers to a situation in which the rate of tax applied to sales is zero, though credit is still given for taxes paid on inputs. In this case, the firm will be due a full refund of taxes paid on inputs. In a VAT designed to tax domestic consumption only, exports are zero-rated, meaning that exports leave the country free of any VAT. This is consistent with the “destination principle,” which is the international norm: it requires that the total tax paid on a good be determined by the rate levied in the jurisdiction of its final sale with revenue accruing to that jurisdiction. In contrast, the “origin principle” requires that tax be paid at the rate of, and to, the country or countries in which the item is produced rather than consumed.

“Exemption” is quite different to zero-rating in that, while tax is again not charged on outputs, tax paid on inputs cannot be reclaimed. Thus, no refunds are payable. In this case, because tax on intermediate transactions remains unrecovered, production decisions may be affected by the VAT.

1The Australian Goods and Services Tax (GST) introduced a helpful terminology: “zero-rating” was instead called “GST-free,” and “exemption” instead called “input-taxed.”

The Origin and Spread of VAT

The VAT is a modern tax. Before its introduction, domestic indirect taxes were typically limited to narrowly defined products (excises on alcohol and tobacco, for example) and, notably, sales and turnover taxes. The distortions created by the last kind of tax (such as the encouragement of vertical integration of an industry solely to reduce tax liabilities6), combined with rising revenue requirements, provided an incentive to seek alternative less distortionary taxes. Intellectually, the basic idea of the value-added tax appears to have originated with a German businessman, von Siemens, writing in the 1920s. There were other developments in the 1920s, including the suggestion of the invoice-credit method by Adams (1921). Particularly influential contributions were made by “le père de la TVA,” Maurice Lauré (1953, 1957).

Adoption of the VAT began slowly. Early proposals to introduce the tax were made in France in the 1920s7 and by the Shoup Mission to Japan in 1949. Taking the definition used in this report, the first VAT appeared in France in 1948;8 this tax, which initially applied up to the manufacturing stage and gave no credit for tax on capital goods, was converted to a consumption-type VAT by 1954.

Manufacturing level VATs were subsequently adopted by Côte d’Ivoire in 1960 and in Senegal later in the 1960s;9 Michigan, meanwhile, introduced the Single Business Tax10—an accounts-based form of VAT—in 1953.

Beginning in the late 1960s, the spread of VAT accelerated (see Figure 1.1 inside cover). Brazil introduced the tax to South America in 1967,11 the same year in which the adoption by Denmark began its widespread introduction in Europe.12 The pace of VAT implementation remained rapid until the late 1970s, at which point it slackened for a decade before picking up again in the latter part of the 1980s and well into the 1990s. The principal focus of this book is the spread of the VAT in this latest round of implementations.

Underlying the aggregate data is a series of distinct geographic episodes. To develop these—and other regional issues as regards the VAT—the set of countries with which the analysis deals13 is categorized into seven regional groupings: sub-Saharan Africa (AF); Asia and the Pacific (AP); the current membership of the European Union, plus Norway and Switzerland (EU+); Central Europe, and the Baltics, Russia, and other countries of the former Soviet Union (CBRO); North Africa and the Middle East (NMED); the Americas (AS); and small island economies, defined as islands with populations of under 1 million, plus San Marino (SI). The membership of these groups is listed in Table A.I.1 of Appendix I.

Table 1.1 shows the number of countries in each of these regions having a VAT at selected dates. As can be seen, the early phase was dominated by adoption of the VAT in:

  • Western Europe, following the decision of the European Communities to adopt the VAT as the common form of sales tax; and

  • Latin America, following the initiative in Brazil.

Table 1.1.

Regional Spread of the VAT

(Number of countries with VATs as of the year indicated)

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Source: IMF staff compilation.Note: The figures in parentheses are the total number of countries in each region as of September 1998.

Baltic States, Russia, and other states of the former Soviet Union.

The only countries outside these regions to adopt a VAT by the mid-1980s were Côte d’Ivoire, Indonesia, Israel, Senegal, South Korea, and Turkey.

The acceleration of the spread of the VAT from the late 1980s reflects three new episodes—namely, the adoption of the VAT:

  • by most of the transition economies;

  • by a large number of developing countries, notably in Africa, but also in Asia and the Pacific: over half of all countries in these regions now have a VAT, compared with about 15 percent a decade ago; and

  • by the small island economies, almost none of which had a VAT before 1990.

While there are strong intellectual and practical links between these episodes, the underlying core motivation seems to have differed in each case. In Western Europe, adoption of the VAT was intimately associated with the drive for greater economic integration among the member states of the European Communities: the VAT is particularly well suited to avoiding the trade distortions associated with the cascading indirect taxes that it replaced. In South America, the VAT was seen as a more efficient revenue-raising tax that would be consistent with the increasingly outward orientation of economic policies. The rapid adoption of the VAT in the transition economies reflected the need to replace the traditional sources of revenues (such as levies on state enterprises) that were declining as a result of economic transformation with a tax regime geared to the emerging market economy; in some cases it may also have reflected the status of the VAT as a precondition for joining the European Union. In many developing countries, adoption of the VAT has been given additional impetus by the long-run revenue implications of trade reform—the economic efficiency arguments favoring the VAT have been bolstered as trade tax revenues have come under pressure with deepening trade liberalization commitments.

Table 1.2 indicates how the characteristics of countries adopting a VAT have changed over time. Even within the regional groupings shown for the 1990s, there is a considerable diversity of experience.14 A few key features emerge, however. The VAT has increasingly been implemented by countries with lower average levels of economic development as measured by per capita GDP (the data are stated in current U.S. dollars and accordingly understate this trend). Most strikingly, the African countries adopting the VAT are characterized by much lower per capita incomes and literacy rates—a crude proxy for administrative sophistication—than other groups that have adopted the VAT. The transition economies have higher per capita GDP, high levels of literacy, and higher ratios of trade to GDP than other countries recently introducing a VAT.

Table 1.2.

Changing Characteristics of Countries with VATs

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Source: IMF staff calculations.

Including Grenada, which subsequently removed its VAT.

Including Belize, which removed the VAT in 1999.

These are figures for 1979, 1989, and 1998.

Measured as (exports + imports)/(2 × GDP).

The most populous countries without a central VAT are India and the United States. While there are several possible explanations for nonadoption in these countries—the debate on national consumption taxes in the United States, for instance, has sometimes highlighted a concern that VAT would prove too easy a revenue generator. It is unlikely to be a coincidence, however, that both are federal countries with a strong presence of the states in the levying of general consumption taxes: there are formidable difficulties running the VAT as a lower-level tax (discussed in Chapter 17).15 Two other groups stand out among the set of non-VAT countries. First, although the average population of the countries without a VAT is about 27 million, around 30 percent have populations of less than 500,000; and about half have less than 2 million. That is, many non-VAT countries are small countries. Moreover, many of these are islands. For such economies the VAT may offer relatively little gain over a broad-based tariff (an issue developed in Chapter 16). The other set of countries among which penetration of the VAT remains relatively low are those in North Africa and the Middle East, to some degree reflecting the availability of revenue from natural resources. Even there, however, the desire to diversify revenue sources may cause the VAT to spread still further.

The Current Extent and Importance of VAT

Most countries in the world now have a VAT: as of April, 2001, about 123 had one. Table 1.3 provides information on these VATs. They raise revenues, on average, equal to nearly 27 percent of total tax revenue16 and over 5 percent of GDP.

Table 1.3.

Current VATs: Rates, Thresholds, and Revenues1

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Sources: National authorities and IMF staff estimates; IMF, World Economic Outlook. IMF, Fiscal Affairs Department database; International Bureau of Fiscal Documentation (IBFD); International VAT Monitor; and Ernst and Young, VAT and Sales Taxes Worldwide, New York: (John Wiley).

As of April 2001. Revenue data are for most recent recent year available.

Rates are in tax-exclusive form (i.e., specified as a proportion of the net of tax price).

Most countries zero-rate exports and a few also zero-rate some domestic transactions. Zero-rating of domestic transactions is extensive in Ireland and the United Kingdom.

The threshold shown is the level of turnover at which registration becomes compulsory. For cases in which there is more than one threshold, that indicated is the one judged to be most important in practice in limiting the number of taxpayers.

Tax revenue is variously that of central or general government.

Tax revenue excluding that from hydrocarbons.

There are two thresholds in Bolivia: that shown is an income test. There is also a threshold of $3,270 in terms of assets.

Tax exclusive rate (legislated tax inclusive rates are 9, 11, and 17 percent, respectively).

On interstate transactions the tax exclusive rates are 9.89 and 12.36 depending on the region. The VAT for intrastate transactions varies from state to state, from a rate of 17–18 percent (standard rate) to 25 percent.

Production of goods and taxable services.

Distribution.

The VAT was first introduced in Ghana in March 1995, with a rate of 17.5 percent, and repealed in June 1995; it was reintroduced in December 1998, with a rate of 10 percent.

The threshold of $38,000 applies to retailers (from July 2001); that of $18,000 to manufacturers and listed services.

For retailers.

Malta repealed the VAT in 1997; it was reintroduced in January 1999.

From July 1998 the GST was extended to the nonmanufacturing sector above a threshold of $100,000.

The table reveals a wide diversity of practice and experience. The standard rate, for example, varies from 3 percent in Singapore to 25 percent in Denmark and Sweden. Moreover, while some countries have only a single rate of VAT, others have several rates: as a relatively extreme example, Colombia currently has seven distinct rates. There is considerable variation in the yield of the VAT—several countries garner less than 1 percent of GDP in VAT revenue, while five raise over 10 percent of GDP.

Table 1.417 analyzes some of the key features of the VAT by region. Clearly, the VAT is a major source of revenue wherever it has been adopted. The standard rate is higher in Western Europe and in the transition economies than elsewhere, being lowest in the Asia/Pacific region. Moreover, Western Europe, and North Africa and the Middle East have the most complex VATs in terms of the number of rates. In contrast, it is the regions in which the spread of VAT has been most recent—Africa, the transition economies and the small islands—that typically have the simplest VAT tax structures.

Table 1.4.

VAT Features by Region

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Source: IMF staff calculations.

Average, in percent.

Average number of rates (including standard rate and excluding zero rate on exports).

Figures are unweighted averages over those countries in Table 1.3 for which data on VAT revenues are available.

Table 1.5 presents some comparative data on countries with and without a VAT. Not surprisingly, those countries that have implemented a VAT are relatively more developed (as gauged by per capita GDP). They also rely somewhat less on international trade—this is of interest since, as will be elaborated below, the ability of the VAT to tax neatly international trade transactions is one of the principal merits conventionally claimed for the tax. Literacy is noticeably higher in countries that have adopted a VAT. As noted above, other than the cases of India and the U.S., non-VAT countries are also marked by relatively small populations.

Table 1.5.

Comparing Countries With and Without a VAT

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Source: IMF staff calculations.

All countries without a VAT in September 1998.

Measured as (exports + imports)/(2 × GDP).

Data available only for a subset of countries.

Figures are for the 99 countries with a VAT for which revenue data were available in early 2000.

Table 1.5 also reports comparative revenue figures for countries with and without a VAT. Broadly speaking, general government tax revenue is noticeably higher in countries with a VAT than in those without, while there is no striking difference once other revenue and grants are added to the measure or attention is confined to tax revenue of the central government. Little can be read into these simple averages, however, which fail to control for other country characteristics that may be powerfully correlated with revenues. A more comprehensive attempt to discern revenue effects associated with the presence of VAT is made in Chapter 3.

Experience After Adopting a VAT

Table 1.6 reports summary information on developments in two key structural aspects of the VAT subsequent to its introduction: the level of the standard rate and the number of rates. The conventional wisdom that a country’s VAT rate tends to rise over time proves correct, in the sense that the common experience is of an increase in the standard rate. That said, in many countries, the standard rate has remained unchanged, possibly reflecting the fact that the sample includes many countries where the VAT has been introduced only relatively recently. In others it has actually fallen. This mostly reflects the attempts of transition countries to lower initially high VAT rates, though there are also some other cases—including Brazil, Paraguay, and Peru—where the standard rate has fallen.

Table 1.6.

Developments in VAT Structure Since Introduction1

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Source: IMF staff calculations.

Figures are for the 99 countries included in the empirical exercise of Chapter 3.

Perhaps more significant is the tendency for proliferation in the number of rates, lending support to the notion that VATs tend to become more complex over time. This happened in about one-third of all cases. These summary statistics are, however, clearly no more than suggestive, making no adjustment, in particular, for the length of time that the VAT has been in place. The issue of rate proliferation is examined more closely in Chapter 7.

Finally—and with obvious implications for the perceived effectiveness of the tax—only five countries18 have ever removed a VAT:19 Vietnam (in the 1970s); Grenada (introduced 1986 and gradually dismantled); Ghana (introduced March 1995, removed two months later); Malta (introduced 1995, removed 1997); and Belize (introduced 1996, removed 1999). Three of these, however, have since reintroduced the VAT—Ghana in 1998, Malta and Vietnam in 1999.

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  • Kay, John A., 1980, “The Deadweight Loss from a Tax System,” Journal of Public Economics, Vol. 13, pp. 11119.

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  • Kay, John A., and Evan Davis, 1990, “The VAT and Services,” in Value Added Taxation in Developing Countries, ed. by