Front Matter Page

Fiscal Affairs Department

Contents

• I. Introduction

  • 1. Why a VAT?

  • 2. Organization and summary

• II. Conceptual Aspects

  • 1. How can value added be computed?

  • 2. What is the nature of a VAT?

  • 3. What is the difference between a VAT and an RST?

  • 4. What is the aggregate base of a VAT?

• III. Social, Economic, and Political Considerations

  • 1. Should anything be done about the regressivity of the VAT?

  • 2. Is a VAT inflationary?

  • 3. How does a VAT affect economic growth?

  • 4. Can a VAT be administered by subordinate levels of government?

  • 5. Is the VAT a money machine?

• IV. Tax Coverage, Base, and Rate Issues

  • 1. Should a VAT extend through the retail stage?

  • 2. How should small traders and craftsmen be treated?

  • 3. Should farmers be taxed?

  • 4. Does it make sense to tax public sector bodies?

  • 5. Which goods and services should be exempted?

  • 6. How should immovable property be treated?

  • 7. What about secondhand goods?

  • 8. What kind of rate structure should be applied?

• V. Legal and Administrative Features

  • 1. What is the lead-in time of a VAT?

  • 2. Which department should administer the VAT?

  • 3. Who should be taxed, on what, where, and when?

  • 4. How should a VAT be operated?

  • 5. Is a VAT costly to collect and comply with?

• VI. Basic Requirements for a “Good” VAT

• Table 1. Computation of VAT Liability

• Appendix. VATs and Other Sales Taxes in OECD Member Countries, 1991

• References

Summary

In the course of introducing a market-oriented tax system, most Central and Eastern European countries are actively considering the merits of a tax-credit type of value-added tax (VAT). A general, destination-based consumption tax, such as a VAT, is the most product-neutral and factor-neutral tax which exists. This is an important attribute in a highly competitive, interdependent world that leaves the optimal allocation of resources to the free play of market forces.

Measured against income, a VAT levied at a uniform rate falls more heavily on the poor than on the rich. This effect can hardly be mitigated by taxing essential consumer goods at a lower-than-standard rate. Adjustments of the income tax and the income transfer system are much more effective in helping the poor. Also, differentiated rates distort consumer and producer choices and add to administrative and compliance costs. There is no evidence to support the allegation that a VAT is inflationary. Since a VAT is neutral with respect to the choice between whether to consume now or to save for future consumption, its effect on saving and, hence, on economic growth, may be more favorable than that of an income tax. A VAT can be administered by subordinate levels of government.

Once a country has decided to introduce a VAT, it must address various structural issues relating to the coverage, base, and rate(s) of the tax. A strong case can be made for having the VAT include the retail stage from the beginning, although most retailers (though not retail sales) and craftsmen could be excluded through a generous small-firm exemption. Primary sectors--in particular, agribusinesses--should be taxed, although an exemption-cum-optional-registration approach might be more suitable for countries like Poland, which did not collectivize its agricultural sector. On economic and administrative grounds, public sector bodies should be taxed as widely as possible. As regards the tax base, exemptions should be confined to health care, education, social and religious activities, and finance and insurance. Building materials, repair and maintenance services, and newly created buildings should be taxed at the standard rate. If a dual-rate structure is contemplated, the lower-than-standard, but positive, rate should apply to all foods for human or animal consumption; placing a zero rate on these items is not advisable.

Conventional wisdom suggests that a country needs 18 to 24 months to make a VAT fully operational, but unfamiliarity with the tax and the need for intensive taxpayer education may require the usual lead time to be extended by, say, six months. Since compliance must be ensured through books of account, the VAT and the income tax should be administered by the same department. The preparation of precise, complete, and unambiguous legislation and operational methods and procedures is essential if a VAT is to be effectively implemented. Subsequently, sustained efforts to elicit taxpayer cooperation are required. Finally, the introduction of a VAT should be preceded by a substantial degree of price liberalization and enterprise autonomy.