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Iran has the lowest VAT rate of 3 percent; Taiwan POC and Nigeria also have a 5 percent rate.
On June 2, the government issued a draft report proposing a gradual increase in the VAT from 5 percent to 10 percent by FY2015, but there has not yet been a political consensus on this proposal.
Japan’s overall government revenue, including social security contributions, is also one of the lowest among OECD economies.
For example, in Japan, the effective personal income tax rate for average middle-income households (two adults and two children) is only about 5 percent, while the corresponding tax rate in other G-5 economies is between 10 and 20 percent.
Unless the rate is expected to change over time—a point of some importance in the present context, and taken up below.
The VAT also does not impose a direct burden on exports, which are zero rated under the destination principle. Thus, the VAT does not worsen competitiveness. However, a higher VAT may be passed on to other prices. For instance, to the extent that the VAT leads to higher wage demands by laborers, it may indirectly raise producer costs and export prices. Most likely, therefore, the VAT will have similar implications as direct taxes on the current account balance.
The United States is the only member of the OECD that does not have a VAT.
Ebrill et al. (2001) discuss the strengths and limitations of C-efficiency as an indicator in assessing VATs. Lower C-efficiency ratios in other advanced economies largely reduced rates on basic goods, such as food. In addition, higher VAT rates can lower C-efficiency ratios by encouraging tax avoidance and evasion.
In these simulations, we assume a 2 percentage point VAT hike in 2012 and 2013, and a 3 percentage point hike in 2015 and 2017. The calculations assume that the C-efficiency remains unchanged, which may be somewhat optimistic as a higher rate could lead to increased noncompliance.
The expenditure adjustment of 5 percent of GDP is assumed.
This corresponds to additional revenue of 3 percent of GDP relative to the current VAT revenue. The total adjustment is 8 percent of GDP, including the expenditure measures.
This corresponds to tax revenue of 5 percent of GDP. The expenditure adjustment of 5 percent of GDP is also assumed.
International experience with recent VAT increases (e.g., Carare and Danninger, 2008) suggests that tax-induced increases in the inflation rate are temporary and are reversed once the tax increase passes through.
In 1997:Q1, private consumption rose by 2 percent (q/q) which was well above the 0.5 percent average growth for 1992–1996.
There can also be an impact on investment acting in the opposite direction: if the VAT increase is not fully passed on to consumers, the increases in the VAT rate imply a step reduction in the after-tax prices received by firms—which corresponds to a higher real interest rate, and so may lead to less investment. Only if the tax increase is fully passed on to consumers are returns to investment unchanged, which would imply at best a constant level of the real interest rate after the temporary effects of the VAT increase on prices passes.
2010 Japanese household income and expenditure data are used to determine income and consumption parameters. For simplicity, we ignore behavioral effects by assuming that the consumption bundle does not change before and after the tax increase.
Ebrill et al. (2001) have a more detailed discussion of the distributional effects of the VAT. While a tax on consumption will also bear on bequests when these are spent, it does not directly target the intergenerational transmission of wealth that may also be a concern. For this, the tax on inheritances is the preferred instrument.
Setting a lower rate on transportation and communication whose shares in consumption differ significantly between high- and low-income households could reduce the burden for low-income households further, but would not materially change the argument that rate differentiation could play only a limited role.
The theoretical case for differentiating rates of indirect taxation—to alleviate distortions to labor supply caused by the taxation of labor income and pursue equity objections—is reviewed by Crawford, Keen, and Smith (2010), who provide an empirical application to the U.K. The conclusion, broadly speaking, is that—beyond the special issues associated with goods subject to special excises (tobacco, alcohol, and petrol)—the empirical case for rate differentiation is very weak.
Illustrating the general point, Crawford, Keen, and Smith (2010) show how the impact on the poorest of the current extensive zero rating in the U.K. could be offset by adjusting benefits—and still leave substantial additional net revenue.
The chart calculates lifetime net transfers from the government (both historical and future), including education, pension, and medical benefits.
Of total VAT revenue, 43.6 percent is distributed to local governments, including central government VAT revenue transferred to local governments as the local grant tax.
The main exception is in relation to environmental taxes, whose revenue potential is generally fairly limited.
For example, the United States has not adopted a federal VAT.