FOLLOWING THE ADOPTION of value-added taxes (VAT) by Western European countries, many developing countries have been giving increased attention to this form of tax as a means of rationalizing their sales taxes and improving their revenues. France is credited with the first VAT, adopted in 1954, but this extended only to the wholesale level. It was not until 1967 when the European Economic Community (EEC) directed its member countries to replace existing turnover taxes with a VAT that this technique gained widespread acceptance. Although not then a member of the EEC, Denmark was the first European country to adopt a VAT extending to the retail level (on July 3, 1967); it was followed by France and Germany (on January 1, 1968). Since then, the VAT has been implemented at the retail level by Sweden and the Netherlands (January 1, 1969), Luxembourg and Norway (January 1, 1970), Belgium (January 1, 1971), and Ireland (November 1, 1972). Austria, Italy, and the United Kindom introduced VATs in 1973.
The value-added principle is incorporated in the manufacturers’ sales taxes of a number of developing countries, including those of Argentina, Colombia, the Philippines, and member countries of the West African Customs Union. Several other French-speaking countries, including Algeria, Ivory Coast, the Malagasy Republic, Morocco, Senegal, and Tunisia, have replaced their turnover taxes with a VAT along the lines of the 1954 French model. But more general systems were not instituted until after 1966—by Brazil (levied by the states) in 1967, Uruguay in 1968, and Ecuador in 1970. Other developing countries have been examining the feasibility of a general VAT, and several—including Argentina, Chile, the Republic of China, Colombia, and Mexico—have drafted legislation for a VAT to replace existing sales taxes but for various reasons have not introduced it.1 This cautiousness can be explained in large part by the uncertainties that arise in the introduction of any major new tax, and especially one with which the developing countries have limited experience.
The purpose of this study is to examine the applicability of a VAT to developing countries. It will cover the structure of such taxes that are now in effect and will compare the feasibility of implementing a VAT with other forms of sales tax.
Mr. Lent, Advisor in the Fiscal Affairs Department, formerly served as assistant director of the tax analysis staff, U. S. Treasury Department; consultant, Organization of American States; and research associate, National Bureau of Economic Research. He has been on the faculty of the University of North Carolina and Dartmouth College.
Miss Casanegra, Senior Tax Administration Analyst in the Tax Administration Division of the Fiscal Affairs Department, formerly served as Assistant Commissioner for Planning and Research of the Internal Revenue Service in Chile and as a consultant, United Nations and Inter-American Development Bank.
Miss Guerard, economist in the Tax Policy Division of the Fiscal Affairs Department, formerly served as an economic advisor to the Ministry of Planning in Brazil and as Associate Research Economist, Brazilian Development Assistance Program at the University of California at Berkeley.
China plans to introduce its draft legislation in June or July 1973; if approved by the legislature, it will go into effect in July 1974. Viet-Nam has scheduled the replacement of its production tax with a VAT on July 1, 1973.
See P. D. Ojha and George E. Lent, “Sales Taxes in Countries of the Far East,” Staff Papers, Vol. XVI (1969), pp. 532-50; John F. Due, “Alternative Forms of Sales Taxation for a Developing Country,” The Journal of Development Studies, Vol. 8 (January 1972), pp. 263–76.
No account is taken of the VAT on purchases of other supplies and services.
See Alan A. Tait, Value Added Tax (London, 1972), p. 32. The zero rate was introduced by the Netherlands, and has been adopted by Ireland for a select list of activities, and also by the United Kingdom.
A number of developing countries also collect manufacturers’ sales taxes on the so-called fractional payment basis. However, these levies of the value-added type, which usually employ the direct substraction method (reducing the taxable base by the amount of taxed purchases rather than allowing a credit against tax due, as in the tax-credit method), are imposed only at the production and import stages. They are not considered here as a VAT.
This is a tax on presumptive taxable sales that is assessed by the tax department on the basis of information supplied by the taxpayer. A fuller description and evaluation of the forfait assessment method is presented in the section, Treatment of small enterprises and farmers.
See Michèle Guerard, “The Brazilian State Value-Added Tax,” Staff Papers, Vol. XX (1973), pp. 141–42.
These items include fertilizers, seeds, pesticides, veterinary products, animal feed, agricultural machinery, and tractors.
For a detailed analysis of this system, see Tait, op. cit., pp. 46–50.
The processor draws up two copies of an invoice showing the price before tax (100) and the tax due on purchases (5). One copy is given to the farmer, and the other is signed by the farmer and retained by the purchaser in order to support his claim for tax credit.
Senegal, Ministry of Finance, Law 66–34, May 25, 1966, concerning the reform of the turnover tax system, Article 5–3°.
Ibid., Article 9–1°.
See Guerard, op. cit., pp. 135–36.
The recently revised tax in Uruguay includes a reduced rate on financial institutions that will replace an existing tax on financial transactions.
EEC, Report of the Fiscal and Financial Committee (The Neumark Report), Brussels, 1958, par. 185.
This is equivalent to applying a zero rate to exports, thereby providing, as for other rates, for full credit against taxes payable—in this instance, zero.
See Guerard, op. cit., pp. 139, 144–45, and 149–50.
Also, some French-speaking countries provide for a reduced rate on foodstuffs not otherwise exempt.
These include fresh fruits, vegetables, eggs, and poultry; in the northeastern states milk, sugar, fish, and manioc flour are added to the list. However, staples, such as beans and rice, are conspicuously absent from the exempt list.
See, for example, Ian Little, Tibor Scitovsky, and Maurice Scott, Industry and Trade in Some Developing Countries: A Comparative Study (Oxford University Press, 1970), pp. 145–48 and 330–33; George E. Lent, “Tax Policy for the Utilization of Labor and Capital in Latin America” (unpublished, International Monetary Fund, October 2, 1972).
In the Brazilian states, the dual internal/interstate rate structure is designed to differentiate not on the basis of the type of product sold but on the geographic destination of the sale. This rate structure is related to considerations of interstate revenue allocation in the Federation, and is not concerned with the distribution of the tax burden among income classes.
This is the well-known butoir physique of the VAT based on the French model, which has recently been repealed. An exception to this is the Ivory Coast statute, which not only allows full deductibility but even grants cash refunds on prior-stage tax borne by products that are taxed at the reduced rate of 7.5 per cent.
It is of interest that in France 1.4 million of the 2.0 million taxpayers are subject to forfait, and they contribute only 7 per cent of the revenue. See Georges Egret, “La Taxe sur la Valeur Ajoutée en Belgique,” in L’Entreprise Face a la T. V. A., Séminaire Organisé a Liege, November 13, 14, and 15, 1969 (The Hague, 1970), pp. 262–63.
Except for Brazil, this is a percentage of central government tax revenue exclusive of payroll taxes, which are usually assigned to a separate fund. The ratio for Brazil is based on total tax revenue of the federal, state, and local governments.
The percentage ranged between 8.0 (Ghana) and 32.9 (India). In India, as in Brazil, this represents a percentage of total government tax revenue.
Guerard, op. cit., p. 156.
Ibid., pp. 154–55.
See Ojha and Lent, op. cit., p. 558.
For the fiscal year 1970, the percentages were 60 for Ivory Coast, 58 for Malagasy Republic, and 61 for Senegal. The percentage for Tunisia is also about 60.
That is, 48.7 per cent in 1968 and 54.4 per cent in 1969.
See Due, “Alternative Forms of Sales Taxation for a Developing Country” (cited in footnote 2), p. 274.
See, for example, Ojha and Lent, op. cit., p. 557.
Guerard, op. cit., pp. 125–26.
Between 1968 and 1969, the year of introduction, the Malagasy Republic’s revenue more than doubled, increasing from FMG 3.1 million to FMG 7.2 million, of which the tax on imports accounted for FMG 3.8 million; the internal tax revenue, however, declined slightly. Between 1969 and 1970, the first full year of the VAT, Ecuador’s sales tax revenue rose from S/ 162 million to S/ 439 million, of which an estimated 40 per cent is attributable to imports.
According to Danish tax officials, even though the new tax is believed to be far easier to administer than was the wholesale tax, “it is not yet clear how readily the mass of small and medium-sized firms will understand and follow the tax law and regulations.” An observer outside the Government has suggested that the enforcement effort needed will be great indeed, relative to the number of qualified officials available. See Carl S. Shoup, “Experience with the value-added tax in Denmark, and prospects in Sweden,” Finanzarchiv, Neue Folge, Band 28, Heft 2, March 1969, p. 247.
For example, for the Chilean general turnover tax, 4 per cent of the taxpayers account for 74 per cent of the total sales reported, while 58 per cent of them report only 2.1 per cent of total sales. These data were obtained for July 1965; estimates for the succeeding years show that the situation has not changed significantly. In the municipality of São Paulo, Brazil, 8 per cent of the taxpayers account for 90 per cent of the VAT collections.
In the United Kingdom, it has been estimated that the number of taxpayers covered will expand from 65,000 under the rather selective purchase tax to some 2 million under the VAT, Tait, op. cit., p. 124. In Denmark, the VAT covers an estimated 365,000 taxpayers, against 60,000 covered by its wholesale sales tax, Shoup, “Experience with the value-added tax in Denmark” (cited in footnote 35), pp. 246–47. On the other hand, Sweden’s change from a retail sales tax to a VAT involved an increase in licensed taxpayers from about 170,000 to 350,000, Martin Norr and Nils G. Hornhammar, “The Value-Added Tax in Sweden,” Columbia Law Review, Vol. 70 (1970), p. 412. The VAT in the Republic of Ireland is not expected to expand the number of taxpayers substantially because the two-tier sales tax system already embraces most wholesale/retail firms—about 30,000. Where a multistage turnover tax has been in effect, as in Chile and Peru, the number of taxpayers is not likely to be increased. This was Germany’s experience.
The simplicity of a single-rate system is best exemplified by Sweden’s use of an ordinary punched card for a tax return form. The taxpayer reports only total sales and export sales for the period, together with tax on sales and tax paid on purchases during the period. Further simplification of payment and collection of the tax is achieved by the use of the postal check, or “giro,” system, Norr and Hornhammar, op. cit., p. 410.
Sweden provides a tax payment period of two months, but with the permission of the tax authorities a firm may file in a period of four, six, or even twelve months, depending on the size of its annual turnover. Under these rules, most farmers can be expected to report their taxes only once a year, Norr and Hornhammar, op. cit., p. 410.
As Shoup states, “At all earlier stages, down to the retail stage, the business firm buyer insists that the seller show his (the seller’s) tentative tax on the invoice. If, then, the seller does not in fact pay this amount of tax (minus the credit for taxes shown on invoices for the things he has bought), his evasion can in principle be discovered by matching his tax return with the invoices in the files of his customers,” Shoup, “Experience with the value-added tax in Denmark” (cited in footnote 35), p. 246.
In many developing countries a so-called black market chain is formed, with respect to goods sold and bought without invoices. Producers sell a part of their output through regular channels, giving invoices and other required documents, but they also dispose of an important part of their production to wholesalers or retailers with whom they have close business connections—perhaps even family ties—without invoices or other documentary evidence. In turn, these wholesalers or retailers also sell an appropriate fraction of their goods with invoices and another part without, in such a way that what was originally sold at the first stage without invoices reaches the final stages of distribution in the same manner.
The forfait system may be illustrated by the procedure employed in the French-speaking West African countries. There, small taxpayers are required to submit an annual declaration of gross turnover, purchases, number of employees, wages and salaries paid, and the value of inventory. On the basis of these data the internal tax department estimates taxable sales and assesses the taxpayer, who has 20 days to accept or reject it. If the assessment is rejected, the tax department negotiates a mutually acceptable assessment. If no agreement is reached, the case is referred to an ad hoc commission composed of the director of the internal tax department (chairman), representatives of the ministry of finance, and businessmen. Unless the taxpayer chooses to appeal to the courts, this assessment is final and is generally valid for two years.
Egret, op. cit., p. 262.
Ivory Coast, the Malagasy Republic, and Senegal, in common with the practice among French-speaking countries, have divided small firms into two categories depending on whether they are engaged mainly in (1) selling merchandise or providing restaurant and hotel services (Category A) and (2) other activities, mainly services (Category B). The limits of gross receipts on firms subject to forfait are as follows:
|(In millions of CFA francs)|
|Category A||Category B|
|(In millions of CFA francs)|
|Category A||Category B|
Recently, the Republic of Ireland and the United Kingdom have followed this policy; the Inland Revenue Department and the Board of Customs and Excise, respectively, were selected to administer the new VAT. Similarly, the Customs and Excise Department in Malaysia was charged with the administration of Malaysia’s new manufacturers’ sales tax.
A special problem exists when the VAT and the income tax are administered at different levels of government. In this situation, coordination becomes the key to a better administration of both taxes. In Brazil, the Federal Government sponsored centralized procedures for state and federal tax administration and provides federal technical assistance to the less developed states.
See Jonathan Levin, “The Effects of Economic Development on the Base of a Sales Tax: A Case Study of Colombia,” Staff Papers, Vol. XV (1968), pp. 75–93.
See John F. Due, Indirect Taxation in Developing Economies: The Role and Structure of Customs Duties, Excises, and Sales Taxes (Baltimore, 1970), p. 56.
See, for example, the conclusion of John F. Due that “these defects are so serious and lead to so many complaints that the tax is completely unacceptable as a revenue source for any country,” Indirect Taxation in Developing Economies (cited in footnote 48), p. 123. See also Carl S. Shoup and others, The Fiscal System of Venezuela: A Report (Baltimore, 1959), pp. 305–306.
For an excellent account of the effect of Chile’s turnover tax in encouraging integration in that country, see Stephen Malcolm Gillis, Sales Taxation in a Developing Economy—The Chilean Case (University Microfilms, Ann Arbor, Michigan, 1969), pp. 117–65.
The Commission to Study the Fiscal System of Venezuela recommended adoption of a tax at the wholesale level, Shoup and others, The Fiscal System of Venezuela (cited in footnote 49), p. 305.
Sometimes referred to as the “ring” system.
East Cameroon, Dahomey, Guinea, Mali, Mauritania, Niger, Togo, and Upper Volta.
See Organization for Economic Cooperation and Development, Fiscal Committee, Some Problems Concerning Value-Added Taxation (Paris, February 1970), p. 15.
Ireland exempts all licensed taxpayers from tax on imports.
Colombian Commission on Tax Reform, Fiscal Reform for Colombia, ed. by Malcolm Gillis (Harvard University Law School, 1971), pp. 594–95.
Ojha and Lent, op. cit.; Alan Tait and John F. Due, “Sales Taxation in Eire, Denmark and Finland,” National Tax Journal, Vol. XVIII (1965), pp. 286–96.
See John F. Due, “The Retail Sales Tax in Honduras,” Inter-American Economic Affairs, Vol. XX (Winter 1966), reprinted in Readings on Taxation in Developing Countries, ed. by Richard M. Bird and Oliver Oldman (Baltimore, Revised Edition, 1967), pp. 326-36; Donald E. Baer, “The Retail Sales Tax in a Developing Country: Costa Rica and Honduras,” National Tax Journal, Vol. XXIV (1971)-pp. 465–73.
Baer, op. cit., p. 472.
Ibid., p. 471.
Ibid., p. 466.
A similar step was taken by Finland when on January 1, 1964, the manufacturers’ tax was moved to the wholesale level and retailers were made subject to tax on their value added, Tait and Due, op. cit., p. 294.
According to Shoup, “the highest-level tax officials of the Danish Ministry of Finance are emphatic in their conclusion that the present value-added tax is far easier to administer than was the wholesale tax, and representatives of both farm and non-farm business say that compliance is much easier under the value-added tax,” Shoup, “Experience with the value-added tax in Denmark” (cited in footnote 35), p. 247.
Ibid., p. 239.
See George E. Lent, “Manufacturers’ v. Wholesalers’ Sales Tax Base,” Taxes—The Tax Magazine, Vol. 36 (1958), pp. 573–601.
Principally because of the relative amenability of a manufacturers’ tax to rate differentiation, Gillis has recommended this structure for reform of Chile’s turnover tax, Sales Taxation in a Developing Economy (cited in footnote 50), p. 396.