The Value-Added Tax in Developing Countries
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

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.

Abstract

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.

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.

I. Principal Features of Value-Added Taxes in Developing Countries

Value-added taxes

While general sales taxes differ in scope, the stage at which levied, the rate structure, and other characteristics, certain recognizable varieties have been adopted by both developed and developing countries. For analytical purposes, these may be classified as follows: (1) multistage turnover taxes; (2) single-stage taxes at the retail, wholesale, or manufacturing level; (3) hybrid retail/wholesale taxes; and (4) value-added taxes carried to the retail, wholesale, or manufacturing level.2 In legal concept, sales taxes apply only to the transfer of goods; when extended to services the application is usually accomplished by supplemental legislation that identifies the services that are subject to tax. The conceptual basis of a VAT is described in the following section, and alternative forms of sales tax are compared in Section IV.

The conceptual basis of a VAT

A VAT is a tax on the value that is added to goods and services by enterprises at each stage of the production and distribution process. The principal ingredients of value added are wages and salaries paid and profits earned before income tax; additional elements are taxes other than those on income, rentals, royalties, and interest. Although the tax payable by each enterprise could be measured by the total (net) amount of these separate items, that is, the so-called additive approach, the substractive technique is universally employed. This can operate in either of two ways: (1) by deducting purchases of goods and services from net sales and taxing the balance; or (2) by the tax-credit device. The latter, which is more widely used, sets off the tax paid on purchases against the tax payable on sales.

Unlike a multistage turnover tax, which is applied to the full value of a product every time it changes hands in the process of production and distribution, a VAT is assessed at each stage only on the increment in value acquired by the product since the last taxable transaction. At the end of the chain, the total amount of tax paid on a given commodity is only a function of the rate of tax and of the final price of the commodity, independently of the number of stages through which it has passed. What has been collected in fractional payments is equivalent to a single-stage tax on the value of the final product. There is no incentive to vertical integration, and no discrimination against products that embody value added at an early stage versus commodities that receive the largest part of their value in the later stages of the production and marketing chain.

The treatment of capital goods varies with the type of VAT employed. The gross product variant makes no allowance for investment; its conceptual base is the gross domestic product (GDP). The income variant permits the deduction of annual depreciation to allow for the fact that a firm’s capital equipment gets used up in the production process. Finally, the consumption variant allows a deduction (or tax credit) for the full value of investment goods at the time of purchase. In this form, the VAT reaches only consumption expenditure, and, if it is carried through the retail level, its base is identical with that of a retail sales tax on consumer goods and services.

A VAT that applies only through the manufacturing or the wholesale stage does not offer the advantage of noninterference with market processes to the same extent as one that covers all sectors of the economy, including retailing and services. As long as any stage remains outside the scope of the tax, some distortion may result from the incentives remaining to business firms to integrate forward or backward. For this reason, the VAT systems in Europe all extend the tax to retail sales and cover most services.

According to the system that is most widely used, the tax that is due by a business firm is computed by applying the relevant tax rate to total sales during a given period, and deducting from the resulting figure the amount of tax paid by the firm on its purchases of intermediary products and capital equipment (in the consumption variant). This procedure requires that invoices show the amount of tax paid on value added at earlier stages. A continuous chain of tax credits therefore accumulates as a product moves through the production and distribution process up to the finished product stage and into the hands of the final consumer.

The workings of a VAT may be illustrated by the following simplified example based on the various stages involved in the production and sale of bread produced from, say, 500 bushels of wheat.3 The figures shown are in U. S. dollars.

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It can be seen that a 10 per cent tax is assessed at each stage of the process on the amount of sale, excluding the VAT, but that credit is taken for tax paid on purchases, leaving a net amount of tax chargeable on the value added at each stage. The cumulative tax—$400—is equivalent to a rate of 10 per cent on the final retail sale of the product to consumers.

Apart from adding administrative complications, an exemption at any point along the cycle (except at the very beginning or at the ultimate stage) normally results in a break in the tax-credit chain, which leads to a loss of neutrality and introduces an element of double taxation to the extent that the exempt product re-enters the taxable sector at the next stage.

With regard to exemptions, an important distinction is sometimes made between a so-called zero rate and normal exemption from tax.4 When a zero rate applies, sales are exempt from tax and the firm is also entitled to a credit for taxes paid on purchases, so that no element of tax is included in the final cost of goods and services. A tax credit may result in a tax rebate, or it may be offset against tax on taxable sales. On the other hand, a normal exemption does not provide for the remission of taxes paid on purchases. Whether or not the tax is zero rated, European countries usually provide for full rebate of the VAT on goods exported.

In principle, a VAT is generally conceived as one that extends to the retail stage and to virtually all sectors of the economy, including services, with minimal exemptions. This is the model that has been generally accepted by European countries. Only with a comprehensive and uniform coverage is it possible to achieve a truly neutral sales tax.

Introduction of the VAT in selected developing countries

Although it has been proposed in many developing countries in recent years, the actual move to a general consumption tax of the value-added type has been made in relatively few of them. The tax structures of seven developing countries are compared to show the different adaptations that have been made to the VAT concept (see Table 1). These countries are Brazil (state levy), Ecuador, Ivory Coast, the Malagasy Republic, Morocco, Senegal, and Uruguay.5

Table 1.

Selected Developing Countries: Principal Features of the Value-Added Tax

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The average per capita income of these seven countries covers a wide range of income levels associated with various stages of development, from a little more than US$100 in the Malagasy Republic to approximately US$200 in Eucador, Morocco, Ivory Coast, and Senegal, US$300 in Brazil (the per capita income of the more developed states in Center-South Brazil is twice as high as the national average), and US$600 in Uruguay.

Manufacturing accounts for a low percentage of the total product (10 per cent to 15 per cent) in six of the seven countries, and in all but a few of the Center-South states of Brazil. Except in Brazil, the external sector plays a major part in the economy, with imports reaching 20 per cent to 30 per cent of GDP. The share of taxes in the gross national product (GNP) is relatively high (18 per cent to 20 per cent in most instances and 28 per cent in Brazil).

The VAT was introduced in the seven countries to replace either a general turnover tax, or some form of manufacturers’ sales tax, or a combination of both. In Ivory Coast, Senegal, and Morocco, the VAT replaced production taxes based on the French system (with fractional payments) on manufacturers and importers. The Malagasy Republic had a general turnover tax on goods and services before the introduction of the VAT. In the Brazilian states the VAT also replaced general turnover taxes levied on merchandise sales. Ecuador, until 1970, had a tax on gross receipts from mining, manufacturing, construction, and on certain services; imports were not subject to sales tax. In Uruguay, the sales tax complex that was replaced by a VAT in 1968 included a manufacturers’ sales tax (originally collected by the suspensive method), which was subsequently extended to wholesalers on a value-added basis (indirect substraction method), and was supplemented, after 1963, by a tax on gross receipts of retailers and service enterprises.

The taxable base

The VAT systems employed in developing countries, like their counterparts in the developed countries, use broad levies designed to reach a substantial part of domestic consumption expenditure. On the whole, however, they are somewhat less comprehensive in scope. While coverage varies substantially from one developing country to another, the taxes generally do not apply to farm sales, sometimes exclude services, and do not always extend to the retail stage, or even to all wholesale activities. Capital goods may be only partly removed from the scope of the tax. An element of multiple taxation and potential distortion may also persist as a result of limitations on the use of credits for tax either borne or paid at earlier stages and a fairly widespread reluctance to provide refunds for excess tax credits. The troublesome problem of dealing with small businesses is usually solved by resorting to the forfait assessment method.6 The use of numerous exemptions and multiple rates by some states also complicates administration.

General scope of the VAT

The scope of the VAT is usually defined with reference to both taxable transactions and taxable persons. In the developing countries under review, taxable transactions are usually defined broadly as sales by persons engaged in industrial and commercial activity. Except in the Brazilian states, sales by farmers as well as sales of forestry, hunting, and fishing products are excluded at the outset. Taxable transactions are further defined to include both the sale of goods and the rendering of services, except in Brazil and Ecuador, where services are subject to a separate tax. Distinctions are also made between movable goods (such as merchandise) and immovable goods (such as real property), and the latter are subject to value-added taxation only under certain circumstances (in Senegal, the Malagasy Republic, and Ivory Coast), or not at all (in Brazil, Ecuador, and Uruguay).

Taxable persons are defined to include producers (both manufacturers and artisans), importers of taxable goods, sometimes merchants, and service enterprises if services are taxed. Mining, which is not taxed by Brazil, is generally included in industrial production. Construction is usually treated as a service activity and is taxed as such. The treatment of public utilities varies, but they are largely left outside the scope of the tax or are granted specific exemptions.

Sales by farmers

Special problems arise in applying the VAT to sales by farmers. Because farmers normally would be subject to tax on their inputs of machinery, feed, seed, fertilizers, pesticides, etc., it would be necessary for them to maintain adequate records to claim a credit for tax paid on their sales. However, the large number of small-scale farmers in developing countries, many of whom are illiterate, virtually precludes general operation of such a system, with the result that in none of the countries under review, with the exception of some Brazilian states, are off-farm sales subject to a VAT.

The common tax model prescribed by the Federal Government of Brazil does not provide for farm exemption, but it is in fact granted by the more developed states in the Center-South.7 The northeastern states, in general, continue to collect tax from the farmer or from his “substitute taxpayer,” that is, processors or traders who purchase the goods. Revenue lost by exempting farm sales is recouped in any event at the processing or marketing stages (except for direct sales to consumers). The problem remains, however, of how to allow for the tax paid by farmers on their inputs. One way to deal with the problem is to exempt farm inputs from the tax. The southern states of Brazil have followed this policy from the beginning, and in 1969 the Brazilian Government made the exemption of farm inputs compulsory in all states.8 Ivory Coast, the Malagasy Republic, Senegal, and Uruguay provide similar exemptions. The Malagasy Republic further exempts an extensive list of raw materials and supplies required for the manufacture of agricultural producer goods. Such exemption, in turn, poses a problem for manufacturers of agricultural producer goods of obtaining refunds for taxes paid on their inputs. This can be accomplished through zero rating. Imports of such goods can, of course, be exempted with no great difficulty.

Another way of avoiding the assessment of a VAT on farmers without sacrificing credit to taxable processors or wholesalers of farm products is the “global credit offset” technique employed by EEC countries.9 Under this method, farmers may elect to pay tax and claim credit for taxes on purchases on the basis of their accounting records, or they may elect not to pay tax at all. In the latter case, the purchaser of farm produce, however, is fully accountable for tax on his sales (usually at a reduced agricultural rate) and is entitled to a credit for tax presumed to be paid by the farmer on his inputs; to provide for this, a standard global credit offset is allowed, equal to a specified rate on the farmer’s sales that approximates tax paid on farm inputs. For example, if farm sales of 100 are made, the tax payable by the processor on these purchases at a (reduced) rate of 10 per cent is 10, for which he can claim a global credit offset of 5, computed at a standard 5 per cent of the purchases.10 No comparable device is used in the developing countries.

Sales by merchants

The tax status of merchants varies widely among the countries covered. In the three Latin American countries, as in the Western European countries, merchants are expressly included in the scope of the VAT, at both wholesale and retail stages (with special provisions for assessing the tax on small retailers). In Senegal and Ivory Coast, however, the VAT extends to only a small part of merchandising activities beyond the manufacturing and import stage, and in the Malagasy Republic only sales of imported goods are taxed. The same appears to be true of the Moroccan tax.

In Ivory Coast, only producers, building contractors, and service enterprises are required to register as taxpayers (imports are taxed by the customs office). Merchants may elect to come under the tax, but normally they will take that option only if they sell to taxable producers, or if they wish to claim tax credits on exports. Otherwise, they are entirely outside the ambit of taxation to the extent that they engage only in strictly merchandising activities.

The Senegal statute exempts resale of goods not further processed or altered, provided that the tax has already been paid at the production or import stage.11 Merchants therefore are required to register as taxpayers only if they sell goods that have not yet been subject to tax (for instance, goods bought directly from farmers). As in Ivory Coast, they have the right to opt for the VAT, if they find it advantageous to do so, for passing on to taxable purchasers the credit for tax borne on their merchandise. Those who sell only to retailers generally will not elect to be taxed, because retail sales are exempt. However, even if merchants in Senegal do not register as taxpayers, they are allowed to state on their sales invoices the tax paid on their purchases, for purposes of facilitating claims for tax credit by taxable customers.12

Services in general

Services are included within the scope of the VAT by five of the seven countries (Ivory Coast, the Malagasy Republic, Morocco, Senegal, and Uruguay). In Brazil and Ecuador, on the other hand, services are subject to a separate gross receipts tax, which in Brazil is imposed by the municipalities. In the countries where the VAT applies, all services are covered unless specifically exempt. A number of exemptions exist, however, the most common being real property rentals, transport and communications services, and financial services. The liberal professions are universally exempt.

Even though the scope of the VAT on services may be limited by exemptions, a substantial part of the value of services may be taxed indirectly when purchased by taxable businesses. Because there is no tax credit for these costs, the taxable margins of these businesses are increased and the VAT payable, accordingly, is greater. Moreover, when a separate tax is imposed on services, as in Brazil and Ecuador, these service inputs are, in fact, taxed twice.13 In the EEC, member countries are obliged to tax at least those services that, as business inputs, are likely to have a significant impact on the price of goods and other services, for example, accounting and engineering services.

Financial services

The tax treatment of financial institutions is not uniform in the seven countries. The three Latin American countries follow the European practice of excluding banking, insurance, and other financial activities from the scope of the tax; they subject them instead to separate levies.14 In the two West African countries and the Malagasy Republic, on the other hand, it would appear from the statutes that financial services are, in principle, within the scope of the tax, although a number of financial transactions are granted exemption. Insurance premiums, for example, are exempt from the VAT in Morocco, Senegal, and Ivory Coast (where a special levy is assessed), but the exemption does not extend to any related activities, such as insurance brokerage, fees, and commissions. Certain banking transactions are similarly exempt, particularly those relating to the activities of official financial intermediaries.

It is generally agreed that a VAT is not well adapted to financial services, especially banking and insurance.15 The value added by banks and insurance companies is difficult to calculate under the indirect substractive (tax-credit) method, although it would be feasible to employ the additive method and to apply tax to total payrolls and profits after depreciation allowances. Perhaps the most expedient treatment is the levy of a separate tax on profits of financial institutions, as in France and Denmark and as has been proposed by the Republic of China.

Construction activity and real property transactions

Construction activity is subject to the VAT in Senegal, Ivory Coast, and the Malagasy Republic, but the tax paid on building purchases by business firms is creditable for industrial buildings in Ivory Coast and for industrial as well as agricultural, mining, and tourist installations in the Malagasy Republic. In Latin America, only Uruguay taxes building activity, but at a reduced rate. In Brazil, building contractors are subject to the separate municipal service tax, on the value of services performed, while construction materials are subject to the VAT; tax paid on any building purchases is not creditable. Only the materials used are taxed in Ecuador, and building contractors’ margins appear to be excluded from the scope of both the VAT and the separate gross receipts tax on services.

Transactions in real property, in general, are left outside the scope of the VAT in Brazil, Ecuador, and Uruguay, but are included, in principle, in the other countries. In fact, however, only the sales made in the other countries by registered taxpayers are taxable, while property sales by private individuals and exempt persons are not. Similarly, rentals are not covered by the tax in Latin America and are taxed in the other countries only to the extent that they constitute a receipt from commercial or industrial activity.

Exemptions

In general, only exports are totally exempt from the VAT on their final value, by allowing full credit for taxes paid earlier in the production process.16 For most other transactions, exemption is incomplete, as no provision is made for recovering tax borne on the inputs used in the manufacture of exempt products. In the developing countries, however, these inputs are themselves exempt for a number of products, so that the amount of prior-stage tax incorporated in the price of the exempt final product is reduced, even resulting in complete exemption for some products. This has been seen to be true for off-farm sales in most of the countries covered (see the section, Sales by farmers).

Exports

If the VAT is intended as a levy on personal consumption, on the assumption that the tax is shifted forward in higher prices, it is proper to provide for the exemption of exports. This practice follows the so-called destination principle, according to which sales taxes are levied only by the country of final consumption, a principle that is sanctioned by the General Agreement on Tariffs and Trade. By effectively removing all sales taxes that may have accumulated in the production and distribution process, a country can better compete in the world market for its industrial goods. Virtually all countries, in fact, provide for the exemption of industrial exports from their different types of sales tax. One of the advantages claimed for a VAT in this respect is that the amount of tax applicable to the goods can be determined with greater precision, and no residual indirect taxes (taxe occulte) remain, as frequently happens with other types of sales tax.

On the other hand, many primary producing countries that enjoy a comparative advantage in the production of certain commodities do impose export taxes, and the retention of a VAT on semiprocessed or processed agricultural products may sometimes be justified.

When exempt, exports are, in principle, zero rated, that is, they are exempt from further tax and full credit is granted for taxes paid at earlier stages or on deductible inputs. Generally, however, creditable inputs include only the cost of goods purchased and other current inputs, and specified types of capital input (see section, Investment goods). Moreover, the tax credits that exporters accumulate thereby are normally supposed to be applied against VAT liabilities arising from the exporters’ taxable domestic sales. If the VAT liabilities are lacking or are insufficient to absorb the credits, the latter may be made transferable to suppliers or to other taxpayers.

Only as a last resort do most of the developing countries go so far as to provide exporters with cash refunds of the excess tax credits, and then often after the credits have been carried by them for an extended period without possibility of being used up. In Senegal, for instance, the adjustment for exporters’ excess credits can take place only after the close of the year, for either transfer to other taxpayers or as eventual cash refunds. Similarly, in Ecuador, excess tax credits arising from exports may be transferred to suppliers only after a six-month lag. No refunds are contemplated in either Ecuador or the Malagasy Republic. Uruguay appears to favor either offsetting the excess export credits against domestic tax liabilities or transfers to suppliers. In Morocco, there are no refunds, but export production can be exempted from taxes paid at earlier stages if producers are registered with the Customs Department for this purpose or if exports constitute at least 85 per cent of total turnover. Ivory Coast is the only one of the seven countries that clearly places no limitations on cash refunds.

In Brazil, the treatment of exports differs somewhat from that in the other six countries.17 Exports of primary products generally are not exempt but are taxed at reduced rates in some states and are taxed fully in others. Exports of manufactured goods are exempt, but, until recently, state policies on credit for taxes already paid and on refunds varied widely. State practices are now being standardized, and by 1974 it is expected that tax on manufactured exports paid at earlier stages will be fully creditable throughout the country. The extent to which actual cash refunds will be allowed, however, is still uncertain. Moreover, the export of a whole range of semimanufactured goods still generates prior-stage tax credit only in the states in the Center-South, while in the northeastern states such goods benefit only from a regular exemption at the export stage.

Food and other basic necessities

All seven countries grant some tax relief on food. This is generally provided in two ways: (1) by not taxing direct sales by farmers of unprocessed agricultural products in general; (2) by exempting specific foodstuffs, processed or unprocessed, regardless of the seller.18

The exemption of off-farm sales is provided in the VAT laws of the seven countries covered, except those of several Brazilian states. The attendant tax relief on basic food items probably goes much further in developing countries than in developed countries toward providing a general exemption of expenditures on food even if foodstuffs are not specifically exempt.

Of the seven countries surveyed, only Ecuador appears to rely solely on the farmers’ exemption to provide tax relief on food consumption. All the others complement this with a specific foodstuff exemption, which varies from country to country. Brazil exempts only a limited number of foodstuffs, mostly in their natural state.19 Until 1973, Uruguay had an extensive list of exemptions that included a number of processed foods as well as basic necessities, such as medicines, soap, water, gas, electricity, coal, firewood, and kerosene, but many of these items are now subject to a reduced rate. The two West African countries also exempt most foodstuffs, while the Malagasy Republic adds household necessities and some school supplies to the list and expressly exempts a number of raw materials and intermediate products used for manufacturing goods that are exempt as basic necessities. Similarly, in Ivory Coast, the exemption of bread, for instance, is supported by an exemption for flour and cereals. Morocco exempts only basic foodstuffs.

Newspapers, periodicals, and other exemptions

Newspapers and periodicals are exempt everywhere, usually along with newsprint (as in Brazil, Uruguay, Senegal, and the Malagasy Republic), and Uruguay also exempts printing equipment. Occasionally the exemption is extended to books, other educational materials, and records.

Exemptions other than those covered elsewhere apply mostly to certain services (in those countries where the VAT applies to services) and to real property sales and rentals (either totally or partially). In Senegal and Ivory Coast, exemption is also granted on the sales of certain public utility enterprises that operate under state concessions.

Goods subject to special excises

The tax treatment of goods subject to excises presents a special problem. Excises on tobacco products, alcoholic beverages, petroleum products, sugar, etc., are generally levied at high rates and account for a substantial part of government revenues; in some instances these goods are produced and sold through government monopolies. If these excises were replaced with a VAT, it would be necessary to introduce special high rates so as not to sacrifice revenue; also, the advantages of excise tax administration and enforcement might be lost. On the other hand, producers would be subject to a VAT on their purchases, and unless these purchases were made taxable, or were zero rated, the producers would not be able to recoup tax paid. European countries have generally extended the VAT to cover sales of excisable goods; in some countries, such as Denmark and Sweden, it has been superimposed on existing excise tax rates, while in others, such as the Netherlands and Germany, excise rates were reduced so as to maintain approximately the same level of tax as before.

In developing countries, a limited number of goods and services subject to excises or sold by state monopolies are excluded from the VAT, particularly alcoholic beverages, tobacco, petroleum products, and public utilities. On the other hand, luxury excises are often superimposed on the regular VAT, as an alternative to using the luxury rates in the VAT itself (see the third paragraph of the section, Tax rates).

Investment goods

The consumption variant of the VAT provides for a full credit of the tax included in purchases of capital goods. This is the policy followed uniformly by European countries. In developing countries, however, there is a wide variation in practice, and investment is not entirely removed from the VAT in any of the seven countries covered in this paper. Even when the law makes such tax creditable, because of the sizable credits frequently involved and the reluctance of the governments to make refunds, considerable time may be taken to liquidate the credit.

In the two West African countries and in the Malagasy Republic, tax is creditable on only specified categories of fixed asset. In general, the law is designed to give credit only to industrial equipment and sometimes building installations for industrial use, as in Ivory Coast. As a rule, tax on transport equipment is not creditable, except when designed exclusively for the internal handling of materials.

Both Ecuador and Uruguay provide full credit for the tax paid on fixed assets. Brazil originally allowed a credit for tax borne on industrial machinery, although not on buildings. Industrial equipment is now granted an outright exemption from the tax, and the tax-credit system has been repealed. The exemption is supposed to be complete (that is, a zero rate). To achieve this, manufacturers of equipment are to be granted full credit for taxes already paid on their inputs, in much the same way as exporters.

Although industrial countries consistently avoid taxing investment goods (except in a transitional period), this policy need not necessarily set a pattern for developing countries. In the latter, labor is generally in surplus supply, and a cost advantage is frequently enjoyed by capital through overvalued exchange rates, favorable credit terms, and income tax concessions. Taxes on capital goods, whether import duties or sales taxes, may serve partly to redress the imbalance between the cost of labor and capital, and thereby encourage more labor-intensive production methods and industries.20

Tax rates

For purposes of comparison, a distinction must be made between nominal rates of tax and effective rates, depending on whether or not the tax is applied to price exclusive of tax. In all European countries except Sweden, and in Ecuador, the Malagasy Republic, and Uruguay, the tax is based on the price of goods and services exclusive of tax, and the nominal rate is the same as the effective rate. On the other hand, Brazil, Ivory Coast, Morocco, and Senegal apply the tax rate to the tax-inclusive price; the effective rate therefore is higher than the nominal rate. For example, the 15 per cent rate in Ivory Coast and Morocco is equivalent to an effective rate of 17.65 per cent (0.15 ÷ 0.85 = 0.1765).

The VAT rates in the developing countries are somewhat lower, on average, than those prevailing in the VAT systems of the industrial countries. Effective normal rates range from 10 per cent to 23 per cent in Western European systems. In the developing countries, the effective normal rates on domestic sales range from 4 per cent in Ecuador to 20 per cent in Brazil (Table 2).

Table 2.

Selected Developing Countries: Value-Added Tax Rates

(In per cent)

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Food, basic necessities, drugs, textiles; construction materials and buildings; equipment; intermediary products; public utilities, banking, insurance, transport; services in general.

Rate of 14.0 per cent on interstate sales and exports.

Ships, printed fabrics; certain equipment goods.

Alcoholic beverages, cosmetics, jewelry, and bars and restaurants in the luxury category.

Foodstuffs, shoes, fuel alcohol, candles, bicycles, soap, coal, seeds, fertilizers. Also, rates of 8.0 per cent on pharmaceutical products and of 11.25 per cent on radio and television sets.

Luxury goods, automobiles.

Reduced rates of 4.2 per cent on transport services and of 6.4 per cent on water, gas, and electricity.

Sugar, water, electricity.

Luxury import rate (consumer durable goods, cosmetics). Normal rate of 11.9 per cent on imported goods.

Construction, electricity, and bars and restaurants.

As regards rate structure, Ivory Coast, the Malagasy Republic, Morocco, and Senegal have chosen the typical European multiple rate format, with a normal rate, a reduced rate (usually half the normal rate), and a steeply higher luxury rate. In the three Latin American countries, the rate was uniform for all commodities until December 1972, when Uruguay adopted a reduced rate for many goods that previously were exempt from the VAT, being subject only to a gross receipts tax.21 In Brazil and Ecuador, the differentiated treatment of luxury goods is achieved not through the VAT but rather through separate luxury taxes, which in Ecuador take the form of excises. In Brazil the luxury taxes are incorporated in the Federal Government’s manufacturers’ VAT system, which is characterized by a high degree of rate differentiation on a product-by-product basis.

The reduced rates are used in the two West African countries and in the Malagasy Republic for different purposes: (1) to grant a measure of relief to basic necessities that have not been exempted altogether (certain foodstuffs, household products, school supplies, medicines; textiles in the Malagasy Republic; rough printed fabrics in Ivory Coast); (2) to assess public utilities more lightly in the countries where they are not totally exempt (as in the Malagasy Republic and Senegal); (3) to tax construction and services (in the Malagasy Republic and Senegal, and in Morocco, where the rates on services are lower); (4) to tax equipment (in Senegal and the Malagasy Republic), thereby reducing the amount of tax credit that is subsequently allowed to business firms for purchases of investment goods; and (5) to assess intermediate products (in the Malagasy Republic, where a long list of industrial raw materials and semifinished goods is added to the list of equipment that is charged at the reduced rate).

The higher rates apply essentially to luxury consumer goods, which are mostly imported (cosmetics, jewelry, alcoholic beverages, automobiles, and other consumer durable goods). The effective import rate on most luxuries is 33.33 per cent in Senegal, 42.85 per cent in Ivory Coast, and 25 per cent in Morocco.

Tax credits and refunds

All seven countries use the tax-credit method, which is the accepted method in Europe. Credit is normally allowed for tax borne and shown on purchase invoices of all current inputs and fixed assets to the extent specified in the statutes. No credit is allowed, as a rule, for tax paid on inputs used in the production of outputs that are exempt, with the important exception of exports and, in Brazil, of industrial machinery and equipment. Sometimes it is not possible to recover all the tax incorporated in an item that is taxed at a reduced rate when the inputs have borne the higher, normal rate of tax.22 This is so because of a provision whereby the credit for taxes already paid on intermediate goods cannot exceed the tax due on the final product.

An excess of credits over tax liability is normally carried over to subsequent periods until it can be absorbed by a corresponding tax liability on a firm’s sales. The transfer to other taxpayers and the eventual refund of unused credits are reserved almost exclusively to export tax credits. In addition, as mentioned before, Brazil grants the same facilities to credits accumulated by manufacturers of equipment, which is tax exempt. In Senegal, cash refunds may also be granted for tax credits arising from purchases of investment goods.

Special provisions for small businesses

Generally, small businesses either are exempt or are assessed on a forfait basis. Sometimes, large numbers of small taxpayers have been excluded automatically from the tax by the exclusion of those sectors where they are numerous (for example, agriculture, in some instances services, retailing, and even small-scale wholesale activities in the West African countries). In addition, within the scope of the tax, the very small business may be exempted, as in Ecuador and the Malagasy Republic. In other countries no statutory exemption exists even for the smallest businesses if they operate in a taxable sector; rather, they are covered by a forfait tax as in Brazil.23 In Sao Paulo, 174,000 out of about 382,000 taxpayers are subject to the forfait system.

II. Revenue Importance of the VAT

Share of total tax revenue

As is usually true of broadly based general sales taxes, the VAT makes a substantial contribution to government revenue. In the countries selected for the study, the share of the VAT revenue in total government tax revenue in 1968–70 ranged between about 10 per cent and about 30 per cent (Table 3).24 In only two of the seven countries, Ecuador and Uruguay, was the revenue less than about 20 per cent of total tax revenue.

Table 3.

Selected Developing Countries: Value-Added Tax (VAT) Revenue as a Percentage of (1) Total Government Tax Revenue and (2) Gross Domestic Product, 1968–701

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Sources: Government reports; International Monetary Fund, International Financial Statistics.

Government tax revenue is that of the central government, exclusive of social security payroll taxes, except for Brazil where it covers revenue of federal, state, and local governments. The VAT revenue includes that of supplementary tax on services levied by the same level of government, where applicable.

1971.

Fiscal years ending 1969, 1970, and 1971.

A comparison with 15 other developing countries that have sales taxes indicates that the VAT countries generally have a greater relative dependence on sales tax revenue. In only 5 of the 15 countries did this revenue in a recent year amount to 20 per cent or more of total central government tax collections, and in only one (India) did it approximate that of Brazil.25

Ratio of the VAT to GDP

Perhaps of greater significance is the claim on GDP represented by the VAT. Although the nature of the VAT suggests that the GDP (or GNP) represents the potential tax base, there is a wide gap between the two. Besides the fact that exports, the value of capital goods produced, and the value of government services are excluded, many other exemptions and exclusions from tax may narrow the base (for example, farm sales, services, and retail sales). On the other hand, the value of imported goods destined for consumption is included in the tax base although it is not part of GDP. The effective ratio of tax collections in relation to GNP, therefore, depends on three basic factors: (1) the value of expenditure excluded or exempted, (2) the level of the tax rate or rates, and (3) the level of enforcement.

Coverage of GDP

As we have noted in the section, The taxable base, in none of the seven countries covered is the VAT very complete in its sectoral scope. All countries exempt farm sales, exports of manufactured goods, and substantially all financial services; only three tax retail sales but they grant exemptions for certain essential foods and other products; two exempt all services, but the others exempt only specified services.

No estimate is available of the proportion of GDP covered by the VAT, except for Brazil, where it is approximately 60 per cent.26 It should not be inferred, however, that this represents value added only by the taxable sectors of agriculture, manufacturing, and trade; the output of the excluded sectors (for example, services and mining) is taxed indirectly by the purchases of such exempt goods and services because they carry no tax credit. The value of the intermediate production that is outside the direct scope of the VAT in Brazil and that is effectively taxed in the form of noncreditable inputs is estimated to amount to from 15 per cent to 20 per cent of the value added by agriculture, manufacturing, and trade.27

Tax ratios

For the seven countries covered, the VAT tax collections in a recent year ranged between 1.1 per cent of GDP for Ecuador and 8.1 per cent for the Brazilian states (Table 4). While some difference in these extremes could be expected because of the wide disparity in rates—ranging between 4 per cent for Equador and 20 per cent for Brazil—this accounts for only about 70 per cent of the difference.

Table 4.

Selected Developing Countries: General Sales Tax Revenue as a Percentage of Gross Domestic Product (GDP), Recent Years

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Sources: Government reports; International Monetary Fund, International Financial Statistics.

Type of sales tax: (1) multistage turnover tax; (2) tax on sales by manufacturers and importers, and usually on selected services; (3) tax on sales of a broad range of selected commodities; (4) VAT; and (5) hybrid tax, on sales by licensed manufacturers and merchants.

With effect from January 1, 1973, replaced with a tax on sales by manufacturers and importers, with a partial tax credit, and separate lower rate taxes on wholesale sales and certain services.

With effect from June 1, 1971, revised to a single-stage manufacturers’ tax (2).

In Ivory Coast, Morocco, and Senegal the VAT is also important in relation to GDP. While their rates are fairly high—ranging between effective normal rates of 10 per cent and 17.65 per cent—their tax ratios are at least twice that of Uruguay, which has a rate of 10 per cent. Moreover, Uruguay taxes retail sales whereas the others do not.

It seems clear that in developing countries, in general, sales tax revenue depends heavily on the value of imported goods.28 Information is not available for all the countries covered that have a VAT, but data for Ivory Coast, the Malagasy Republic, and Senegal show that the VAT revenue collected by the customs administration amounts almost uniformly to about 60 per cent of total revenue.29 In Morocco, the proportion is about one half.30 Imports probably play a less important role in Latin America, especially in Brazil, but rough estimates indicate that Ecuador derives at least 40 per cent of its VAT revenue from imports.

It is rather striking that, of a representative list of 30 countries with sales taxes, 5 of the 6 countries with the highest ratios of sales tax to GDP are those with a VAT (see Table 4). On the other hand, both Uruguay and Ecuador are at the lower end of the range, and the Malagasy Republic falls in midrange.

It is sometimes argued that the VAT is best prescribed for conditions of high sales tax effort because it becomes increasingly difficult to enforce tax collections from turnover taxes as tax rates are increased.31 This theory finds support in practice by the decision of 5 of the 6 countries with high ratios of sales tax to GDP to employ this form, and by the fact that others with high tax ratios—including Chile, the Republic of China, Peru, and Korea—have been giving serious consideration to converting to a VAT. On the other hand, countries with low sales tax ratios, such as Argentina, Colombia, and Mexico, have also considered the feasibility of the VAT technique.

Elasticity of revenue

It would be important to know whether or not VAT revenues in developing countries increase at a faster rate than the growth of the economy, but the available data do not provide any clear answer. While the ratio of VAT revenue to GDP has increased over the past few years in three of six countries with more than a full year’s experience (Morocco, Senegal, and Uruguay), this may be attributable partly to changes in rates and tax base as well as to enforcement, rather than entirely to built-in elasticity (Table 3). In Uruguay, it may reflect largely a revenue lag associated with the introduction of a new tax. On the other hand, revenue elasticity of the VAT would appear to be less than unity in Brazil, the Malagasy Republic, and possibly Ivory Coast. Brazil’s declining ratio to GNP can be explained mostly by the liberalization of credits for exports and investment and the extension of payment deadlines. The Malagasy Republic’s revenue from domestic sales declined for reasons that are not clear, but there was a slight increase in the tax on imports. A priori, the taxable sector can be expected to increase generally at a faster rate than does GNP, and experience with sales taxes in other countries shows an income elasticity that is usually greater than 1.32 There would appear to be no reason, other than changes in the tax base and tax rates, why this should not also be true of the VAT.

Because of the concern over the revenue effect of the transition to a VAT, the experience of the countries covered would be of interest. In all countries for which information is available, introduction of the VAT apparently resulted in higher revenue than did the yield of the preceding tax. In Brazil, the state VAT revenue in 1967 rose by 54 per cent over the revenue in 1966 from the turnover tax, but because prices rose by 30 per cent on average, the real increase was nearer to 17 per cent.33 Uruguay’s VAT revenues in 1968 also were appreciably higher than revenue from the tax that it replaced. The VAT in both Ecuador and the Malagasy Republic significantly increased sales tax revenue in the early years because the base was expanded to include imports, which had been excluded under the previous tax system.34

III. Problems of Administration

The feasibility of a VAT in developing countries depends largely on the ability of the countries to administer it. This is a function not only of the scope of the tax but also of the degree of its complexity with regard to rate structure, exemptions, VAT techniques employed, treatment of small businesses and farmers, and other provisions that have been reviewed.

As was shown earlier, the VAT offers a wide variety of possibilities as to its coverage, ranging from a broad-based tax designed to reach a substantial part of domestic consumption expenditure—touching all stages of the production and distribution of goods and services—to more limited forms that exclude retailing, services, and farming. Another facet of the VAT that has direct influence on its administration is its rate structure. While a single-rate VAT is much simpler to administer than a multiple-rate one, a number of countries have adopted multiple rates, for equity or revenue purposes. Exemptions also complicate the administration of sales taxes, since they require special records, invoices, credits, and, possibly, refunds. Exemptions provided on grounds of equity have such a strong political appeal that their complete elimination in developing countries is highly unlikely.

We must also consider the fact that the ability to administer a VAT or, indeed, any other sales tax varies according to the stage of development in each country. Developing countries present a wide spectrum as to their degree of literacy, size of monetary economy, nature and size of industrial and trade establishments, adequacy of record keeping, attitudes toward taxation and tax administrators, and efficiency of tax administration services. The existence of a great variety of situations with respect to these factors precludes generalizing on the feasibility of value-added taxation in developing countries. The proper approach is to try to identify certain crucial administrative problems that must be resolved in each country before such a tax can be implemented successfully.

These problems should be viewed from the angle of not only government administration but also the taxpayers’ problems of compliance. The costs of doing business tend to increase with the introduction of a VAT, especially during the initial period, because of the need to adapt to new accounting procedures.

The principal difference in enforcement and compliance between developed and developing countries arises from the relatively larger number of small businesses in the latter and the inadequacy of bookkeeping records. The same problem exists on a smaller scale in developed countries, as may be seen, for example, in Denmark.35

While the problem of small taxpayers is important in developing countries, this fact should not obscure the overall vision of their tax structure, as industry and commerce are becoming more concentrated in large enterprises in many of these countries. Therefore, strictly from the point of view of revenue, the problem of enforcing tax on small taxpayers should not be overemphasized.36

Number of taxpayers and their registration

A VAT that reaches all stages of production and distribution is bound to increase the number of taxpayers substantially, unless it replaces a multistage sales tax.37 In developing countries, the problem of increasing the number of taxpayers should be viewed with caution, especially if only a small percentage of the new taxpayers will affect the revenue significantly. Even though the control and audit of small taxpayers may be kept at a minimum, their number alone may pose problems of registration, filing returns, and tax collection that could impede the efficient administration of the entire tax system. The cost of administering large numbers of relatively unproductive small taxpayers must be weighed against the considerations of efficiency and equity that may lead to their inclusion.

The problem of numbers, of course, can be minimized by exemptions. In both Denmark and Sweden the inclusion of farmers in the VAT system accounted for most of the increase in taxpayers. As we have seen, virtually all developing countries exempt farmers and thereby avoid this problem without necessarily prejudicing tax revenue because of the “catching up” at the processing stage. Moreover, substantial agricultural output may be exported and therefore may not be subject to sales tax. Also, the VAT may be limited to a select list of services, as in Sweden, or services may be exempted from the VAT, as in Brazil and Ecuador, thereby eliminating many small personal service firms.

Another practical approach is to limit the VAT to firms with annual sales in excess of a specified minimum, a policy that is generally practiced in Europe. For example, Denmark exempts persons with sales of less than DKr 5,000, and Sweden of less than SKr 10,000. In the Republic of Ireland, retail units with annual sales of less than £ 12,000 and persons providing services of less than £ 1,800 are not obliged to register. These limits may be too high for developing countries; Brazil, Ivory Coast, and Senegal, for example, provide no exemption based on size but rather rely on a simplified forfait system for small businesses (see footnote 6).

In order to efficiently administer a VAT, as well as any type of sales tax or income tax, one must have a proper system of taxpayer registration. Such systems already exist in many developed and developing countries, where they have been implemented with varying degrees of success.

In some countries, taxpayers have been registered and given a number that has generally been valid only for a particular tax, and different numbers have been given to the same taxpayer for each tax that requires a numbering system for filing, collection, etc. In general, these different numbering systems have led to lack of coordination of the information about each taxpayer.

In recent years, there has been a trend toward a registration and numbering system, called the “master file system,” in which each taxpayer is given a number that identifies him for several or all taxes to which he is liable. To operate successfully, this system should be computerized. The use of a master file system is ideal for administering a VAT, as it makes possible an efficient control of tax collection; moreover, computer programs could be designed to analyze returns of both the VAT and the income tax, with respect to profit margins, relation of purchases to sales, etc., and for preselecting cases for audit. The use of a master file system with classification of taxpayers is also valuable in obtaining statistics on input and output of businesses.

For many developing countries, however, it is not feasible to computerize their tax administration and to introduce a master file system. This is a handicap but not necessarily a barrier to the introduction of a VAT.

If the taxpayers who are subject to the VAT have not already been registered for tax purposes, a special registration system must be devised for them. Even though a registration system may exist, the introduction of a VAT provides a good opportunity for purging these registers by requiring taxpayers to register again for purposes of the new tax. When feasible, the registration system should be designed for use within a computerized operation, and a numbering mechanism should be devised that will be adequate for the overall requirements of the system.

Invoices and accounting records

One of the essential elements for applying and controlling the VAT is the invoice. As the invoice states not only the value of the goods sold but also the amount of tax paid in relation to such goods, it is the buyer’s main evidence of the taxes that he has paid on his inputs, for which he will be able to claim credit against his tax on sales.

One problem that arises is whether invoices should be given on official forms, printed and numbered by government offices, or on privately printed forms that, although containing a uniform set of facts, are not standardized in format. Sometimes the latter must be registered with the government, which affixes an indelible seal.

There is general agreement that the following information should be included: name and address of both the supplier and the customer; quantity and description of goods; unit price of the goods; separate statement of taxable and nontaxable goods; separate statement of the tax applicable, together with the rate that applies in each case; and date of the invoice. The invoice should also include the registration numbers of both the buyer and the seller. Experience has shown that small retailers and artisans greatly resist issuing invoices, not only for the administrative complexity that they imply but also to avoid registering total sales. This problem is considered in the section, Audit of a VAT.

With respect to accounting records, it is necessary to distinguish between taxpayers whose internal organization allows them to absorb tax changes without undue administrative effort, and those of smaller size and less efficient operations for whom new requirements of accounting and recordkeeping imply high costs compared with their total profits. The principal difference between the accounting requirements of a general turnover sales tax and those of a VAT is that for audit and control purposes of the VAT the taxpayer’s records must show clearly not only total sales and the sales taxes payable but also his purchases and the taxes paid.

Multiple rates and exemptions compound the problems of recordkeeping. With respect to multiple rates, purchases and sales taxed at the different rates must be recorded separately.38 Similarly, exempt purchases and sales should be recorded separately from taxable sales. It is also necessary to separate those exemptions that lead to a refund of the taxes previously paid on the goods and services used in the production of the exempt items (that is, zero rated) from those exemptions that do not result in a refund of taxes previously paid.

A further complication arises when an enterprise deals in both exempt goods on which tax is not refundable and taxable goods. If the law does not allow for a system of proration, it will be necessary to record separately the inputs that will go into the production of exempt goods and taxable goods. In order not to overburden the taxpayer, a practical solution would be a system that allows the taxpayer a pro rata credit of his total taxes paid on purchases, based on the same proportion that his taxable sales have in relation to his total sales.

Filing of returns, payment of the tax, credits, and refunds

The form of the returns that must be filed by taxpayers who are subject to the VAT will vary according to whether the tax has a single rate or a system of multiple rates, and also according to the mechanism for dealing with exempt sales. The returns filed must contain all the information needed for mathematical verification of the tax due, as described earlier.

Ideally, the returns that a taxpayer is required to file should be mailed to him with his registration number, name, and address preprinted by the computer. Since many developing countries have neither sufficient computer capacity to do this work nor reliable postal services, the taxpayer must obtain the forms in the tax offices and file them personally.

Normal payment periods vary from one month (as in the French-speaking West African countries) to three months (in the Netherlands and the United Kingdom). A monthly period for filing and payment can become a burden to the taxpayer as well as to the tax administration in developing countries, and perhaps a two-month period might be considered acceptable; longer periods are employed in some countries for small taxpayers.39 On the other hand, it may be argued that this arrangement benefits the taxpayer unduly, in having the use of government funds for a relatively long period, and makes eventual collection more risky; against this argument is the fact that in most VAT schemes the taxpayer who sells on credit has a liquidity problem if he is liable to the tax when the sale is made.

As has been stated, exemptions from the VAT, if zero rated, may result in refunds of taxes previously paid on goods and services used in the production of the exempt items. Refunds may also occur in other situations, such as claiming excess credits, or absorbing credits during the transitional period between the old turnover tax and the VAT. In some countries the law provides for a gradual liquidation of these excess credits until they are absorbed by taxes payable, but in others it provides for refunds, especially on exports.

The administration of refunds is inefficient in many developing countries; whenever possible, refunds should be avoided and a credit mechanism against future taxes should be used. The refund procedure entails not only a burden for the tax administration but also sometimes a long and unpleasant struggle for the taxpayer in obtaining his money.

Audit of a VAT

Auditing a VAT concerns both sales and purchases as well as the taxes paid on them. Auditors therefore must check a variety of matters, such as exemptions, multiple rates, connection between purchases and sales, and credits and refunds claimed by the taxpayers.

Existing literature emphasizes the “cross-checking” procedure of controlling evasion; this consists of comparing the invoices issued with the returns filed by taxpayers, to uncover possible tax evasion at any stage.40 The following observations should be made about cross-checking VAT payments:

(1) Cross-checking purchases against sales is not a new idea; it is a standard procedure for both sales and income tax audit in many countries. In general, invoices are required for administering both of these taxes, and different systems of cross-checking—manual and computerized—have been applied.

(2) In general, manual cross-checking has proved to be cumbersome, time-consuming, and relatively unproductive, owing to the complexity and size of the operations involved. Computerized cross-checking has run into difficulties because of lack of uniform invocies, insufficient capacity of the computers, and other administrative problems. Developing countries should be cautioned against relying on their computer systems for cross-checking; often the computers have proved to be barely capable of performing relatively simple operations, such as printing bills and tax rolls.

(3) Once a discrepancy between invoices and returns has been discovered, the tax auditors must investigate the case. In practice, this operation is also troublesome, as a discrepancy in one or two invoices may not allow the whole of the taxpayer’s records to be disregarded, unless fraud can be proved.

(4) Cross-checking retail sales is impracticable, since the retailer is under no pressure from consumers to pay the tax.

A more fundamental question should be raised, especially within the context of developing countries: Is it correct to assume that each buyer will “insist” on obtaining an invoice from the seller, so as to be able to credit the tax stated in that document? The whole theory of the built-in checking system of the VAT rests on this assumption (except for retailers).

In this context, the difference between the VAT and an ordinary turnover sales tax lies in the fact that the buyer should have a greater interest in obtaining an invoice when he is subject to the VAT, as it is the only proof of his right to a credit against his own tax liability. In reality, each taxpayer is subject not only to VAT but also to a variety of other taxes, among which the income tax is one of the most relevant. Therefore, the problem of evasion and control of a VAT cannot be analyzed in isolation, but it must be studied within the context of the total situation of the taxpayer.

Experience has shown that the evasion of sales taxes generally has a twofold objective: to evade the payment of both these taxes and the income tax through the understatement of sales. Evasion is easier to accomplish through the understatement of sales than through illicit deductions, which when stated on accounting records may be subject to scrutiny by tax auditors. The understatement of sales for this dual purpose requires an accompanying reduction of purchases so as to give an appearance of consistency and thereby to disarm the tax auditors. Therefore, faced with the combination of the VAT and the income tax, taxpayers may be tempted to forgo “insisting” on obtaining invoices and may prefer to obtain a price reduction on their purchases so that they also can sell a part of their output without invoices.41 In such situations, it is obvious that cross-checking invoices against returns will give limited results, as taxpayers using this method of evasion will be careful to have enough invoices to justify the purchases that they record in their books, as well as to produce sufficient invoices to cover the amount of sales that they wish to report.

Therefore, even though the VAT provides an important incentive for accurate reporting of sales and purchases, through the self-interest that the purchaser will have in obtaining an invoice, one should not place undue faith in the virtues of the so-called built-in control system or in the cross-checking of documentary evidence provided by the taxpayers.

Audit of a VAT will have to rely on additional mechanisms such as those used in traditional sales taxes; one of the most important is the physical checking of inventories of goods on hand, which is practically the only method of piercing the taxpayer’s web of documentary evidence. The principal problem in following this procedure in developing countries is the relative scarcity of trained personnel, as staff time is usually devoted mostly to the daily problems of collection, appeals, and other administrative matters, and only a small percentage of trained personnel is free for audit functions. Obviously, this physical checking of inventory can best be accomplished by personnel with experience in income tax audit, and it should be coordinated with the administration of the income tax.

Treatment of small enterprises and farmers

Small enterprises

As has been pointed out, large or medium-sized enterprises can absorb the accounting and procedural requirements of a VAT with relative ease. Because there are relatively few such enterprises in developing countries, and an important part of total economic activity is concentrated in their hands, they tend to become a target for audit and control by the tax administration services.

The problem arises with the large numbers of small artisans, traders, and peddlers that exist in developing countries, who may comprise an insignificant proportion of total business activity. Various solutions to problems of administering the tax on these firms have been advanced, mainly the following:

(1) Apply the VAT to all stages of production and distribution, including retailing, but limit it to those firms that have a yearly turnover above a specified level. Since most of the exempt firms would pay tax on their purchases, tax would be sacrificed only on their retail margins. These small firms could choose coverage by the VAT and might do so if the tax paid on their purchases exceeded the tax paid on their sales (or if their buyers insisted on a tax credit). As we have seen, many European countries and some developing countries exempt small businesses.

(2) Establish a limit, generally based on yearly turnover, below which taxpayers may elect either to be incorporated within the VAT system or to pay a low rate of turnover tax on their total sales with no deduction for taxes paid on their purchases.

This system relies heavily on the accuracy of sales reported by small taxpayers. It is precisely this point that causes most difficulties in administering any type of sales tax, as it is practically impossible to determine total sales of a large number of small taxpayers. In such a system most customers of these small taxpayers have no interest in paying the tax or in receiving an invoice, while the taxpayer wishes to minimize his total sales for purposes of both sales tax and income tax.

(3) Use the forfait type of assessment. This system is widely used for small businesses both in the countries that provide no exemption for small businesses and in those with firms that are larger than those in the exempt category.42 In Uruguay, a variant of this system is to assess all exempt small firms with a special turnover levy (applied to either actual or estimated gross receipts) that substitutes for both the VAT and several other taxes, including the schedular income taxes on business enterprises. The VAT that is assessed on a forfait basis is in some respects a separate levy, especially to the extent that it does not provide credit for taxes already paid, and since normally it cannot be stated on invoices even if sales are made to taxable taxpayers. One exception to this rule is the Senegal statute specified in footnotes 11 and 12, which allows firms assessed by forfait, and even unregistered traders, to pass on to business purchasers the tax credit on their sales invoices.

The forfait mechanism is a crude way of taxing small enterprises and is subject to arbitrary decisions on the part of the administration and to collusion between taxpayers and tax inspectors. In those developing countries in which political influence or other disruptive factors characterize tax administration, the forfait system might tend to perpetuate such abuses. Moreover, use of this technique does not encourage the use of invoices and improvements in accounting.

(4) Use a variation of the forfait technique in which the taxpayer would be allowed to deduct from his fixed tax the amounts of the VAT that are shown on his purchase invoices. Here, the forfait payment would be fixed at a higher amount than in a normal forfait system to allow for the deduction of taxes paid on purchases. One advantage of this modified forfait is that the taxpayer has a greater interest in obtaining an invoice for his purchases. Moreover, it has been suggested that the relative amount of tax credit taken by the forfait taxpayer would provide a guide to the administration in making periodic changes in the forfait estimates.

(5) Give small enterprises, especially in the retail field, the option of coming within the scope of the VAT or of being subjected to an “equalization” levy that is chargeable at various rates on goods delivered to them, depending on their selling margins. This technique has been adopted in Belgium and has been studied for possible application in the Central American countries that have adopted a hybrid system of sales taxes. Under this system, it is the responsibility of sellers to collect the equalization tax, showing on their invoices both that tax and the VAT. The Belgian system, which is of a transitory nature, has the advantage of incorporating small businesses within the scope of the VAT without the need to audit or control them directly; however, it has been criticized for the multiplicity of the rates required, the burden on the seller, and the reluctance of small businesses to come under the system.43

With respect to the problem of small businesses, the fundamental difficulty, common to all the systems described, is to determine which taxpayers should be considered “small.” Faced with this problem, most countries have fixed a limit on total yearly turnover as an appropriate dividing line.44 This criterion is open to several objections. One of the main difficulties of administering any type of sales tax is to obtain an accurate report of total sales from small enterprises. Small taxpayers will try to adjust their total sales to fall within or outside the scope of the VAT, according to their interests, and the authorities are generally unable to control such a situation. The amount of the limit is also arbitrary, and it is difficult to justify why two taxpayers should be in different situations only because one has a turnover that slightly exceeds the fixed limit and the other is barely below this limit. It may therefore be desirable to incorporate in the definition other objective elements, such as value of total assets, value of inventory, or number of employees.

Farmers

The inclusion of farmers presents one of the most serious problems of administering a VAT. As we have seen in the section, Sales by farmers, some European countries have dealt with them by means of a “global credit offset” device, according to which farmers do not have to pay the VAT but simply issue a receipt for goods that enables purchasers to claim a tax credit. The main reason for using such a procedure is to avoid imposing on these taxpayers the obligation of keeping the records that are essential for administering the VAT. If this is the situation in developed countries, it cannot be expected that the VAT can be applied to farmers in developing countries with any degree of success, unless a similar technique were to be devised for them.

In developing countries in which a VAT is in force, one solution has been to exempt direct sales of unprocessed agricultural goods by farmers and to exempt agricultural producer goods that comprise the main cost of their inputs. While this method may not be precise in avoiding cumulation of tax, neither does it sacrifice tax revenue, because the value of the farmer’s output is recouped at the next taxable stage, that of the trader, cooperative, or processor.

On the other hand, in many developing countries there is a great cultural and economic difference between different categories of farmer; frequently, large holdings are concentrated in the hands of a small percentage of landowners, who make an important contribution to total agricultural production and many of whom maintain accounting records required for a VAT. Therefore, although administrative reasons are of considerable weight in favoring the exemption of most farmers in developing countries from the VAT, they do not justify exempting large commercial producers.

Organizational aspects

When a country decides to adopt a VAT, one of the first administrative questions that must be answered is which government service will be responsible for administering it. The main possibilities include (1) the organization that administers customs and, sometimes, excise duties; (2) the organization that administers internal indirect taxes, where such administration is separate from that of the income tax; and (3) the income tax administration.

It is difficult to make a general statement as to which of these organizations is best equipped to administer a VAT. Nevertheless, some guidelines for a decision in a particular situation may be inferred from the experience of different countries with this matter.

It is true that up to a point the administration of the VAT is related to that of customs duties; usually the VAT will be applied to imports and remitted on exports. Nevertheless, apart from these two main points of contact, the whole expertise of a customs organization is directed principally to establishing the value of goods that cross the border of a country. Generally, its personnel are not experienced in such matters as auditing taxpayers’ records, cross-checking invoices, checking inventories, or other functions that are necessary to administer a VAT effectively.

As to the second alternative, in many countries a clear organizational separation exists between the administration of income taxes and of indirect taxes. Generally, a high-ranking official or board of officials has the responsibility of supervising the two separate organizations and of coordinating their operations. Effective coordination between the two organizations depends on many factors, including the degree of authority of their common supervisor, the personality and political influence of each of the heads of the separate organizations, the revenue importance of the taxes administered by each organization, and the position of the employees of the different organizations as to salary and other benefits.

It has become general practice to leave the administration of the VAT to the organization in charge of indirect taxation.45 There are good reasons for such a decision, for usually the VAT replaces another kind of sales tax that has been administered by this organization, which has a certain degree of skill in the matter, maintains taxpayer registers, etc.

Nevertheless, the efficient operation of a VAT requires a level of expertise in auditing that is more akin to that for the control of income taxes than of other forms of sales tax. At the same time, the information obtainable through the VAT should be helpful in enforcing the income tax. These considerations seem to argue more in favor of a united administration, under a single organization, of both income taxes and the VAT.

Long administrative history and political reasons, however, militate against this solution in many countries. In situations where sales taxes and income taxes are administered by separate departments, efforts should be directed toward establishing a high degree of coordination between the two organizations. This coordination not only should be enforced at the level of heads of organizations but also should be institutionalized at different technical levels, such as automatic processing of data obtained through tax returns or audits, exchange of this information, consultation as to special audit programs, and design of forms.46

problems of changing over to a VAT

While the problems connected with filing returns, collecting the tax, and auditing accounts are of a continuing nature, a series of other problems of administering a VAT are mainly of a transitional nature, and they tend to disappear once the tax has been in force for a period of time. These include (1) training the technical personnel who will administer the VAT, with respect to the new procedures and requirements necessary for controlling it; (2) educating the taxpayers and the general public about the characteristics of the new tax, as well as about the new requirements with which taxpayers will have to comply; and (3) administering special transitional provisions that are generally included in a new VAT law, covering mainly the treatment of investment goods and inventory on hand when the new tax goes into effect.

The lack of adequate personnel training is one of the weaknesses of the tax administration services in developing countries that adversely affects the efficient administration of their whole tax structure, especially the implementation of any new tax scheme. The intensity of training will depend on the previous experience of the personnel in administering more or less complex forms of taxation. In this respect, obviously personnel who have been in charge of auditing income taxes will require much less training than, for example, customs officials.

Educating the taxpayers and the general public about the features of the VAT is also of great importance to its adequate implementation. If it is a change from a general turnover tax, then it is not only a matter of teaching the new technique but also of explaining the merits of a VAT in contributing to the general equity and fairness of the sales tax, even if it sometimes entails initial hardship for some taxpayers.

Adequate information about a new tax is conducive to better administration. In many instances there is a lack of necessary contact between the administration and organizations of taxpayers or of professionals who devote themselves to tax problems. Information directed to the general public is useful, but direct contacts with business or trade unions, associations of lawyers, accountants, etc., may be of more practical use for a better administration of a new tax such as the VAT.

Another important administrative problem is that of applying the special transitional provisions included in most VAT laws. These provisions, which deal mainly with investment goods and inventories, may be necessary when these items have borne some form of sales tax before the introduction of a VAT. If investment goods have borne no tax (as in Ireland and the United Kingdom), no problem arises; but when they were taxable, as under a multistage turnover tax, it is necessary to avoid undue discrimination by reason of the exemption of investment goods under a VAT. The solution of Belgium, Germany, and the Netherlands was to give a partial credit and to reduce the amount of credit for tax on investment goods gradually over a transitional period of several years. This problem would arise mainly in developing countries with a multistage turnover tax, for example, in Chile and Peru, where investment goods are taxed.

The problem of relief from double taxation of inventories in the transition to a VAT arises in virtually every country where the sales tax replaced is not of the retail variety. One method of relieving double taxation is to allow taxpayers to take credit for sales tax that had already been paid on inventories on the date of the change-over; this is the system that was implemented by Ireland and is planned by the United Kingdom. When the sales tax replaced is of the multistage turnover variety, however, a difficult problem arises in determining the effective tax rate cumulated on the many types of goods in inventory. No attempt was made by most European countries to mitigate this double taxation; rather, it was left to be worked out in the market process.

IV. Comparison of the VAT with Other Forms of Sales Tax

The choice of sales tax technique, as with other taxes, rests on a variety of considerations that must be weighed by each country in the light of its own social and economic conditions. And in appraising the feasibility of a VAT for a developing country, it is necessary to specify the realistic alternatives at its stage of development. The relative merits and limitations of the alternative forms of sales tax that were listed in Section I are discussed in this section.

In this analysis no consideration is given to the stage of development at which a country may be justified in introducing a general sales tax in any form. According to one view, such a move depends on the comparative importance of domestic production in a hypothetical sales tax based on imported and domestic consumer goods and services: a general sales tax may be warranted at a stage of development when domestic production becomes sufficiently important and accessible to leave a significant gap in the hypothetical base.47 According to another view, a nondiscriminatory sales tax on imports and domestic production may be justified as a revenue measure that reduces the protective effects of customs duties that might otherwise be enacted, even in early stages of development.48

In evaluating the choice of a VAT by a developing country, three practical alternatives that have proved successful in operation are given primary consideration: (1) a single-stage manufacturers’/importers’ tax of the suspensive type, on the model of Malaysia and Tanzania; (2) a hybrid retail/wholesale tax modeled on that of Honduras; and (3) a tandem manufacturers’ (or wholesalers’)/retail tax similar to that of Ireland’s former system. Neither the multistage turnover tax nor a single-stage retail sales tax is considered suitable, the former because of its discriminatory cascade effects and the latter because of difficulties in enforcement. These alternatives will be appraised on the basis of several criteria, including (1) neutrality as to organization and form of business; (2) neutrality as to effects on relative prices and consumer choice; and (3) problems of administration and compliance. While compatibility with an economic union, such as a common market, and effects on exports are also important, there seem to be no significant differences in these respects among the alternatives considered.

Multistage turnover taxes

Probably the most elementary form of sales tax is a tax on each transfer of title to goods, known as a multistage turnover tax. Such a tax is usually supplemented by a levy on selected services. This type of turnover tax was in effect in most EEC countries until it was replaced by a VAT; it is still in operation in the Republic of China, Korea, and Mexico.

Fiscal economists have faulted this type of turnover tax on grounds of its discriminatory effects on domestic and external trade.49 This arises from the “cascading” of the tax that is added to sales on each transaction and cumulated in the price of the final product. Since the amount of tax cumulated depends on the tax rate and the number of taxable transactions incurred in the production and distribution process, it tends to squeeze out the independent trader and producer and encourages vertical integration; because transactions within an integrated enterprise are not chargeable, such a business enjoys a substantial tax advantage in competing with independent, small-scale enterprises.50

The unequal cumulation of the tax on different industries, depending on the structure of the manufacturing and distribution process, also creates discriminatory effects in international trade and makes it especially difficult to apply to trade among members of a common market. If the turnover tax on imports is higher or lower than that cumulated on domestic goods, or if the tax remitted on exports is higher or lower than tax actually cumulated, distortions may arise. This situation led to its replacement by a VAT in the EEC as the best means of harmonizing sales taxes among its members.

Single-stage manufacturers’ sales tax

Single-stage taxes may be imposed at one of several stages in the manufacturing and distribution process. The states of the United States and the provinces of Canada impose general retail sales taxes; by exempting sales for resale, they leave taxes on the final consumption of goods and selected services. In order to restrict further the incidence to consumption goods, exemptions may be provided for machinery, equipment, feed, seed, fertilizers, fuel, and other intermediate goods. Single-stage taxes at the wholesale level—such as the United Kingdom’s purchase tax and sales taxes in Australia, New Zealand, and Israel—are levied on sales by manufacturers or wholesalers to retailers (or direct manufacturers’ sales to consumers at a presumptive wholesale price). A single-stage tax at the manufacturers’ level is designed to limit tax to sales by manufacturers to wholesalers or to retailers; this is usually accomplished by a suspensive system according to which licensed manufacturers are exempt from tax on their purchases. In addition, a complementary tax is generally assessed on imports of finished manufactured goods so as to equalize the burden with that on domestic production. Single-stage manufacturers’ sales taxes of this type are imposed by Canada and, among developing countries, by Ghana, Malaysia, Tanzania, and Uganda.

Developing countries, in general, have limited their sales tax to the manufacturing stage, with a compensating tax on imports. The principal exceptions are to be found in Latin America and in some states in India, where the tax has been extended to the retail stage.51 The retail base has been avoided principally because of administrative problems of enforcing tax on a large number of small-scale retail units that dominate distribution in developing countries, although, as is shown later, these problems can be partly met by using a hybrid wholesale/retail tax.

Elimination of cascading

Cascading is inherent in the taxation of most manufacturing industries if purchases of raw materials, semifinished goods, and supplies are made taxable. Two different well-established techniques are employed to eliminate the cumulation of tax on manufacturing: (1) the suspensive system, according to which licensed manufacturers are entitled to purchase goods and services tax free,52 and (2) the value-added principle, according to which an allowance is made for the tax paid on purchases.

The suspensive principle is illustrated by the law recently adopted in Malaysia, whereby licensed manufacturers, with the authorization of the Customs Department, are entitled to import or purchase materials and components from other manufacturers free of tax; when these goods are purchased from a tax-paid source, such as an importing firm, the seller may apply to the sales tax office for a refund of the tax previously paid. If, as is usually true, sales tax is collected by the Customs Department at the time of import, this system may be cumbersome because of the seller’s need to apply for tax rebates on tax-paid goods. The scope for this treatment is greatly reduced by a long list of goods, including materials and supplies, that are exempt under the law. Although this system, in principle, should substantially avoid the accumulation of taxes on manufacturers’ sales, it may leave a residue of tax that is impracticable to recoup on purchases from taxable sellers; while this is likely to be of little overall significance, it may be important for particular industries.

The value-added principle is applied at the manufacturing level by a large number of developing countries. The French-speaking West African countries 53 as well as Argentina, Colombia, and the Philippines employ the direct deduction technique. With minor differences, the taxes in the West African countries replicate the French production tax as revised in 1948 to provide for fractional payments on the value added by each producer; the French tax follows the physical deduction principle in allowing a deduction from manufacturers’ sales only for taxable purchases of raw materials and components that either are physically included in the product or lose their identity, such as abrasives, lubricants, and chemicals. Unless exempted outright, purchases of capital equipment are also taxable. These countries differ in the extent of the deductions allowed.

The sales taxes in Algeria, Ivory Coast, the Malagasy Republic, Morocco, Senegal, and Tunisia, although differing among themselves in some respects, best approximate the concept of a VAT at the manufacturing/wholesale level. They follow in general the 1954 French model, which came to be known officially as the value-added tax. It differs in two major respects from the reformed production tax of 1948 that was adopted by other French-speaking countries in (1) providing for the elimination of tax on purchases of machinery, equipment, and industrial buildings (the financial deduction) and (2) replacing the direct deduction method with a tax credit. This improved version represents a more desirable model at the manufacturing level than the production taxes of other French-speaking West African countries.

Full application of the VAT principle, whether based on the direct deduction or the tax-credit method, provides a clear-cut elimination of any cascade effect and avoids discrimination among competing manufacturers with different structures of production (that is, integrated versus nonintegrated). When imports of equipment, components, and supplies serve a variety of uses, there may be some advantage in assessing tax uniformly on all goods at customs and allowing manufacturers to claim a deduction or credit for tax on their sales; the risk of evasion is greater if tax is not imposed at this point.54 On the other hand, when imports are used in producing for export, it may be more expeditious under a VAT to provide for the exemption of imports of materials by licensed exporters, as in Morocco, so as to avoid the need to finance inventories of goods that include an element of sales tax.55 Moreover, such a system minimizes the problem of refunding tax on exported goods. In this respect, there is no essential difference from a single-stage manufacturers’ sales tax, except for the accumulation of tax on goods that are not imported directly by the licensed manufacturer who uses them, but the VAT has an advantage because it completely eliminates double taxation.

Colombia’s experience with the two methods illustrates possible limitations of the suspensive system. With the introduction of the tax in 1965, provision was made for manufacturers to buy materials free of tax by notifying the seller that the purchases were to undergo further processing; in addition, manufacturers were allowed to reduce their tax base by the cost of other materials that were subject to tax (that is, using the direct deduction method). Because of the abuses of this system by manufacturers who overstated their purchases of taxable materials, and the difficulties of checking and controlling such evasion, Colombia amended the law to limit the suspensive principle to those manufacturers who produce goods for export, or other specifically exempt goods, and replaced the direct deduction method used for other purchases with a credit for taxes paid.56 Pakistan also recently replaced its suspensive method with the tax-credit device.

Neither Indonesia nor Thailand completely resolves the cascading problem. Rather, they tax raw materials, other intermediate products, and services in general at a reduced rate—in Indonesia at one half the normal rate and in Thailand at a nominal rate of 1.5 per cent. Thus, cascading is mitigated somewhat but not eliminated at the manufacturing level. Its elimination could be accomplished either by sacrificing revenue or by higher tax rates. From an administrative point of view, it is necessary to specify the materials and supplies that are subject to the reduced rate and to enforce payment of the correct tax. It is more difficult, of course, to provide for precise rebate of tax imbedded in the cost of manufactured goods that are exported.

Administration and compliance

From the point of view of administration and compliance, there would appear to be no significant difference between the suspensive and tax-credit approaches at the manufacturing level. Substantially the same number of taxpayers would be covered under both systems, and neither would entirely avoid the need for refunds. However, as noted earlier, uniform application of the tax to purchases, including imports of taxable goods, would limit the possibilities of evasion that are implicit in the suspensive method. Auditing of accounts would, of course, be necessary to check the validity of invoices for which tax credit is claimed and to ensure that all taxable sales are reported.

Exemption of exports would present no problem under either system. No tax refund would be needed under the suspensive method, where no tax is assessed; however, it may not be feasible to eliminate the tax completely when taxable purchases of supplies, etc., are unavoidable. Tax refunds may be necessary under the VAT method unless purchases of licensed exporters are completely exempt. Payment of tax on purchases of materials, of course, would increase the cost of financing inventories under the VAT method.

Hybrid retail/wholesale tax systems

A manufacturers’ sales tax is not well suited to a country where manufacturing is of little importance; moreover, a tax at this level is subject to various discriminatory effects as to channels of distribution and consumer prices. On the other hand, taxes at the retail level in many developing countries encounter serious objections because of the dominance of small retail units that multiply compliance and enforcement problems. These conflicting objections have been partly reconciled by a hybrid tax at the manufacturing/wholesale/retail level that was first instituted by Honduras, on January 1, 1964, and later adopted by Costa Rica, Nicaragua, and Paraguay. Similar taxes have also been in effect in Finland, certain states in India, and Nepal.57 According to this system, tax is collected only on sales made by registered firms to unregistered buyers; firms with annual sales above a specific amount (US$30,000 in Honduras) are registered. By this technique, sales are taxed either at the retail level by the registered seller or at the wholesale or manufacturing level on sales to the small, unregistered retailer. The margins of small retailers and artisans therefore remain outside the tax base.

The Honduran tax applies to sales of all nonexempt commodities by registered firms to unregistered buyers; in addition, certain services, such as hotels, amusements, and restaurants, are made taxable.58 Registration is required only of larger firms, including manufacturers, wholesalers, retailers, hotels, and restaurants, with annual sales in excess of a stipulated amount. Imports by registered firms are taxed at the time of sale by the importer; tax on imports by nonregistered firms is collected by customs.

Exclusions from tax in Honduras are defined as far as possible to confine the tax to sales for final personal consumption. Registered firms are exempt on their purchases of not only raw materials, intermediate goods, and machinery but also basic foodstuffs, drugs, certain clothing, and goods subject to excise tax. Export sales are also exempt.

Unless special permission is granted to absorb the tax, registered firms are required to state the tax separately and to collect it from customers. It can be seen that, in the absence of further provisions, liability for the type of sales tax instituted by Honduras falls on only a limited number of larger firms (about 1,100 in Honduras and 1,900 in Costa Rica); most of the smaller firms pay tax only on their purchases.

Allocative effects

The Honduran prototype is well adapted to countries where manufacturing is undeveloped and it is desirable to have a broadly based tax that is distributed roughly according to consumer expenditures. As a single-stage tax, it avoids cascading and does not encourage integration. Rather, it favors small-scale entrepreneurs who are taxable only on their purchases and who escape tax on their value added. This very discrimination, however, may provide an undue advantage to small firms that are not required to add the tax to their sales, thereby attracting business because of their actual, or apparent, tax-free status. This has been the experience in Costa Rica where marked competition developed between registered and nonregistered restaurants, bars, nightclubs, and other service firms that were small enough to escape the tax entirely.59 But the same type of discrimination could arise with a VAT that provided similar exemptions.

The degree of disparity between registered and nonregistered firms is suggested by data for Honduras that show that only 27.4 per cent of tax was collected from retailers and 3.1 per cent from restaurants, bars, hotels, etc.60 This means that possibly as much as two thirds of the Honduran-type tax is based on wholesale or manufacturing sales to retailers and other sellers who are not taxable on their own value added. While the discrimination inherent in this situation may not be serious at present rate levels (5 per cent in Costa Rica and Nicaragua and 3 per cent in Honduras), it may be necessary at higher rates to close the gap in the effective tax burden between registered and nonregistered firms.

Beginning in 1968 Honduras took measures to assess the sales tax at the end of the year on the difference between taxable purchases and sales by nonregistered firms with annual turnover above a certain minimum, covering about 2,000 firms.61 Since this is tantamount to applying the VAT principle, it would seem to be a short step to replace this hybrid form of tax with a VAT.62 Alternatively, it might be feasible to lower the limits of registration to the level adopted for the annual assessment, and to collect the tax regularly throughout the year. If this were done, the differences between the two techniques would substantially disappear, except for the use of the suspensive principle by the hybrid method in exempting intermediate goods and machinery from tax.

Administration

As has been noted, the difficulty of enforcing a single-stage sales tax at the retail level in developing countries militates against its use and has led to the adoption either of taxes at the manufacturing/wholesale level or of retail sales tax structures based on the Honduran model or the VAT principle. Both types of tax extending to the retail level have been administered successfully in developing countries, although neither has been without problems. Since the main touchstone of their applicability to developing countries is their ease of administration—especially at high rates—it is important to compare the principal characteristics of each from this point of view.

Sales taxes generally run into trouble because of the large numbers of returns that must be processed and taxpayers who must be controlled and audited. The hybrid method has been advanced as a practical means of confining the tax to larger firms without producing undue interfirm discrimination. But, as we have seen, inequities arise even at low tax rates, and these would be intensified with a rise in rates. Attempts to mitigate such discrimination by compensating taxes on the value that is added by nonregistered retailers and other firms increase the administrative burden. At this point of development, the number of taxpayers covered by a retail VAT would not appear to be greater than those covered by a modified hybrid system, especially since it may be most practicable to exempt the very small firm under each system.

The suspensive system employed under the hybrid model facilitates diversion of taxable to nontaxable sales, similar to that already discussed in connection with a manufacturers’ sales tax and which led Colombia and Pakistan to replace it with a tax credit. From the point of view of compliance, it is necessary for sellers to make a distinction between taxable and nontaxable sales of intermediate goods, based on the statement of the purchaser. No such distinction need be made under a VAT; all sales are uniformly subject to tax, and the purchaser simply sets off the tax paid on purchases against tax added on his sales.63 On the other hand, all firms covered have to maintain accurate records of purchases as well as sales.

As discussed in the section, Audit of a VAT, one of the advantages claimed for a VAT is the self-reinforcing nature of the assessment and collection process. Because the tax paid on purchases is set off against tax, every taxable firm should have an interest in seeing that tax is included in the seller’s invoice. This process, however, is subject to abuse through collusion and by the use of fraudulent invoices; moreover, no such discipline is imposed at the final sale to consumers. Experience nevertheless appears to attest the efficiency of the system in minimizing evasion. Danish tax officials, for example, believe that evasion is more easily deterred if it is based on a false statement to tax officials to gain a credit or refund than if it is only necessary to give false information to a seller as to the intended use of the goods in order to obtain an exemption under a single-stage tax.64

Some advantage also is claimed in the splitting up of the tax liability in the manufacturing/distribution chain, so that a single firm is not subject to more than a fraction of the cumulative tax at the retail level—the part that is applicable to its value added. The significance of this factor, of course, is related directly to the rate of tax. Under the hybrid system, the tax is paid only at a single stage, and if this is evaded the entire amount of tax is sacrificed; the risk of loss is minimized when more than one seller is involved in the payment of the VAT on a particular good or service. Nevertheless, a problem may remain under either system for personal service businesses with a high labor content. Where taxable purchases of materials are a relatively small part of the total business revenue, the burden of the sales tax may represent a large share of net profits.

Tandem systems

Ireland has successfully applied a dual system of sales taxes consisting of separate taxes at the wholesale and retail levels. Such a system in effect would permit a developing country with an already established manufacturing tax to supplement it with a retail sales tax rather than by raising existing rates to meet increasing revenue requirements.

The reverse order of introduction took place in Ireland, which in 1963 introduced a 2.5 per cent tax on retail sales of a wide range of goods and services. This was followed in 1966 by a 5.0 per cent levy on sales at the wholesale level of a select list of goods; broadly speaking, it covered all goods within the scope of the retail tax except food, beverages, medicine, clothing, fuel, tobacco, and gasoline. The tax was chargeable on sales by manufacturers and wholesalers to retailers, as well as on direct sales to consumers. No tax was chargeable at either level on plant, machinery, and equipment, and on certain materials and equipment used in agriculture. Subsequently, the retail tax rate was raised to 5.0 per cent, and the normal wholesale tax rate was increased to 10.0 per cent, with a rate of 20.0 per cent on less essential goods, such as motor vehicles, television sets, radios, and recording equipment. (Both taxes were replaced on November 1, 1972 by a VAT at rates corresponding to combined rates previously in effect at the retail and wholesale levels.)

Effects on channels of distribution

A tandem system, whether based at the manufacturing or wholesale level, is inherently discriminatory as to distribution channels; markups vary among different types of commodity and also, even for competing goods, the sales tax base varies with the division of the marketing functions between the manufacturer or wholesaler and the retailer. With a tax at either level, large retailers are encouraged to buy directly from manufacturers at preferential prices and assume much of the wholesaling function themselves. They are thereby favored with lower effective tax rates in relationship to the retail value of their sales than those chargeable to small unit retailers who buy from a wholesaler or jobber. This type of discrimination with respect to distribution channels has posed serious problems under both the Canadian manufacturers’ sales tax and the British wholesale (purchase) tax, especially at the higher rates, and has led to the adoption of “uplifts” in the United Kingdom for equalization purposes.65 As we have seen, a VAT through the retail level is neutral in its effects on channels of distribution and avoids integrative effects.

Conversion from a multistage turnover tax to a VAT presents special problems for integrated industries that have succeeded in minimizing their turnover tax, as in Chile and Peru. Because a substantially higher VAT rate might be necessary to replace turnover tax revenues, taxes chargeable against integrated manufacturers, for example, would be increased greatly. When the turnover tax rate is already high, as in Chile, much higher rates might be resisted and administrative problems would be intensified. When turnover rates are low, however, as in the business activities taxes in Korea and the Republic of China, and integration has not reached large proportions, similar problems may not exist. Replacement of turnover taxes by separate sales taxes on manufacturing and retailing would somewhat mitigate the sharpness of the increase, especially when integration has not been carried to the retail level.

Flexibility

One reason advanced in favor of a tandem system is that a sales tax at the manufacturing or wholesale level is more adaptable to rate differentiation.66 A VAT is also amenable to multiple rates, but it is most easily administered with one or two rates, as in Latin America, Denmark, the Netherlands, Germany, Norway, and Sweden. While higher rates on luxuries are frequently defended on distributional grounds, and may be necessary for political reasons, it is questionable if a sales tax is the best tax instrument for achieving vertical equity. On the other hand, it is usually thought desirable to mitigate the regressivity of a sales tax by exempting such necessities as food, medicines, and rent, and this probably can be done as readily through a zero rate or exemption under the VAT as under a tandem system.

Enforcement considerations also tend to limit the level of rates that may be necessary to expand sales tax revenues, both at the manufacturing or wholesale stage and the retail stage. This is known to be an important factor in the sales tax planning of Ireland, although its entrance into the EEC was the decisive consideration in adopting a VAT. Fractional payment of tax under a VAT and its built-in self-checking features tend to reduce the risk of evasion, and thereby permit higher tax rates than might be tolerable on manufacturers’ or retailers’ sales under a dual regime.

Administration

Administrative considerations do not appear to give any clear net advantage to either sales tax structure. While a tandem system is likely to entail fewer taxpayers, the difference is not likely to be so great as to give it much weight in the choice. On the other hand, as we have already seen, the VAT principle is less conducive to tax evasion: the same arguments made with respect to the comparative advantages of the suspensive method of eliminating cumulation of tax are equally applicable to the VAT system (see the section, Elimination of cascading).

It is also argued that a tandem system permits a low tax rate at the retail level and thereby reduces incentives for evasion in a sector that is especially vulnerable. A greater share of the revenue can then be collected at high rates from a more limited number of manufacturers and importers. There is some force to this argument for personal service businesses with a high labor content, but it should not be overlooked that retailers are subject to the VAT only on their gross profit margins, usually a moderate fraction of their sales.

Because of the administrative problems that are encountered under any sales tax on small retailers and artisans in developing countries, the need for a special regime to cover them is generally recognized. Provision can be made, as in a hybrid tax, to exempt small firms from a VAT, leaving them taxable only on their purchases. Or a forfait system can be adopted, based on presumptive sales (see (3) and (4) in the section, Small enterprises). One alternative that has been proposed in the Republic of China and other developing countries is to tax small businesses at a reduced rate (say, one fourth of the standard rate) on their reported sales, but to give them the option of being taxed under the VAT system and claiming credit at the standard rate. This system would obviate the need for maintaining proper records of purchases, etc., but would reach the value added by retailers and other small firms.

V. Conclusions

Since the introduction of the VAT in Western Europe, a number of African and Latin American countries have adopted sales taxes based on the value-added principle. The VAT systems in Brazil, Ecuador, Ivory Coast, the Malagasy Republic, Morocco, Senegal, and Uruguay are representative of the various forms that this type of tax has taken. All the systems differ, in some respects, from the European model of a comprehensive, uniform, and neutral tax on the consumption of goods and services, thereby showing the adaptability of tax structure to different economic and social conditions; however, all use the tax-credit device in applying the value-added principle.

Summary of analysis

Differences in structure

On the basis of the laws enacted in these seven countries, it is not possible to construct a model of the type of VAT that is likely to emerge in developing countries. These examples, however, suggest some lines along which these countries may be expected to go in their efforts to adapt the tax to their particular circumstances.

The scope of the VAT is narrowest in Ivory Coast, Morocco, and Senegal and is somewhat broader in the Malagasy Republic. Only the Latin American countries and the Malagasy Republic (in part) attempt to follow the distribution circuit all the way to the retail stage. Services are taxed, however, in all these countries but Brazil and Ecuador, where they are covered by other taxes.

Developing countries are apt to limit the range of the VAT by excluding the most troublesome sectors (farmers, retailers, etc.) because they pose difficult enforcement problems. Virtually all developing countries exempt farmers as a simple way of providing tax relief to the lowest-income group. Even if no measures are taken to exempt processed foodstuffs and other basic necessities or to tax them at a reduced rate, equity purposes are served. Luxury goods, on the other hand, are mostly imported and may be assessed at a higher rate of tax directly at the customs. Selective excises on luxury goods also increase the tax burden on the higher-income groups without necessarily resorting to multiple rates for the VAT.

The tax is also simpler in structure in the Latin American countries because of the use of a uniform tax rate and relatively few exemptions (as in Brazil and Ecuador). In the Malagasy Republic the value-added technique apparently is not used to the full extent even in the manufacturing sector: the extensive list of intermediate products exempted or taxed at a reduced rate suggests that a substantial proportion of the total tax that is due on industrial goods is collected at the last stage of manufacture rather than being spread over earlier stages.

Developing countries are likely to be less concerned than industrial countries with removing investment expenditures from the tax base. The tax treatment of investment may vary with the objectives of the country’s economic policies, including the relative incentives for using labor and capital.

Another characteristic of the VAT in developing countries is their reliance, in part, on exempting producer goods from the tax, rather than on the tax-credit method, when the former is easier to apply. This results not only in the widespread exemption of agricultural producer goods but also in the exemption of industrial machinery equipment in Brazil and of construction materials in Uruguay. The tax exemption of industrial producer goods in the Malagasy Republic also represents in effect a partial use of the suspensive principle to postpone collection of tax on intermediate products.

One of the major problems that confronts the developing countries under a VAT is the treatment of small businesses. While in industrial countries small firms are concentrated in the agricultural and retail sectors, in the developing countries a significant share of manufacturing and trade may still be carried out on a small scale. Techniques designed to deal with this type of situation include use of the forfait technique and the tax-credit pass-through facility offered by Senegal to its forfait taxpayers and unregistered traders on sales to registered purchasers.

Revenue importance

Revenue data for the countries covered show that the VAT is one of the most productive forms of sales tax, accounting for between 10 per cent and 30 per cent of government tax revenue. VAT revenue in a recent year exceeded 2 per cent of GDP for all countries except Ecuador and ranged as high as 8 per cent in Brazil. As with sales tax revenue generally, VAT revenues in developing countries can be expected to increase at a faster rate than the rate of growth of the economy.

With few exceptions (Brazil, for instance), a substantial part of the revenue is derived from imports (almost uniformly 60 per cent in the African countries). No information is available on the proportion of GDP covered by the VAT in the developing countries except for Brazil, where it is estimated at 60 per cent. Despite substantial exemptions, the VAT effectively taxes a substantial portion of GDP outside its direct scope; this is so because of the nontaxable purchases by businesses for which no tax credit is given on their chargeable sales—amounting to an estimated 15 per cent to 20 per cent of value added by agriculture, manufacture, and trade in Brazil.

Administrative considerations

The possibility of efficiently administering a VAT in developing countries depends on many factors, including characteristics of the VAT to be introduced, the economic structure and social environment in which it is to be applied, the revenue that it is expected to produce, and experience with the sales tax that it is intended to replace.

The fundamental difficulty in administering this type of tax in developing countries is the problem of coping with small taxpayers, which include a large percentage of retailers, service enterprises, and farmers. If an adequate solution can be found to exclude these taxpayers from the general requirements of the VAT, the problems of administering such a tax will be reduced greatly. Various methods for dealing with this problem have been devised in industrial as well as developing countries; most provide for the exemption of very small businesses, and others, such as Brazil and the African countries, provide for their taxation on a forfait basis.

A VAT with multiple rates and many exemptions undoubtedly presents greater difficulties of administration and compliance than does a single-rate tax with few exemptions. The VAT systems in the Latin American countries except Uruguay have uniform rates, while in Africa they are differentiated with the class of consumption expenditure.

The administrative requirements for efficient control and audit of a VAT are closer to those of an income tax than to those of other types of sales tax; therefore, those countries that have a high degree of efficiency in administering income taxes are in a better position to administer a value-added type of sales tax. Even though a VAT contains a built-in system of cross-checking, undue reliance should not be placed either in the ability of administration in developing countries to effectively apply a computerized or manual system of cross-checking of information, or on the incentive that a VAT gives to purchasers to require invoices from sellers. Other audit techniques must complement such cross-checking and self-enforcing features of the tax in order to adequately enforce compliance.

Finally, the transitional aspects of introducing a VAT must be studied in each case, depending on the taxes for which it is intended to substitute. Simple, although perhaps less equitable, transitional provisions seem to be preferable, so as not to overburden tax administrators and taxpayers in the initial stages of its application.

The choice of a sales tax

The choice of a sales tax technique rests on a variety of considerations that must be weighed by each country in the light of its own economic and social conditions. Three alternative techniques have proved successful in this respect: (1) a single-stage manufacturers’/ importers’ tax of the suspensive type; (2) a hybrid retail/wholesale tax modeled on that of Honduras; and (3) a tandem system, including a tax on sales by manufacturers or wholesalers and one on retail sales.

Neither a single-stage retail sales tax, because of enforcement problems, nor a multistage turnover tax, because of the discriminatory effects arising from its cascading, appears to be a viable alternative.

Most developing countries have limited their general sales taxes to the manufacturing stage, with a compensatory tax on imports. Two techniques may be employed to eliminate double taxation: (1) the exemption of purchases by licensed manufacturers and importers (the suspensive method); and (2) the value-added technique, which provides either for a deduction from taxable sales of taxable purchases, or a credit against tax chargeable on sales for sales tax paid on purchases.

Both systems have merit and have been applied successfully. The suspensive technique avoids tying up funds in tax that is added to the cost of inventories, with resulting pyramiding of the tax in price. On the other hand, it offers greater opportunity for evasion and may require greater administrative effort in its enforcement. The value-added technique permits greater precision in the elimination of cascading, including the remission of taxes on exports, and is less subject to tax evasion. For these reasons, both Colombia and Pakistan recently converted to this form.

A hybrid retail/wholesale tax system has been applied successfully in several developing countries in Latin America. Under this system, tax is collected only on sales made by registered firms to unregistered buyers. Since only firms with annual sales above a specified amount are registered, small retailers, artisans, and suppliers of services are taxed only on their purchases; the larger firms are taxed on sales other than those to registered firms. The suspensive, rather than the VAT, principle is applied. Greater possibilities therefore exist for evasion, as under a manufacturers’ sales tax. On the other hand, the number of taxpayers is considerably smaller than would be covered by a VAT. Small retailers, etc., are not taxed on their value added, and they enjoy some tax advantage as against larger retail firms. It is possible, however, to assess these margins by an annual tax, as in Honduras.

Separate taxes at the manufacturing or wholesale level and at the retail level offer another realistic alternative to developing countries. Once a manufacturers’ sales tax has been established, it can be supplemented by a lower tax rate on retail sales of goods and services. Such a tandem system has operated successfully in Ireland and has been suggested for replacement of multistage turnover taxes, as in Chile. One advantage claimed is the greater flexibility of taxation at the manufacturing or wholesale stage, so as to permit variation of rates with classes of consumer goods. A tax at the manufacturing or wholesale level, however, encourages the absorption of wholesaling functions by retailers for the purpose of minimizing tax, and discriminates against the small-scale retailer. Such discrimination is avoided by a VAT at the retail level.

Conditions favoring adoption of a retail VAT in developing countries

It seems to be evident that the choice of a VAT over other forms of sales tax in a developing country rests on a number of conditions. While it cannot be held that all these conditions need to be fulfilled, their degree of fulfillment will determine the comparative success with which a VAT can be implemented as against other forms of sales tax. Both the greater complexity and greater number of taxpayers comprehended by a VAT through the retail level are the main distinguishing features that set it apart from other sales taxes at this stage.

Size of retail units

As we have noted, only sales taxes carried to the retail level can be truly neutral in their effects on the organization of production and distribution and on consumer prices. The European precedent for a VAT at the retail level has, in fact, identified the VAT as a comprehensive tax on household expenditures that is implemented by means of fractional payments on producers and traders through the retail level. A necessary condition of any retail sales tax is the development of retail units of a sufficient size to facilitate its administration at this point. The fact that retail distribution in many countries at an early stage of development is characterized by small traders militates against effective enforcement of a retail tax, and a VAT in itself offers no solution to this problem. Indeed, very small businesses are typically excluded from such a tax. Optional assessment methods, such as forfait, are available, but there are limits to their toleration in a VAT system.

Records and bookkeeping

Another indispensable condition is the adequacy of records maintained by firms. Since a true record of purchases and sales is a minimum requirement for applying a VAT, the system could break down when proper invoices are not used, Artisans, farmers, shopkeepers, and small service firms are notoriously lax in keeping accounts and frequently make no distinction between household and business transactions; this situation makes it virtually impossible to enforce accounting for tax. Even when accounts are kept, their reliability is often open to question.

On the other hand, the introduction of a VAT is bound to enforce better accounting discipline because of the need for invoices to support claims for tax credit. Standard forms issued or approved by the government could be used for this purpose.

Administration and compliance

Closely identified with the adequacy of records is the level of administrative competence in collecting and enforcing a sales tax. Although a VAT imposes a somewhat greater burden on both taxpayers and the administrative service than other forms of sales tax, it nevertheless is less complex than an income tax. Unless the administrative service is strong or can be strengthened, it would not be advisable to take on the additional burden. Computerization of tax returns is an important consideration.

Previous experience with sales tax

It would appear inadvisable for any developing country to adopt a VAT at the retail level without previous experience with a sales tax. All VAT systems now in effect evolved from different forms of preexisting sales taxes, and it was a short step to the introduction of a VAT. The nature and extent of the transitional problems vary with the form of the preceding tax and the stage to which it was carried. There would be some advantage if retail sales were taxed previously.

Level of tax rate

Another important consideration is the level of the tax rate that would justify introduction of a VAT rather than an alternative form of sales tax. If rates are low, the discriminatory effects inherent in a turnover tax or hybrid form may not be sufficiently great to warrant a more complex and comprehensive tax, and the incentives for evasion may be minimal. As tax rates are increased, however, they may reach a critical point at which a VAT technique of fractional payment is required to minimize loss on evasion and avoidance. A VAT not only imposes greater discipline by reason of its so-called self-checking features but also is self-correcting in “catching up” with tax that may have been escaped at a previous stage. In this respect, it has some advantage in reducing the risk of revenue leakage.

*

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.

1

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.

2

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.

3

No account is taken of the VAT on purchases of other supplies and services.

4

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.

5

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.

6

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.

7

See Michèle Guerard, “The Brazilian State Value-Added Tax,” Staff Papers, Vol. XX (1973), pp. 141–42.

8

These items include fertilizers, seeds, pesticides, veterinary products, animal feed, agricultural machinery, and tractors.

9

For a detailed analysis of this system, see Tait, op. cit., pp. 46–50.

10

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.

11

Senegal, Ministry of Finance, Law 66–34, May 25, 1966, concerning the reform of the turnover tax system, Article 5–3°.

12

Ibid., Article 9–1°.

13

See Guerard, op. cit., pp. 135–36.

14

The recently revised tax in Uruguay includes a reduced rate on financial institutions that will replace an existing tax on financial transactions.

15

EEC, Report of the Fiscal and Financial Committee (The Neumark Report), Brussels, 1958, par. 185.

16

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.

17

See Guerard, op. cit., pp. 139, 144–45, and 149–50.

18

Also, some French-speaking countries provide for a reduced rate on foodstuffs not otherwise exempt.

19

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.

20

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).

21

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.

22

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.

23

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.

24

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.

25

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.

26

Guerard, op. cit., p. 156.

27

Ibid., pp. 154–55.

28

See Ojha and Lent, op. cit., p. 558.

29

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.

30

That is, 48.7 per cent in 1968 and 54.4 per cent in 1969.

31

See Due, “Alternative Forms of Sales Taxation for a Developing Country” (cited in footnote 2), p. 274.

32

See, for example, Ojha and Lent, op. cit., p. 557.

33

Guerard, op. cit., pp. 125–26.

34

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.

35

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.

36

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.

37

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.

38

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.

39

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.

40

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.

41

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.

42

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.

43

Egret, op. cit., p. 262.

44

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:

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45

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.

46

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.

47

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.

48

See John F. Due, Indirect Taxation in Developing Economies: The Role and Structure of Customs Duties, Excises, and Sales Taxes (Baltimore, 1970), p. 56.

49

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.

50

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.

51

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.

52

Sometimes referred to as the “ring” system.

53

East Cameroon, Dahomey, Guinea, Mali, Mauritania, Niger, Togo, and Upper Volta.

54

See Organization for Economic Cooperation and Development, Fiscal Committee, Some Problems Concerning Value-Added Taxation (Paris, February 1970), p. 15.

55

Ireland exempts all licensed taxpayers from tax on imports.

56

Colombian Commission on Tax Reform, Fiscal Reform for Colombia, ed. by Malcolm Gillis (Harvard University Law School, 1971), pp. 594–95.

57

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.

58

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.

59

Baer, op. cit., p. 472.

60

Ibid., p. 471.

61

Ibid., p. 466.

62

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.

63

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.

64

Ibid., p. 239.

65

See George E. Lent, “Manufacturers’ v. Wholesalers’ Sales Tax Base,” Taxes—The Tax Magazine, Vol. 36 (1958), pp. 573–601.

66

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.

IMF Staff papers: Volume 20 No. 2
Author: International Monetary Fund. Research Dept.