REVIVING THE VALUE ADDED TAX DEBATE AGAIN
Advantages and Disadvantages
Last week the first part of the Business
Page article revisiting the debate over the introduction of Value Added
Tax (VAT) discussed the economic and fiscal logic of sales taxes
generally and looked at how Value Added Tax (VAT) in particular
operates. Today in our concluding piece we discuss the advantages and
disadvantages, perceived and real, of VAT.
The main disadvantages which have been
identified in connection with the Value Added Tax are:
VAT is Regressive
It is claimed that the tax is
regressive, i.e. its burden falls disproportionately on the poor since
the poor are likely to spend more of their income than the relatively
rich person. There is merit in this argument particularly if it
attempts to replace direct or indirect taxes with steep, progressive
rates. However observation from around the world and even Guyana has
shown that steep tax rates lead to evasion and, in the case of income
tax, act as a disincentive to effort. The steep rates may therefore be
evaded except in extremely limited circumstances.
Further there is now a tendency in some
countries to reduce this progressivity of taxes as has been done in
Guyana where a flat rate of income tax has been introduced. In any
case VAT recognises and makes room for progressivity by applying no or
low rates of tax on essential items such as food, clothes and
medicine. In addition it also allows for steep rates of taxes on
luxury items although this can create problems for administration and
open opportunities for evasion by way of deliberate
mix-classification, a problem incidentally not peculiar to VAT and
which takes place extensively in the area of customs duties.
2. VAT is too difficult to operate
from the position of both the administration and business.
It is often argued that VAT places a
special burden on tax administration. However it is worth noting that
wherever VAT was introduced one of its effects was the rationalisation
and simplification of the previous indirect tax system and its
administration. Several indirect taxes such as customs duties,
purchase tax and excise duties replaced by VAT had their own rate
structure as well as a different tax base and separate administrative
procedures. The consolidation and incorporation of numerous indirect
taxes into the VAT would simplify the rate structure, tax base and
administration of the indirect tax system.
In addition, the abolition of a number
of alternative indirect taxes releases experienced personnel to focus
on a single tax. It also means reduction in the number of forms used,
legislation to be applied and returns and accounts with which the
business person has to contend.
It is true that the VAT is collected
from a larger number of firms than under any form of income tax or
single state sales tax; to the typical smaller firms the complexities
of the tax and the need for more extensive records (for example, to
justify deductions) are likely to prove serious.
Under the Income Tax (Accounts and
Records) Regulations of 1980 every person, without exception is required
to maintain detailed and extensive records of all its transactions.
There is widespread non-compliance with this requirement and there is no
obvious reason to believe that the introduction of VAT will meet with a
higher degree of compliance. This could create immense problems for the
administration and the revenues of the country. However since there is
an actual benefit to be derived from accounting for VAT paid on input
there is an incentive for proper record keeping.
Under any form of sales taxation, small
businesses have to be granted special treatment because of their
inability to cope with the requirements of keeping adequate records
which larger enterprises can handle at a reasonable cost. The intent of
the special treatment is to reduce the administrative burden on small
enterprises, but not the taxes that normally would be charged on the
goods and services they supply. The revenue loss at the final link in
the commercial cycle is limited only to the value added at that stage
whereas in the case of income tax or sales tax the entire tax is lost.
To recover the loss from exemption a flat tax on turnover may be
In the larger businesses with proper
staff and computers the task is really one of double entry book-keeping
and any additional work is easily absorbed into the routine.
VAT is inflationary
Some businessmen seize almost any
opportunity to raise prices and the introduction of VAT certainly offers
such an opportunity. However, temporary price controls, a careful
setting of the rate of VAT and the significance of the taxes they
replace should generally ensure that there is no increase if any in the
cost of living. To the extent that they lead to a reduction in income
tax any price increases may be offset by increases in take home pay.
VAT favours the capital intensive firm
It is argued that VAT places a heavier
direct impact of tax on the labour-intensive business compared to the
capital-intensive competitor, since the ratio of value added to selling
price is greater for the former. This is a real problem for labour
intensive businesses and industries which should be a focus of direct
attention as we consider how best to structure the system.
Against these disadvantages are some
considerable and weighty theoretical advantages. Whether the benefits
they offer actually materialise will depend on the quality of the
administration and enforcement procedures.
If the tax is carried through the retail
level it offers all the economic advantages of a tax that includes the
entire retail price within its scope. At the same time, the direct
payment of the tax is spread out over a large number of firms instead of
being concentrated on particular groups, such as wholesalers or
If retailers do evade, tax will be lost
only on their margins because customers that are registered firms gain
nothing if their suppliers fail to collect tax except delay in payment;
they will pay more to the government themselves. Under other forms of
sales tax both seller and customer gain by evading tax.
One particular advantage is that of the
widening of the tax base by bringing all transactions into the tax net.
Specifically VAT offers the opportunity to bring back into the tax
system all those persons and entities who enjoy a range of hard to
justify tax exemptions in one form or another.
VAT represents an important instrument
against tax evasion and is superior to a business tax or a sales tax
from the point of view of revenue security for three reasons.
In the first place, under VAT it is only
buyers at the final stage that have an interest in undervaluing their
purchases, since the deduction system ensures that buyers at earlier
stages will be refunded the taxes on their purchases. Therefore, tax
losses due to under valuation should be limited to the value added at the
Secondly, under VAT, if payment of tax is
successfully avoided at one stage nothing will be lost if it is picked
up at a later stage; and even if it is not picked up subsequently, the
government will at least have collected the VAT paid at stages previous
to that at which the tax was avoided, while if evasion takes place at
the final stage the state will lose only the tax on the value added at
A significant advantage of the value
added form in any country is the cross-audit feature. Tax charged by one
firm is reported as a deduction by the firms buying from it. Only on the
to the consumer is there no possibility
of cross audit.
In Guyana many businesses which do their
own importing sell a large proportion of their goods direct to the final
user. Many such businesses are among the group with significant
leakages. VAT will not do much to change this. Professionals and
contractors are another hard to tax group which the introduction of VAT
will not address.
VAT may be selectively applied to
specific goods or business entities. We have already addressed essential
goods and small business. In addition the VAT does not burden capital
goods because the consumption-type VAT provides a full credit for the
tax included in purchases of capital goods. The credit does not
subsidize the purchase of capital goods; it simply eliminates the tax
that has been imposed on them.
The call for VAT is partly driven by the
IMF and its ubiquitous and apparently omniscient consultants. The
private sector, particularly manufacturers, considers it a solution to
the Consumption Tax problem which inhibits their growth. They need to
realize however that VAT generally increases overall taxation, which
explains its popularity with governments,
Business Page considers VAT inevitable.
It cautions however against rushing into it without careful study and
preparation. VAT requires an infrastructure of tax administrators, tax
practitioners, judiciary, reasonably honest businesspersons and an
informed public. The Revenue Authority is still some way from being
fully capable of its mandate and meeting public expectations. It would
not be fair to impose on it a completely new form of taxation for at
least another couple of years. We should use that time to carry out
meaningful tax reform and preparing the nation for the revolution in
taxation which VAT entails.