Business Page –  VAT compromise give signals hope Conclusion

Sunday, May 1st, 2005

Business Page today concludes its three-part article on Value Added Tax, the bill which the PNCR convinced the government should be taken to a select committee for further consideration. It will be recalled that the Private Sector Commission had asked for a delay citing inadequate consultation. VAT is due to be introduced in July 2006 following the registration exercise which will begin in May 2006.

Back to Bird:

This piece begins by drawing from Professor Bird's paper presented at the First Global International Tax Dialogue Conference on VAT held in Rome last month. Professor Bird has for years been considered the world's foremost authority on taxation in developing and transitional economies. His book, Readings on Taxation in Developing Countries with Oliver Oldman and published by Johns Hopkins is still one of the most widely read books by those interested in the economics of development.

Professor Bird notes that in developing and transitional economies (DTE), VAT is invariably among the most important sources of government revenue, but that this creates problems for those countries as they become dependent on VAT and hence more vulnerable to potential problems.

Rates are often changed not on any rational basis, but entirely to meet revenue needs. On the other hand, zero-rating and exemptions become the vehicle through which some sectors win favour. Our legislation must therefore guard against any politicization of the VAT.

Despite the herd mentality which drives increasing numbers of countries to introduce VAT, the tax does not always work well in many DTE, principally because some are simply not ready for 'self-assessment.' If proof be needed, we show each year how unprepared for self-assessment the country is. If we are not ready for self-assessment for income and corporation tax purposes, can we be ready for self-assessment for VAT and if not, as Professor Bird asks, can such a country have a VAT at all? And, if it does (as many already do), is the best VAT for it always the same as the 'model' implicitly set out as a standard in most of the literature?'

The debate in Parliament seemed to have assumed that there is such an animal as a uniform, standardized VAT. That is not correct and VAT like other taxes is subject to 'the NOSFA principle' - No One Size Fits All.' That the Bill is imported from some unstated country is clear when the definition section (s 2) refers to 'memorandum, articles of association' - terms that are now obsolete under the Companies Act, 1991.

Experience in DTE suggests that the oft-cited '18-24 months' needed for successful VAT implementation vastly understates the nature and time-scale of the task in many countries. According to Professor Bird, some countries "that adopt a VAT must sometimes, for better or worse, take what may be called the 'big bang' approach - a short lead time with the consequences addressed later." Experience has shown that when this happens, it has seldom worked out well, which is probably one reason he stresses for the need to follow the 'normal' time schedule. When one hears of the eleventh-hour consultation now taking place it is hard to escape the conclusion that the government is allowing itself - once again - to be pushed in a direction and at a pace which this environment cannot sustain.

VAT is a particularly complex and costly tax to comply with and administer, and is consequently ill-suited to developing countries. VAT revenues are higher - all else being equal - in countries with higher literacy rates and hence presumably with better administrative capacities.

In the presence of a substantial 'informal' sector, a tax like VAT that falls on the formal sector acts to deter the growth and development of the economy as a whole. Indeed, one recent study (Hines 2004) concludes that increasing consumption taxes definitely fosters the expansion of the hidden economy as more businesses go outside the formal structure.

I now turn to some other relevant issues taken from the Background Paper presented at the same conference at which Prof Bird presented his paper.

How many rates:

of VAT?

Standard advice has been for a single-rate VAT (other than a zero rate for exports only). Rates vary from 5% in Singapore and Nigeria to 25% in Sweden with a multitude of rates within this range across the world. In Barbados, Jamaica and Trinidad & Tobago, the VAT rate is 15%, having started at 10 per cent.

Guyana is yet to set the rate(s) which will apply. This should be a function of the answers to the questions posed earlier in this brief presentation.

What exemptions?

The standard advice is also for a short list of exemptions, limited to basic health, education, and financial services. Systematically documenting worldwide practice in this area is difficult, but the proliferation of exemptions in VATs in practice is an increasingly common concern. Politicians have been all too willing to grant special treatment to their friends which explains some of the anomalies in the present tax system. Are we likely to see this pattern continue under VAT?

The threshold:

The level of the threshold at which registration for the VAT becomes compulsory is a critical choice in the design and implementation of the VAT. Experience suggests that many countries have tended to set the threshold too low, putting themselves in considerable difficulty when their tax administration is found to be insufficiently developed to administer a large VAT population. Indeed, in both Ghana and Malta an initially low threshold was one of the primary reasons for the failure of their first VAT.

The appeal of a high threshold stems from the empirical regularity that a relatively small proportion of firms typically accounts for a very large proportion of potential VAT revenue. A high threshold thus economizes on scarce administrative resourc-es at little cost in revenue.

In Guyana we have had considerable difficulties with setting thresholds whether under the Companies Act for purposes of the audit requirement or for purposes of the presumptive tax under the 2003 Fiscal Amendment Act. We need to think this one through.

Self-assessment:

procedures

Modern tax systems and their administration are built on the principle of 'voluntary compliance,' meaning that taxpayers are expected to comply with their basic tax obligations with only limited intervention by revenue officials. Which Guyanese would put their hands on their chest and swear that there is such a culture in Guyana?

Audit:

In many countries, especially developing and in transition, audit performance is reported to be a particularly poor aspect of VAT administration. With false claims for refunds a major threat, an efficient audit system is absolutely vital. Here again, our performance has been very weak as too many (non-)taxpayers get away with millions because of the absence of basic auditing skills in the Revenue Department.

No recipe for

success

Countries with well- designed VATs that have been properly implemented are likely to face fewer compliance problems in the longer-term.

Experience shows that it takes 18-24 months to implement a VAT effectively. Key to success is a sound policy design (a single rate, few exemptions and high threshold), simple laws and procedures, an appropriately structured and resourced administration, and compliance strategies based on a balanced mix of education and assistance programmes, and risk-based audit programmes.

Conclusion:

To state that this is no simple piece of legislation is an understatement. It is long, complex and confusing. One section has twenty-one subsections. Another defines a supply of services as including anything done including "refraining from or tolerating an activity"! Experience has shown that even the simplest and least complex law soon becomes subject to myriad amendments, with all its innocence soon lost. We need to avoid that danger.

The Commissioner General has frighteningly wide powers including "issuing an order in writing" and "at any time entering any house or premises described in the order authorising the distress proceedings." Was this discussed with the legal profession? We need to be mindful that insensitivity on the part of the administrators has led to major problems in some countries.

I closed my GMA presentation by asking a further couple of questions which I now repeat. Can, or should we implement a 'full' VAT immediately or should we grow into one over time? If the choice is really a 'bad' VAT adequately administered or a 'good' VAT poorly administered, which is better? Or is this a false choice? And what about a bad VAT badly administered?

There is confidence that the select committee will take an enlightened approach, taking all concerns on board and not considering itself hidebound to any unrealistic deadline. Let us give ourselves enough time and get it right.