The Value-Added Tax
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WHAT DOES IT REALLY MEAN? The Value-Added Tax In the discussion of economic questions, even in the nonspecialist press, many terms are used which until quite recently were employed only by economists or others professionally concerned. This series of articles is designed to explain the economists' shorthand. Bjorn Matthiasson NUMBER OF countries have in recent years A adopted a new tax called the value-added tax. Its spread has been very rapid; only ten years ago there Timetable of Value-Added fax Adoption and Baste Rate (Per Cent) was but one country, France, that used it. Then, with the inception of the Common Market, it was decided to France 1955 23 2 align some of the taxes levied in the member countries. Denmark 1967 12.50 This decision involved the initiation of value-added Germany, Federal Republic of 1968 11 taxes in the member countries, which in turn has in- Sweden 1969 11.11 spired a number of other European countries to fol- Netherlands 1969 12 low suit in their efforts to associate themselves later on Belgium 1971 20 with the European Economic Community. At present Luxembourg 1970 8 there are nine countries in Europe (see timetable) that Italy 1972 3 have either put the value-added tax into operation or Norway 1970* 20 passed legislation for its introduction in the near fu- ture.1 A number of other European countries, includ- 1 Based on price excluding tax. 2 As of January 1,1970. 1 Three other European countries—Finland, Greece, and 4* Tentative date of adoption. Turkey—have a form of value-added tax that extends over Legislative adoption in process. only some of the stages of the production-distribution process. The production taxes in many French-speaking countries are similar. 40 ©International Monetary Fund. Not for Redistribution ing the United Kingdom, have also given the value- From this oversimplified description we see that added tax serious consideration, and it may be expected each link in the production-distribution process acts as that in a decade it will be a predominant instrument of a tax collector for the Treasury and the tax paid at taxation in Europe. each juncture is passed on next time the product changes hands, until the final product lands in the Structure and Coverage hands of the consumer who in the end bears the whole The value-added tax is a sales tax levied in the value tax. It is thus conceived not as a tax on the producer, added to a product or service each time it changes but rather as a tax on the product, borne by the con- hands. To illustrate this, the chart shows how a sumer. We can also see that the proceeds collected by value-added tax is imposed on a steel product as it pro- the Treasury come to exactly $50, or 10 per cent of gresses from iron ore in the mine to the final transaction the final net price. when an article incorporating it is handed to the con- This illustration presents a simple hypothetical out- sumer over the counter. The tax rate is in this instance line of the tax. In practice the matter is of course more 10 per cent of the price as it was before the tax is complicated. In our illustration the mining company levied. got its ore for nothing and hence its sales price for the The mining company brings the iron ore out of the ore was all value added. In reality we would have to ground and sells it to the steel mill for $50. For sim- drop this assumption. The company's value-added tax plicity's sake we shall assume that the mine got the liability is in fact the difference between the value-added iron ore for nothing and paid nothing for its capital tax collected and the value-added tax paid out to equipment and intermediate goods. The "value added" others by the company. Thus, if it collected $100,000 of the ore at the time of sale to the steel mill would in value-added tax on its sales in one tax period and thus be all of the $50 and the steel mill would pay $5 paid $40,000 in tax on its mining equipment and min- to the mining company in value-added tax, which the ing rights to others, its tax liability for that period mining company would in turn remit to the Treasury. would be $60,000. The steel mill then processes the ore in its blast fur- The value-added tax is levied on almost all goods naces and rolls it into sheets, selling it for $150 to a and services in domestic trade. Exemptions from the manufacturer. The manufacturer pays the steel mill tax are usually few, but vary between countries. Bank- $15 in value-added tax. But the mill passes on only ing and insurance, postal services, medical services, $10 to the Treasury. The other $5 received from the newspapers, and services and goods used exclusively by manufacturer compensates the steel mill for the tax the government are most frequently exempted. Some- that it paid on the iron ore. The manufacturer shapes times a good or service is subjected to a special excise the steel into an appliance and sells it for $300 to the tax and at the same time exempted from the value- retailer, collecting $30 in value-added tax. Of this added tax. In France, for instance, entertainment in amount $15 goes to the Treasury, the other $15 is a theaters, cinemas, etc., is subject to an entertainment compensation for the tax paid by the manufacturer to tax, but is exempted from the value-added tax. the steel mill. The retailer sells the appliance to the Exports are always exempted from the value-added consumer for $500 and the consumer pays the retailer tax. In theory the export firm pays the value-added tax $50 in value-added tax, $20 of which the retailer re- on its taxable intermediate goods and services, but gets mits to the Treasury, the other $30 being a compensa- a refund from the tax authorities. France, the country tion for the tax he paid to the manufacturer. with the longest experience in value-added taxation, 41 ©International Monetary Fund. Not for Redistribution Mining Company Steel Mill Manufacturer Retaller Consumer Price Tax Tax Payments Tax Payments Collected by the Treasury 42 ©International Monetary Fund. Not for Redistribution has eliminated this procedure for the most part and al- correct its uneven impact on the final consumer. Such lows exporters in practice to accept goods and services a turnover tax (at one time levied in Germany and for export production or delivery tax free, with the sup- still levied in Austria) is levied at a low rate and its plier in turn not remitting value-added tax on such de- impact on the final product price is often not even livery to the Treasury. This avoids the system of known. collection of value-added tax on supplies to export The value-added tax gets away from these problems. producers with a later refund of the same tax proceeds It simply allows the value-added tax paid on all capital to the exporter. and intermediate products and services bought by the firm to be credited against the value-added tax collected Some Merits of the Tax on its sales. For example, if a company collected a value-added tax of $50,000 on its sales in a tax period, All countries that have so far adopted the value-added but bought at the same time equipment on which it tax have done so in place of a sales tax of some paid a value-added tax of $10,000 in addition to its other kind. These have either been a multiple stage tax on normal inputs of $25,000, the company's tax gross turnover tax (as in the Federal Republic of Ger- liability would be $15,000. Thus, double taxation is many) or single stage sales taxes at the manufacturer eliminated. and/or wholesale level (Denmark) or at the retail level The second advantage of the value-added tax is its (Sweden). neutrality toward transactions in goods and services The advantages of the value-added tax lie primarily and allocation of resources. Under the gross turnover in the fact that it eliminates some of the knotty prob- tax system, as it existed in Germany before the value- lems of misallocation, double taxation, and unfair tax added tax, there was a strong tendency to minimize the exemption that have undermined the success of other tax by integrating firms vertically—for example, a steel sales taxes. There are many sources of such troubles. mill might amalgamate with a steel-using manufacturer. A manufacturer who buys machinery subject to sales This reduced the number of times the product changed tax and in turn has to pay for the machinery out of hands and thereby the number of opportunities the au- taxable sales revenue can do one of two things. If he thorities had to levy the turnover tax. In Germany, one has any measure of control over his own sales price study estimated that for steel bars the cumulative tax (i.e., if he is not unduly restricted by competition from burden in the nonintegrated production-distribution increasing his prices), he can shift a part of or the full process was about twice as high as in a highly integrated price of the machinery, including the sales tax, onto his system. To counteract these integrative tendencies, sales.