Some Unresolved Issues in Design and Implementation of Value
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SOME UNRESOLVED ISSUES IN DESIGN AND IMPLEMENTATION OF VALUE ADDED TAXES** JOHNF.DUE* ABSTRACT Criteriafor Decision Makingon the Issues A numberofvalue-addedtaxissueshave not beenresolved,ordiscussedextensively To indicateoptimal, or at least second in the literaturedespitewidespreadadop- best, solutionsto the issues, it is neces- tion of the tax.The purposeof this article sary to assume appropriate criteria for is to considersuch issues,including cov- evaluation.First, it is assumedthat in the erageof the tax by sector,the appropriate interests of economicefficiency,the tax thresholdforregistration,treatmentoffarm shouldcreate noincentivesto alter meth- inputs;zeroratingvs. exemption;the cov- odsofproductionand organizationofthe erageof services,realpropertyconstruc- productionand distribution systems.As tionand rental;multipleratesvs.separate an element in this criterion, the value levies;specialproblemswithinternational added tax must avoid cascading,that is transactions;and the refundissue. multipleapplicationoftax to the samefi- nal consumption items, which causes both economic distortions and loss of equity. Secondly, the final burden of the tax should alue added taxation (VAT) has be- be the same on imported and domestic Vcome the standard form of sales tax production; the tax should not provide throughout most of the world: Western protection, to be left to customs duties if Europe, Latin America, Canada (as of desired at all, nor discriminate against 1991), Korea, Japan, much of Africa in domestic products. Thirdly, for both eq- simplified form, and now the Caribbean. uity and economic efficiency reasons, it is The literature is substantial, the most assumed that the burden of the tax, in the significant being Alan Tait's Value Added sense of the pattern of reduction in real Tax (1988), OECD's Taxing Consumption income, should rest in relation to con (1988), Charles McLure's The Value Added sumer spending, either uniformly or in Tax (1987), and the World Bank volume conformity with a desired pattern of non- edited by Malcolm Gillis, Carl S. Shoup uniformity. Fourthly, the tax must meet and Gerardo P. Sicat, Value Added Tax- standards of equity accepted in the par- ation in Developing Countries (1990). There ticular country, which typically means are also numerous journal articles, gov- avoidance of significant tax burden on the eniment reports, and World Bank and Bff lowest income groups. Finally, the tax Working Papers.' But as anyone involved must be structured to permit adequate in the designing of a value added tax, compliance and administration at accept- particularly in a developing country, is able cost, a requirement that may conflict well aware, there are a number of issues with the others, necessitating a compro- that arise about which the literature has mise. little to say. This paper is designed to ad- dress some of these issues although sat- isfactory answers cannot be provided for The Scope of Coverage by Sector: many of them. Major ones widely dis- Manufacturing and Distribution cussed, such as the taxation of financial institutions and insurance, will not be The standard form of a value added tax covered. Emphasis is on the developing in the industrialized countries extends through the retail level, with some countries, but much of the analysis is rel- threshold, discussed below, for excluding evant to all countries. very small shops. But in developing coun- *University of Illinois at Urbana-Champaign, tries, retailing is primarily a small scale Champaign, IL 61820. endeavor, the proprietors often illiterate, 383 No. 41 UNRESOLVED ISSUES OF VALUE ADDED TAXES 385 taxable sales. Some provision to allow the nonfarm uses to escape tax-particularly administration to exclude such firms from seed, plants, and fertilizer for home gar- registering is desirable. The second issue dens, and nonfarm tractors. Attempt to is that of voluntary registration; should devise rules that will keep such items firms not required to register because of taxable when sold for nonfarm use, for ex- low sales volume be permitted to apply for ample, with seed, packaged for retail sale, vokntary registration? These are primar- have not proved-woXWle, aAd @ome es- ily firms exporting or selling to registered cape is inevitable. It is important to de- firms. While some countries will not per- fine the farm machinery category in such mit voluntary registration, it is almost a way that hand tools widely used for imperative to do so, provided the firms can nonfarm purposes are not placed in the demonstrate adequate record systems. zero rated category. But decisions must be For firms close to the threshold and made about such items as irrigation having substantial variation in sales from equipment, bee keeping equipment, and year to year, it obviously is desirable to many other borderline categories. An al- avoid the yoyo effect. Once a firm is reg- ternative to zero rating inputs is to au- istered, it should not be deregistered until thorize the European practice of allowing its sales have fallen below the threshold purchasers of farm products to assume that for several years in succession, perhaps a certain percentage of the purchase price three. consists of the tax element. But any such Related to the voluntary registration percentage is arbitrary, and the policy adds issue is that of registration of firms com- complications hardly suitable for devel- mencing operations, without experience oping countries. as yet about actual sales volume. Such firms often seek registration to obtain in- Zero Rating vs. Exemption put tax credit for purchases for establish- ing the business, and this is usually The issue of zero rating vs. exemption granted. has been considered at length by Alan Tait and others and only a few aspects will be mentioned here.' In principle, of course, Farmers zero rating is desirable when the objec- In a sense, farmers constitute simply one tive is to exclude the consumption of the class of small firms, and the same rules product completely from tax, whereas ex- with regard to registration may be ap- emption is warranted when it is not re- plied to them. Some countries, however, garded as feasible or desirable to tax the exclude all farmers from the registration activity but some tax on final consump- requirement if they sell only zero rated or tion is considered desirable, as for ex- exempt goods, as is not uncommon, es- ample with financial institutions. pecially in developing countries, where There are two major objections to ex- unprocessed farm products are usually zero emption. First, cascading results as the rated.' In any event, few farmers will be exempt firms and their business cus- registered in developing countries, or even tomers cannot receive input tax credit. in many industrialized ones (Denmark and Secondly, firms producing both exempt and New Zealand are exceptions). Thus there taxable (including zero rated) items must is no way they can receive credit for tax allocate inputs between the exempt and paid on their inputs, and cascading of tax non-exempt categories, and this is diffi- will result, of particular concern with ex- cult to accomplish in any non-arbitrary Port crops. way and to control. But on the other hand, A common but by no means universal zero rating gives rise to numerous re- rule is to zero rate major farm inputs- funds of tax, and policing of these refunds livestock, livestock feed, seed, fertilizer, is difficult. On the whole, however, zero and farm machinery and equipment. Un- rating is the preferred solution for sales fortunately this rule allows some sales of of commodities, exemption being confined these products for appropriately taxable to certain service transactions not feasi- 386 NATIONAL TAX JOURNAL [Vol. XLIII blieof to tax. The long support in the EEC have shifted from the latter approach to exemption in preference to zero rating the former before the law was enacted appears to be simply a mistake, and the (Trinidad and Tobago is an example). The policy has not been followed in most de- main reason for the specification ap- veloping countries. proach is simply that many services are not regarded as suitable for taxation, Designation of Commodities to be either for social policy reasons (medical, dental, hospital, educational, and even le- Zero Rated gal) or for administration reasons, be- The issue of the selection of those com- cause of the very small scale, non-com- modities to be zero rated, discussed widely mercial nature of the establishments. But in the literature on sales taxation gen- this in itself does not make the specifi- erally, will not be considered here, except cation approach essential; the danger of to stress the now generally accepted rule use of it is that the listing will let various that the broader the coverage of a value services for which there is no strong jus- added tax, like any sales tax, the more ef- tification for exclusion slip out from un- fective is its operation. But one issue has der the tax. The taxation of all services arisen in various developing countries: except those specified uses the same ap- should commodities excluded from the tax proach for services as for commodities but (or subjected to higher rates, as noted be- may bring some into the scope of the tax low) be designated by usual definition, or that are difficult to control. by tariff number? Several countries pre- Regardless of the approach there re- fer the latter approach; in fact, the Tan- main a number of issues. First, should zania sales tax act lists all commodities services rendered primarily to business by BTN number and indicates the rate. 6 firms be included? Under a single stage When many taxable commodities are im- sales tax, clearly they should not be in- ported, there is limited merit in desig- cluded, because of the consequent cascad- nating those zero rated or subject to a rate ing and the incentive given to firms to other than the basic figure by tariff num- provide the services with employees rather ber.