## BACK TO BASICS

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**Canonical URL:** [BACK TO BASICS](https://www.imf.org/-/media/files/publications/fandd/article/2022/march/back-to-basics.pdf)

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### Overview
- Value-Added Tax (VAT) is the modern equivalent of long-standing consumption taxes and has become a major revenue source for more than 160 countries.
- VAT raises, on average, over 30 percent of countries' total tax take.
- As a share of GDP, VAT brings in between 4 percent in low-income developing countries and more than 7 percent in advanced economies.
- The United States is a notable exception that does not have a VAT.
- Recent adopters include Angola, Bahrain, Bangladesh, Oman, Saudi Arabia, Suriname, and the United Arab Emirates.
- Bhutan, Kuwait, Liberia, Qatar, and Timor-Leste are planning to introduce VAT soon.

### How it works
- VAT is imposed on a destination basis: imports are included and exports are excluded from the VAT base (exports are zero-rated), ensuring taxation of domestic consumption only.
- VAT applies to transactions throughout the supply chain, not only final consumer sales, but uses a crediting mechanism to avoid tax cascading:
  - Example with a 20 percent VAT and a yogurt sale:
    - Retail price inclusive of VAT: $1.50.
    - Price net of VAT: $1.25.
    - VAT charged by the store: $0.25 (20 percent of $1.25).
    - Store purchased yogurt from factory at net price $1.00 and paid $1.20 including $0.20 VAT.
    - Store credits the $0.20 input VAT and remits $0.05 to the tax authority.
    - The factory remits $0.20 in VAT unless it has its own input VAT credits.
    - Ultimately, the state receives $0.25 from the yogurt sale, remitted sequentially at each stage.
- The credit-invoice mechanism creates a need for tax administrations to provide refunds, especially to exporting businesses with significant input tax credits; refunds can be difficult to manage in developing economies and failure to pay them can create cash flow problems and deter investment.
- Collecting VAT along the supply chain fosters voluntary compliance because businesses have an incentive to obtain invoices to claim input VAT credits; businesses thus act as collection agents for the state.

### Ideal and real VATs
- The ideal VAT has a broad base of all final consumption and a single rate, usually between 15 and 20 percent, minimizing distortion across goods and services purchased in the formal market.
- VAT concessions undermine revenue objectives and complicate administration:
  - Exempting items like food to support poor households can be costly because the rich also consume these goods.
  - Distributional goals are better served by progressive income taxes and cash transfers.
  - Behavioral objectives (e.g., reducing drinking, smoking, pollution) are better addressed with dedicated excises on alcohol, tobacco, and emissions rather than by differentiating VAT rates.
- Many real-world VAT systems employ reduced rates, exemptions, and special programs:
  - Minimum registration thresholds based on turnover are commonly used to exempt micro businesses from VAT compliance costs.
  - Exemptions and reduced rates are often adopted to improve distributional impact but increase collection costs and frequently facilitate fraud.
  - Reforms to eliminate VAT concessions often meet fierce resistance from powerful vested-interest lobby groups.

### The next VAT
- Countries have adapted VAT to new challenges:
  - Simplified VAT registration has been introduced for non-resident vendors to deal with cross-border e-commerce.
  - Online platforms have become VAT collectors for digital services.
- Emerging digital technologies could change VAT administration and design:
  - Blockchain and digital money may provide tax administrations with transaction information along the full supply chain, potentially removing the need for multistage VATs.
  - If transaction data can be linked to information about individuals, consumption taxes could be personalized and compete with personal income tax as an efficient redistributive instrument.
- Overall assessment:
  - VAT has withstood globalization and its revenue share has risen in recent decades.
  - Whether in current or revised form, VAT’s future as an important revenue-raising instrument is assured.

### Key findings and implications
- VAT is a major and growing source of revenue globally (over 30 percent of total tax revenue on average).
- VAT’s destination-based design with border adjustments ensures taxation of domestic consumption only.
- The credit-invoice mechanism is central to preventing cascading taxes and fostering self-enforcement, but it imposes administrative demands, especially refund management for exporters.
- Deviations from the textbook VAT (reduced rates, exemptions) are common and typically reduce revenue, increase administrative complexity, and can facilitate fraud.
- Digitalization of transactions and platform collection are important developments already affecting VAT treatment of e-commerce and digital services.

*RUUD DE MOOIJ (assistant director) and ARTUR SWISTAK (senior economist), IMF Fiscal Affairs Department.*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2022/march/back-to-basics.pdf_