Editors: Liam Ebrill, Michael Keen, Jean-Paul Bodin, and Victoria Summers
©2001 International Monetary Fund
1 The Nature, Importance, and Spread of the VAT
The Origin and Spread of VAT
The Current Extent and Importance of VAT
Experience After Adopting a VAT
2 Basic Design Issues
Methods for Determining VAT Liability
The Comparison Between VAT and Retail Sales Taxation
3 Is the VAT a Particularly Effective and Efficient Tax?
Taxes It Replaced?
Identifying Efficiency Gains from the VAT
Do Countries with a VAT Raise More Revenue?
4 Understanding the Revenue Performance of VATs
When Is the VAT Most Effective in Raising Revenue?
The Importance of Imports in Collecting VAT
5 Collection Costs and the Complexity of VAT
Administration and Compliance Costs
Is the VAT More Complicated than the Taxes It Has Replaced?
6 A Survey of Advice and Experience
Consistent Advice Consistently Followed
Consistent Advice Not Consistently Followed
Variations in Advice
Impediments to Administrative Implementation
7 Rate Differentiation
How Many Rates of VAT?
Consequences of Exemption
9 Treatment of Agriculture
Distinctive Features of the Sector
Move Toward Full Taxation
10 Poverty, Fairness, and the VAT
The Treatment of Small Traders
11 The Threshold
Considerations in Setting the VAT Threshold
12 Organization of the VAT Administration
Domestic Tax Organization: Customs or Separate Agency?
13 Self-Assessment by Taxpayers
Why Self-Assessment? Factors and Problems
Why and How Is Audit Critical?
Reasons for Failure and Possible Responses
16 Small Countries and the VAT
Performance of the VAT in Small Countries
Comparing VAT with a Uniform Tariff
17 Interjurisdictional Issues
Destination Versus Origin-Based Taxation: Issues of Principle
Difficulties in Implementing Destination Taxation
Implementing Destination-Based VAT Without Zero-Rating
18 What Next for the VAT?
Boxes1.1. A Primer on the VAT
2.1. Production Efficiency and the Diamond-Mirrlees Theorem
7.1. Single-Rate VATs in the WAEMU
7.2. The Optimal Tax Perspective on Rate Differentiation
7.3. The VAT Treatment of Tourism
7.4. Limits to Redistribution Through Indirect Taxation
7.5. Comparing the Costs and Benefits of Rate Differentiation
8.1. Treatment of Pure Insurance Under a Cash Flow VAT
12.1. Introduction of the VAT and Reform of the French Tax Administration
13.1. Conditions for an Effective Self-Assessment System
14.1. Elements of an Effective Audit Program
14.2. Massive Cross-Checking of Invoices--Experience of South Korea
15.1. What Is a Reasonable Level of Refunds?
15.2. Guidelines for a Deferral System for VAT on Imported Capital Goods
16.1. Malta and the VAT
17.1. Workings of an Origin-Based VAT: An Example
17.2. The Equivalence Result
17.3. Clearing Between Israel and the West Bank and Gaza
1.1. The Spread of the VAT
1.1. Regional Spread of the VAT: Number of Countries with VATs as of the Year Indicated
AI.1. Country and State Groups
The rapid and seemingly irresistible rise of the value-added tax (VAT) is probably the most important tax development of the latter twentieth century, and certainly the most breathtaking. Forty years ago, the tax was little known outside dull treatises. Today it is a key source of government revenue in over 120 countries. About 4 billion people, 70 percent of the world's population, now live in countries with a VAT, and it raises about $18 trillion in tax revenue—roughly one-quarter of all government revenue. Much of the spread of the VAT, moreover, has taken place over the last ten years. From having been largely the preserve of more developed economies in Europe and Latin America, it has become a pivotal component of the tax systems of both developing and transition economies.
This book seeks to draw out the lessons from this experience, especially that in recent years. The VAT has been seen as a key instrument for securing macroeconomic stability and growth by placing domestic revenue mobilization on a sounder basis, so that the International Monetary Fund (IMF) has attached considerable importance to its proper design and implementation. Within the context of these wider concerns, the Fiscal Affairs Department (FAD) of the IMF has provided a considerable amount of technical assistance in relation to the VAT (sometimes in conjunction with the IMF's Legal Department).1 Indeed well over half of all countries that have introduced a VAT during the last twenty years made use of FAD advice in doing so, and the proportion has been rising. This book has its origins in a self-assessment of the advice that FAD has provided in the area. While some traces of that exercise doubtless remain, and the book draws heavily on FAD's experience, the focus of this book is outward-looking.
Its purpose is to explore, and draw the lessons of experience for, some of the central questions that those concerned with the VAT—whether as policy- makers, practitioners, or academics—must wonder about. Has the VAT lived up to its promise as an efficient and fair source of revenue? What does a VAT do well, and what, conversely, does it do badly? What are the key issues that arise in designing a VAT? What should be exempt, and what should be taxed? How should small traders be treated? What about the agricultural and financial sectors? Does a VAT require restructuring the organization of the tax administration? What are the main administrative problems that a VAT is likely to encounter, and how can they be resolved? Is it an inherently costly and regressive tax, or, to the contrary, can it be designed to be simpler and fairer than the taxes it often replaces? Are there countries for which a VAT is simply a bad idea?
These and other issues addressed here have both policy and administrative aspects; that is, they involve both the design and the implementation of the tax. Indeed a key theme of the book is precisely the importance when thinking of VAT of the interaction between the two. At the most basic level, they are entirely congruent. Just as economic analysis points to the proper role of the VAT as being a broad-based tax on consumption, so the administrative concern with simplicity (for taxpayer and tax collectors alike) points to a clean tax that is applied with minimal exceptions. Beyond that, however, there can be a tension between the two sets of considerations. There is a trade-off, for instance, between the desire to minimize distortions of competitive behavior by including as many traders as possible in the VAT system and the administrative advantages of excluding small traders from whom little revenue can be expected. The proper response to such tensions, of course, is to incorporate administrative concerns carefully into policy formation. This is a delicate exercise, but we believe an essential and fruitful one. In part it requires that public finance economists address themselves much more forcefully than they have in the past to issues that administrators have long battled with; the analysis here of the proper threshold for the VAT is one example, but there remains much more to do.
The coverage of this book is not exhaustive. We have tried not to duplicate material that can be found elsewhere, most notably in Tait (1988, 1991), which this book complements; the present book does not address other than in passing, for instance, timetables and transitional issues associated with the introduction of a VAT, or the impact of the VAT on inflation. Oldman and Schenk (1995) provides an interesting legal perspective on many of the issues addressed here.
What is most striking, however, is how much the previous literature leaves out. Indeed there has been surprisingly—shockingly—little serious research effort devoted to the VAT. Why this should be is itself something of a puzzle, given the manifest importance and dramatic spread of the VAT. We hope that this book will go some way to stimulate further and deeper work in this area.
This book reflects the efforts and invaluable expertise of many of our colleagues in the Fiscal Affairs Department, who found time in their overloaded schedules to provide us with information and advice. Katherine Baer and John Brondolo were especially generous and helpful. Particular thanks to Assi WoldeMariam, who undertook the substantial exercise of data collection and analysis reported here. We are grateful too to Richard Bird, Alan Tait, and many colleagues in FAD for their helpful comments on various drafts. Jeremy Clift of the External Relations Department edited the manuscript and coordinated production. Views and, unfortunately, errors are entirely the responsibility of the authors, and should not be attributed to the International Monetary Fund.
1The fiscal Affairs Department has as one of its main functions the provision of technical advice in taxation and government expenditure matters to IMF member countries.