THE VAT EXPERIENCE

1
THE VAT EXPERIENCE

• INTERNATIONAL TAX DIALOGUE
• VAT CONFERENCE
• 15-16 MARCH 2005, ROME
• Michael Keen
• Head, Tax Policy Division
• Fiscal Affairs Department
• International Monetary Fund

2

• Nature and Spread of VAT
• Titles vary, and significant variation across
  countries, but the essence is
• A VAT is a broad-based tax on sales, with
  systematic crediting of tax paid on inputs

3

• Economic appeal is
• Unlike turnover tax, there is no
  cascadingimplying no distortion of methods or
  forms of production...........and no distortion
  of trade, in particular, if levied on the
  destination basis
• This is the key theoretical merit
  (Diamond-Mirrlees theorem!)
• Unlike retail sales tax, not all revenue is lost
  if final sale escapes tax

4

• Spread has been staggering
• In 1965, only two countries had a VAT
• Now, about 135 do....
• ....with take-up in transition and developing
  countries in last 15-20 years especially striking
  
• Main areas without a VAT are now
• Middle East (but changing?)
• US and (for a few more days) India (reflecting
  federalism?)
• Small islands (but how big a potential gain?)

5

• Has VAT Lived Up To Its Promises?
• (An aside VAT has been shamefully
  under-researched!)
• Are there any signs that the VAT has delivered
  the efficiency gains that are the main claim of
  its advocates?
• One way to answer this is....
• ....If it is a more efficient tax then, under
  weak assumptions, we would expect countries with
  a VAT to raise more revenueall else equalthan
  those without

6

• Work continues, but signs are that the gains are
  greater in countries
• With higher GDP per capita
• That are less open to trade
• And a market test How many countries have ever
  removed a VAT once adopted?
• .....5 (and three of them reintroduced it!)

7
Three Key Design Issues Rate(s), Exemptions,
Thresholds

• Rate(s)
• Collection costsadministration and
  compliancepoint to a single rate
• other than for exports, which are zero-rated
  (though this is not strictly required for the
  destination principle)
• BUT

8

• Policy admits differentiation
• To deal with commodities in inelastic demand....
• ....though excises deal with most of those
• For equity reasons...
• ....if there is really no better-targeted tax
  or spending instrument

9

• Tension between these concerns is especially
  stark in developing countries, since
  administration is weak and other instruments
  limited
• But tax specialists tend to prefer a single
  rate...
• ....and indeed over 70 percent of all VATs
  introduced since 1995 have had just one positive
  rate

10
Exemptions

• .....(meaning that no tax is charged on sales,
  butunlike zero-ratingtax on inputs is not
  recovered)....
• Are inconsistent with the basic logic of the
  VAT.
• They.....

11

• Introduce cascading and distort production
• Create a bias towards self-supply
• Reduce revenue (or maybe increase it)
• Are not simple to administer
• Favor imports over domestic production
• Tend to creep (as exempt sectors want their
  suppliers to be exempt too)

12

• Scaling back exemptions is likely to be a major
  focus of reform in the years ahead...
• ....and we are learning more about how to do
  this, e.g. in relation to the public sector and
  financial activities

13
Thresholds

• Practice varies hugely...
• ....(from zero to 600,000)...
• for reasons that are less than fully understood
• Standard advice has been for a high threshold,
  but many countries continue to be unconvinced

14

• Basic case for a high threshold is that nature
  is kind, giving us a strong concentration of the
  potential VAT base in a relatively small number
  of taxpayers....
• largest 15 percent of taxpayers may account for
  85 percent of revenue
• ......and recent analytical work, taking account
  of economic distortions associated with a
  threshold, tend to support standard advice

15

• This debateand the focus on large taxpayers
  more generallyis increasingly focusing attention
  on the taxation of small and medium sized
  enterprises, often on fringes of formal
  sector.........so as to
• Protect the VAT
• Widen the tax base
• Provide coherent and simple interface with other
  taxes too (including income tax and social
  contributions)

16
VAT Modernizing Tax Administration

• In some respects, the VAT is (or should be) an
  easy tax
• More fundamentally, however, in many transition
  and developing countries it is a catalyst for
  modernization....
• ....shifting tax administration from a system
  based on direct and often face-to-face assessment
  to one based on....

17

• Voluntary compliance based on self-assessment
  (meaning that taxpayers calculate and pay tax due
  with minimal intervention by authorities, but
  subject to audit and penalty)

18

• This means profound (and continuing) challenges
  in (especially)
• Organization of the tax administration (moving
  away from tax-based to functional or taxpayer
  segment structures)
• Development of audit capacity and programs
• Taxpayer services and education

19

• And key challenges arise from distinctive feature
  that a VAT invoice is a check written on the
  government (Bird)....
• ....which reaches its most pronounced form in
  the difficulty all VAT administrations have in
  dealing with refunds the Achilles heel of the
  VAT
• Very much work in progress, but the prize is
  glittering.....
• ....and includes the prospect of an effective
  personal income tax

20
Concluding Weve Only Just Begun....

• The VAT is still young ahead lie many
  challenges
• Meeting likelihood of increased revenue to offset
  effects of further trade liberalization and
  intensified international tax competition
• Exploiting full potential of VAT, which we are
  still learning about (e.g. in relation to federal
  systems)

21

• Dealing with mobile or location-less consumption
• Increasing need for international coordination
• Reaching into hard-to-tax sectors

22
RECENT POLICY ADMINISTRATION DEVELOPMENTS IN
VAT/GST

• INTERNATIONAL TAX DIALOGUE
• VAT CONFERENCE
• 15-16 MARCH 2005, ROME
• Jeffrey Owens
• Director
• OECD Centre for Tax Policy and Administration

23
VAT Across OECD Countries

• VAT in 29 of 30 OECD countries
• USA is the only exception
• Significant source of revenue across OECD
  countries and growing
• - VAT ( of all tax) 18.7 (2002)
• 15.3
  (1985)
• -VAT ( of GDP) 6.8 (2002)
• 5.1
  (1985)

24
(No Transcript)
25
Rates And Structure

• Standard rates vary widely- from 5-25, averaging
  almost 18
• Standard rates relatively stable over last 5
  years
• Most OECD countries have multiple rate structures
  (i.e. standard, reduced, and zero)
• Some have specific rates for specific regions

26
Rates And Structure

• Complex rate structures clearly complicate
  administration and taxpayers compliance
• Historical and political factors?
• VAT replaced more specific sales taxes
• View in some countries that VAT is a tax on
  luxuries
• Very few have a wide base for the standard rate
  New Zealand Denmark Slovak Republic

27
Rates And Structure

• Thresholds for VAT exemption registration
• - Vary widely across OECD countries
• - Broad mix of zero, medium, high thresholds
  
• Small traders wide use of simplified liability
  calculation schemes and infrequent payment and
  return filing regimes to ease compliance burden

28
Exemptions

• Continue to distort
• Especially financial services (outsourcing)
• Recent New Zealand changes to introduce partial
  zero-rating (for B2B)
• Australias rules on recovery of input tax
• EU updating rules on financial services

29
Valuation Issues

• Cross-border supplies between related parties
• Goods Arms length principle applied by Customs
• Services Normally on amount paid, and
  accounted for under reverse charge
• Opportunities for avoidance by exempt sector?
• Cross-checks to transfer pricing valuations?

30
Policy Developments

• Use of Electronic Commerce
• OECDs 1998 Ottawa Taxation Framework Conditions
• Tax in place of consumption
• Goods less of a problem
• Business-to-Business less of a problem
• Reverse charge
• Business-to-Consumer
• Difficult to collect (EU Directive)
• Relatively little revenue

31
Policy Developments

• International Services and Intangibles
• Growth in sector

32
Chart I SHARE OF MARKET SERVICES IN TOTAL
VALUE ADDED (1980 AND 2001) Source OECD
(STI Scoreboard 2003)
33
Policy Developments

• International Services and Intangibles
• OECD 2004 Report
• Double taxation/double non-taxation
• Lack of refunds
• Uncertainties for business and governments
• Principles developed -2005
• Tax in jurisdiction of consumption
• VAT should not have an economic impact on
  business (except where deliberately designed)

34
Administration Developments

• Good administration key to successful VAT
• Self-assessment by taxpayers, supported by
  effective education and service and backed up by
  timely enforcement (incl. verification) is the
  fundamental administration approach
• Effective compliance risk management processes
  are central to the effective targeting of
  compliance risks and best use of resources

35
Administration Developments

• Issues of taxpayers non-compliance
• Many countries report wide-ranging compliance
  issues (e.g. fraudulent schemes, sales
  suppression, excess input credit claims
  non-payment)
• Limited data on overall revenue losses but some
  EU countries showing up to 17 VAT losses
• Carousel fraud is/has been a major problem in EU
• Refund controls remain a major problem in many
  countries, given numbers interest obligations

36
Administration Developments

• Responses to taxpayers non-compliance have
  included.
• Strengthened risk assessment at agency level
• Joint and several liability in supply chain
• New reporting penalties, and assessment powers
• Tightened business registration checks
• Intensification of refund validation checks
• Targeting specialist resources at criminal abuses
• Better and more audits
• Increased exchanges of information across borders

37
Administration Developments

• UK strategic risk management approach is
  significant/ of major interest
• Measure tax gap top-down bottom-up estimates
• Identify losses amounts and causes
• Develop comprehensive strategies to combat
• Set targets and publicise strategies and outcomes

38
Administration Developments

• Automation growing use of electronic services
  for information provision, return filing
  payment
• Integration
• Early indications of moves towards integrated
  reporting of all business tax liabilities
• Whole of taxpayer tax accounts for all
  liabilities and credits for all taxes growing in
  use

39
Conclusions

• VAT is likely to remain a significant revenue
  source
• International issues will continue to grow,
  especially as businesses re-structure and
  outsource, and taxpayers globalize their
  activities
• Competitive pressures
• Cross-border shopping
• Constraints on rate freedoms

40
Conclusions

• Sustained and well-targeted efforts are required
  to reduce non-compliance and avoid undermining of
  VAT as a reliable method of taxation
• International community needs to address this
  issue
• Maybe new instruments are required???

41
VAT IN DEVELOPING AND TRANSITIONAL ECONOMIES
(DTEs)

• INTERNATIONAL TAX DIALOGUE
• VAT CONFERENCE
• 15-16 MARCH 2005, ROME
• Professor Richard Bird
• University of Toronto
• Consultant to World Bank

42
VAT Worksbut.......

• Some problems remain on the policy side
• Some are old
• Financial sector
• Public sector
• and
• Some are new
• Digital commerce
• Sub-national VATs

43
VAT Works..but.

• Problems also remain in administration
• Again both old problems
• How best to organize VAT administration
• And
• New problems
• Information exchange especially cross-border

44
Unfortunately Life is Harder in
DTEs

• The problems are bigger
• More small businesses
• Larger shadow economy
• Equity aspects are relatively more important
• But the resources available to deal with them are
  scarcer

45
What Can Be Done?

• There is surprisingly much that we do not know as
  well as we should with respect to both VAT policy
  and VAT administration in developing and
  transitional countries
• So there is an important research agenda both for
  tax policy and tax administration
• Still, experience does offer some first thoughts
  on how to proceed

46
The NOSFA Principle

• One main lesson we have learned is that, while
  some policy and administrative decisions are
  clearly preferable in principle, when it comes to
  practice No One Size Fits All (NOSFA)
• That is, the best policy and administrative
  design for each country has to be determined
  carefully in light of the conditions and
  objectives of that country

47
Universal Problems, Local Solutions

• Another way to say much the same thing is that
  while every VAT in every country has many common
  features, the details of how those features are
  designed and implemented often differs, and
  arguably should differ, from country to country
• Since the devil is in the details it is thus
  critically important to pay close attention to
  these details in each country

48
Growing Into VAT?

• Can, or should, a country implement a full VAT
  immediately or should it, so to speak, grow
  into one over time?
• While there is a good general argument for the
  latter approach, it is also potentially dangerous
  since countries may get stuck for a very long
  time with a (theoretically) bad VAT
• Question 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?

49
Some Further Questions (1)

• Taxation is inevitably about equity issues to a
  considerable extent. When it comes to VAT in
  DTE, it seems that
• All agree that luxury rates serve little
  purpose
• And that zero-rating (other than for exports) is
  not advisable
• But then which is better and in what
  circumstances for equity goods exemption or
  reduced rates?

50
Some Further Questions (2)

• Small firms are a big problem in DTEs
• Thresholds seem to be set too low in many
  countries why?
• More thought needs to be given to linking
  simplified systems for small with regular VAT
• When, if even, does VAT withholding make sense
  for coping with the small sector?

51
Some Further Questions(3)

• Visible small firms are hard enough to deal with
  invisible firms of all sizes are worse
• Role and effects of VAT on shadow sector need
  much more thought