International Tax Dialogue THE VAT EXPERIENCE INTERNATIONAL TAX DIALOGUE VAT CONFERENCE 15-16 MARCH...

International Tax Dialogue

THE VAT EXPERIENCE

INTERNATIONAL TAX DIALOGUEVAT CONFERENCE15-16 MARCH 2005, ROME

Michael KeenHead, Tax Policy DivisionFiscal Affairs DepartmentInternational Monetary Fund


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


Economic appeal is:

• Unlike turnover tax, there is no cascading—implying 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


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?)


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 revenue—all else equal—than those without


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!)


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

Rate(s)

Collection costs—administration and compliance—point to a single rate

—other than for exports, which are zero-rated (though this is not strictly required for the destination principle)

BUT


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


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


Exemptions

.....(meaning that no tax is charged on sales, but—unlike zero-rating—tax on inputs is not recovered)....

Are inconsistent with the basic logic of the VAT.

They.....


• 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)


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


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


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


This debate—and the focus on large taxpayers more generally—is 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)


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....


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)


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


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


Concluding: We’ve 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)


• Dealing with mobile or location-less consumption

• Increasing need for international coordination

• Reaching into hard-to-tax sectors


RECENT POLICY & ADMINISTRATION DEVELOPMENTS IN VAT/GST


Jeffrey OwensDirectorOECD Centre for Tax Policy and Administration


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)


OECD tax revenue as percentage of total taxation, unweighted average

0.0

10.0

20.0

30.0

40.0

50.0

1965 1975 1985 1995 2002

Per cent

Value added taxes Taxes on income,profits and capital gains Social security contributions Other


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


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


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


Exemptions

• Continue to distort:– Especially financial services (outsourcing)– Recent New Zealand changes to introduce partial

zero-rating (for B2B)– Australia’s rules on recovery of input tax– EU updating rules on financial services


Valuation Issues

• Cross-border supplies between related parties

• Goods: Arm’s 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?


Policy Developments

• Use of Electronic Commerce– OECD’s 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


Policy Developments

• International Services and Intangibles

• Growth in sector


Chart I: SHARE OF MARKET SERVICES IN TOTAL VALUE ADDED (1980 AND 2001)

Source: OECD (STI Scoreboard 2003)


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)


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



• 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



• 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



• 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



• 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


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


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???


VAT IN DEVELOPING AND TRANSITIONAL ECONOMIES (DTEs)


Professor Richard BirdUniversity of TorontoConsultant to World Bank


VAT Works…but….......

• Some problems remain on the policy side:

– Some are old• Financial sector• Public sector

and

– Some are new • Digital commerce• Sub-national VATs


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


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


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


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


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


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?


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?


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?


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

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International Tax Dialogue THE VAT EXPERIENCE INTERNATIONAL TAX DIALOGUE VAT CONFERENCE 15-16 MARCH...

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