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Contributions from
the Column
Focus
No representation without taxation
VAT triumph
The meaningful goal of fairness: sub-Saharan tax regimes
Funding municipal budgets in Benin and Rwanda
Selfreliance revisited: enabling governments to do their job
“It is extremely difficult to negotiate PPP contracts”
02/2007
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VAT triumph
Value-added tax (VAT) systems are sweeping the globe. Introduced in Europe as long ago as the 1960s, some form of VAT has now been adopted by virtually every country in the world – with the notable exception of the United States. Since the early 1990s, the spread of VAT has accelerated. For one thing, the model has been adopted by many countries of the former Eastern Bloc; for another, the International Monetary Fund has pushed for its introduction in many African countries.
VAT generates high revenues at comparatively little administrative cost. That is why it regularly figures in the debate on development financing. But VAT is not without its problems. In effect, it taxes consumption, and thus the hardest-hit are poor people who have to spend a large share of their income on essentials.
VAT is basically levied on the sales invoiced by companies and the self-employed. All VAT expenses for goods and services accrued before in the course of business are deducted. Accordingly, the system precisely taxes the value added at every stage of production. Even though enterprises and entrepreneurs transfer VAT payments to the fiscal authorities, it is the consumers that bare the true burden as VAT is included in consumer prices.
The basic VAT model is almost the same everywhere, but the way it is implemented varies from one country to another. Governments can apply different VAT rates. Moreover, they grant exemptions to different product groups or types of businesses. Typically, exports are exempt from VAT, whereas imports are taxed.
VAT has been adopted on such a large scale that there are only few countries left that might still consider introducing it. Around the world, two trends are striking.
– Almost everywhere VAT has been introduced, it accounts for a substantial amount of total tax revenue.
– One reason regularly given for its introduction is that it does not distort markets.
In sub-Saharan Africa, VAT generally accounts for 20% to 35% of tax revenues. It typically affects important imports. In some places today, tax on imports makes up as much as two-thirds of all the VAT collected. Where a large part of an economy is informal, ratios that high are not unusual. Often, VAT was introduced at the same time as tariffs were scrapped.
Many governments seem to consider VAT a useful cash cow. However, its redistributive effect is relevant from a development viewpoint. Unlike taxes on income, VAT does not lend itself to progressive or graduated taxation, where the better-off are taxed more heavily than those with small incomes. However, this does not mean that income taxes are always preferable. What matters is how the system as a whole impacts on the poor. If tax revenues are used for transfer payments to the disadvantaged, the result can be progressive even if a tax itself is regressive. Implementing such a progressive system, however, is something that only reform-minded governments committed to poverty reduction as well as to good financial governance will be capable of. In many cases, governments exempt essential goods (like basic foodstuffs) from VAT.
In countries where VAT is already successfully established, action in the future will focus on eliminating shortcomings. For trade blocs like ECOWAS and SADC, regional tax coordination will be at stake. And in most developing countries, capacity building will continue to be necessary in order to strengthen tax administrations. However, one of the greatest challenges in the decades ahead will be organised VAT fraud, especially “carousel” fraud, where bogus claims for VAT deductions are made on business transactions. So far, even EU members have not managed to find a satisfactory solution to this problem.
David Nguyen-Thanh
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