Comparing-the-Value-Added-Tax-to-the-Retail-Sales-

ComparingtheValue-AddedTaxtotheRetailSalesTaxForRichardF.Dye,ThereseJ.McGuireJournalofPublicEconomicsApril2011OverviewofVATMorethan130countriesuseVATasakeysourceofgovernmentrevenue.VATisageneral,broad-basedconsumptiontaxassessedonthevalueaddedtogoodsandservices.VATisgenerallyleviedonvalueaddedateverystageofproduction,withamechanismallowingthesellersacreditforthetaxtheyhavepaidontheirownpurchasesofgoodsandservices(inputtax)againstthetaxescollectedontheirsalesofgoodsandservice(outputtax).Generally,VATis:Ageneraltaxthatappliestoallcommercialactivitiesinvolvingtheproductionanddistributionofgoodsandtheprovisionofservices;Aconsumptiontaxultimatelybornebytheconsumer;Anindirecttaxleviedontheconsumeraspartofthepriceofgoodsorservices;Amultistagetaxvisibleateachstageoftheproductionanddistributionchain;andAfractionallycollectedtaxthatusesasystemofpartialpaymentswherebyasellerchargesVATonallofitssaleswithacorrespondingclaimofcreditforVATthatithasbeenchargedonallofitspurchases.TherearethreemethodsofcalculatingVATliability:thecredit-invoicemethod,thesubtractionmethod,andtheadditionmethod.Thiscolumndealswithonlythecredit-invoicemethod,whichisthemostwidelyused.Thecredit-invoicemethodhighlightstheVATdefiningfeature:theuseofoutputtax(taxcollectedonsales)andinputtax(taxpaidonpurchases).AtaxpayergenerallycomputesitsVATliabilityasthedifferencebetweentheVATchargedontaxablesalesandtheVATpaidontaxablepurchases.ThismethodrequirestheuseofaninvoicethatseparatelyliststheVATcomponentofalltaxablesales.Thesalesinvoiceforthesellerbecomesthepurchaseinvoiceofthebuyer.Thesalesinvoiceshowstheoutputtaxcollectedandthepurchaseinvoiceshowstheinputtaxpaid.Tosummarize,taxpayersusethecredit-invoicemethodtocalculatetheamountofVATtoberemittedtothetaxingauthoritiesinthefollowingmanner:AggregatetheVATshowninthesalesinvoices(outputtax);AggregatetheVATshowninthepurchaseinvoices(inputtax);Subtracttheinputtaxfromtheoutputtaxandremitanybalancetothegovernment;andIntheeventtheinputtaxisgreaterthantheoutputtax.TheUnitedStatesistheonlymemberoftheOrganizationofEconomicCooperationandDevelopmentthatdoesnotlevyaVATonanationallevel;however,VAThasbecomewidelyrecognizedasanimportantoptioninfederaltaxreformdebates.Indirecttaxessuchasvalueaddedtaxes(VAT)generateasubstantialpartoftaxrevenueinmanycountries.Infact,VATsystemsgenerateaquarteroftheworld¡¯staxrevenue.Nearly130countriesnowhaveaVATsystem(withover70countrieshavingadoptedthesystemduringthelast10years)(KeenandMintz2004).MorefocusoninternationallymobiletaxbaseshasdrawnattentiontodirectingmoreofthetaxburdentoindirecttaxessuchasconsumptiontaxesorVATsystems,andlesstoincometaxes,especiallycapitalincome(GordonandNielsen1997).DuringtheharmonizationofEUtaxes,indirecttaxes,andVATsystemsreceivedmuchattention(Fehretal.1995).AgeneralVATlawcoveringallprivategoodsandservicescharacterizesthecurrentEUsystem,buttherearestillmanyexemptionsfromthisgeneralinstruction.SuchaVATsystemalsoexistsinNorwayasaconsequenceoftheNorwegianVATreformin2001.ThereformintroducedageneralVATlawonservices,butmanyexemptionsarestillspaced.ThereareseveralargumentsinfavorofageneralanduniformVATsystem,comparedwithimperfect,nouniform(andnogeneral)systems.Suchasystemmayimproveeconomicefficiencyandreduceadministrationcosts,rent-seekingandfraudactivitiesbyindustriesthatlobbyforlowerratesandzeroratings(KeenandSmith2006).AgeneralanduniformVATsystemequalsauniformconsumertaxonallgoodsandservices.Suchasystemalsoimpliesthattheproducers¡¯netVATrateonmaterialinputsequalszero,irrespectiveoftheratestructure.Thisisoptimalaccordingtotheproductionefficiencytheorem(DiamondandMirrlees1971a,1971b).AVATsystemwithexemptionsviolatestheproductionefficiencytheorembecausetaxationofintermediateswilldifferbetweenindustries.Ontheotherhand,industriesthatarecoveredbytheVATsystembuthavelowerratesorzeroratingsontheirsalesarefavoredbecausetheycanwithdrawexpenditurestoVATonintermediatesatfullratesandonlylevyreducedorzeroratesontheirsales.AgeneralanduniformVATsystemmayalsohavepositiveeffectsonthedistributionofwelfareamonghouseholds.IftheinitialsituationischaracterizedbyaVATonmostgoodsbutonlyonafewservices,theintroductionofauniformrateonallgoodsandservicesmayimprovethedistributionofwelfarebecauseservices¡¯shareofconsumptionincreaseswithincome.Keen(2007)pointstothelackofinterestinvalueaddedtaxationfromthetheoreticalsecond-bestliteratureinspiteoftheVAT¡¯spopularityinpracticaltaxpolicy.Asmentionedabove,VATsystemsareingeneralnotuniform.Theoreticalanalysesdemandrelativelysimplemodelsandsimpletaxstructurestobeanalyticallytractable.Inpracticalpolicies,thestructuresoftheeconomyandthetaxsystemsarequitecomplex,andthereisaneedfordetailednumericalmodelsinordertoanalyzetheeffectsofdifferentVATsystems.ThispapercontributestotheliteraturebyanalyzingthewelfareeffectsofanimperfectextensionofanouniformVATsystem,andcomparingdifferentimperfect,nouniformVATsystemswithauniformandgeneralVATsystemwithinanempiricallybaseddynamiccomputablegeneralequilibrium(CGE)modelforasmallopeneconomy.Thismodelmirrorsarealeconomy,Norway,an