Executive summary of ‘Value-Added Taxes: A Comparative Analysis.’
Gareth E. Glaser
Editor’s Note: The following article summarizes Value-Added Taxes: A Comparative Analysis, a book by the Consumption Tax Committee of Tax Executives Institute. The book, which was published by the I 1992, may be purchased for $30 (plus applicable sales tax) by writing to Tax Executive Institute, 10 N.W., Suite 320, Washington, D.C. 20004-2505, Attention: VAT Book.
In November 1992, the Consumption Tax Committee of Tax Executives Institute released its long-awaited report entitled Value-Added Taxes: A Comparative Analysis. Two years in the making, the book’s publication was especially timely, since it follows on the heels of significant activity in Washington in the field of consumption taxes.
In July 1992, United States Senators John Danforth (R-Missouri) and David Boren (D-Oklahoma) created an advisory group to provide suggestions on ways to alter the current system of Federal income taxation by incorporating a national consumption tax.(1) A key guideline established for the group is that any proposal must be revenue neutral. At the same time, a commission chaired by United States Senators Sam Nunn (D-Georgia) and Pete Domenici (R-New Mexico) has endorsed a plan to abolish the present tax code and enact a new system that would tax consumption while exempting savings. This proposal is part of an economic blue-print issued by the bipartisan “Strengthening of America Commission.” It appears that the Nunn-Domenici commission will be looking to the Danforth-Boren advisory group for guidance on how a national consumption tax might be implemented.
In the midst of all this, the United States had a presidential election in which taxes were, as usual, a major focus of debate. President Clinton made it clear during the campaign (and since) that he intends to propose major changes in many aspects of the U.S. economy. What form these changes will take in the tax area is a matter for speculation, but a consumption tax could well find its way to the national agenda.
TEI’s Value-Added Taxes: A Comparative Analysis offers a comprehensive review of the policy issues surrounding value-added taxes. It can be an important tool in the coming debate over a national consumption tax, since it provides an objective and technically sound analysis of the relevant issues. The following summary of the Institute’s VAT book follows the organization of the main report and draws liberally on the work of the Institute’s Consumption Tax Committee to whom the authors of this summary, who themselves were members of the committee during the book’s development, are indebted. The authors recognize that events have, to a certain extent, overtaken the book — perhaps most notably developments in the European Community. Nevertheless, they — and Tax Executives Institute — continue to believe the book can serve as a valuable research tool.
I. INTRODUCTION
TEI’S VAT book begins by acknowledging that VATS “provoke widely divergent and strongly held opinions.” Among the arguments in favor of a VAT that are presented in the book are that a VAT is necessary for U.S. businesses to compete internationally, to encourage capital formation, to reduce the federal deficit and to simplify the tax system. Opponents argue that a VAT is regressive and a “money machine” that discourages spending restraint by government, is costly to administer and comply with, and encroaches on state revenue sources. With this as an introduction, the book remains objective throughout, emphasizing factual explanation and technical analysis.
II. SOME DEFINITIONS
The two major forms of value-added taxes discussed in the book are the subtraction-method VAT and the credit-method VAT. Under the subtraction-method VAT, the tax base equals sales less purchases (including capital equipment). This form of value-added tax is often referred to as a business transfer tax. The most common form of value-added tax is the credit-method VAT. Under this method, tax is imposed on the price at which goods and services are sold at each stage in a chain of production and distribution. To avoid taxing the same value added more than once, a credit is allowed to a seller for VAT paid on its purchases. These two forms of value-added tax are illustrated in the accompanying two tables.
The first table illustrates a subtraction-method VAT imposed at a 10-percent rate on net receipts at each stage. The total VAT collected is equal to the rate times aggregate net receipts. In comparison, the second table illustrates a credit-method VAT also imposed at a 10-percent rate. The total VAT collected is equal to the tax rate times the total value-added (on a before-VAT basis). The net value added in both cases is 405.
The book defines terms frequently used in discussing value-added taxes, among the most important of which is the so-called destination principle by which goods and services are taxed where they are sold. Under this principle, VAT is imposed on imports but not on exports.
The book also defines the terms “exemption” and “zero-rating.” Exemptions from VAT fall into either of two categories: exemption without credit for VAT previously incurred (the so-called “true exemption”), or exemption permitting credit for VAT previously incurred (“exemption with credit”). Under a credit-method VAT, a key feature of “true exemption” is that the exempt taxpayer cannot claim a credit for tax paid on purchases related to its exempt sales, since taxpayers with these exemptions fall outside the VAT system and do not file returns. Exempting taxpayers in this manner simplifies administration of the tax, but requires exempt firms either to pass the tax through to customers by increasing prices or to absorb the price increases. An exemption with credit or zero-rating does not take taxpayers out of the system. Firms still file returns so that they can claim a credit for VAT paid on purchases. Exemption with credit and zero-rating are virtually identical.
The other major defined term is “multiple rates.” This refers to systems that impose different rates of VAT on different types of goods and services. For example, lower rates are often applied to necessities than to luxuries.
III. TAX POLICY ISSUES
The book objectively discusses the following key tax policy issues that are raised in the VAT debate: (1) Administration and Compliance Costs, (2) Breadth of Tax Base, (3) Who Bears Burden of Tax, (4) State Government Concerns, (5) Trade Implications, and (6) Presumed Effects on Economy. The conclusions of the book are summarized in the following sections.
A. Administration and Compliance Costs
The book stresses the importance of minimizing the costs of administration and compliance in any tax system. It contains a wealth of statistical information regarding the cost of administering and complying with a VAT. The book notes, however, that the only comprehensive study of such costs for a VAT in the United States was done by the Department of the Treasury in 1984. The study estimated that to administer a credit-method VAT with minimal exemptions would take 20,000 additional federal employees and a $700 million annual budget. At a 3-percent rate, this would mean that a VAT would be twice as costly to administer as an income tax to raise the same amount of revenue. The book clarifies, however, that the cost of administering a VAT is relatively static — i.e., the percent administration cost goes down as the tax rate increases. For example, the Treasury study concludes that VAT administration costs will equal those of an income tax at a rate of 6 percent.
For comparison purposes, the book notes that the European experience is that a VAT is typically cheaper to administer than an income tax. The book cites a 1988 study by the Organisation for Economic Cooperation and Development (OECD) showing that administration costs, as a percentage of revenue, are greater for income taxes than for broad-based consumption taxes. For example, income tax administration costs in Europe average 2 percent of revenue, whereas VAT administration costs average between 0.32 percent and 1.09 percent of revenue.
None of these amounts reflects the cost of taxpayer compliance and the lost revenue associated with the added expense to taxpayers. In the recent debate over tax reform in the United States, these costs are referred to as “dead-weight” costs. The more complex a tax system, the greater the dead weight costs. The VAT book concludes that the simpler a VAT is, both from a recordkeeping and other compliance perspectives, the less will be its administration and compliance costs.
Finally, the book compares the relative costs of administering and complying with the two main types of VAT, but does not conclude which type of VAT would be least costly. It does note, however, that a credit-method VAT containing numerous exemptions and multiple rates would probably create burdensome paperwork, whereas a straightforward subtraction-method VAT would probably involve lower recordkeeping costs.
B. Breadth of Tax Base
The VAT book observes that, although the easiest and cheapest VAT to administer would be a VAT imposed at one tax rate on all goods and services, to date there has been no tax proposal anywhere in the world requiring all businesses to collect VAT. In fact, it observes that to address regressivity concerns, the majority of governments that levy a VAT attempt to soften the tax burden on necessities by either exempting, zero-rating, or applying a reduced rate of tax to such sectors. The book cites the 1984 U.S. Department of the Treasury report that concluded that medical expenses, insurance, education, local transportation, foreign travel, and charitable contributions should be exempted from any VAT. If housing services were added to this list, only 25 percent of all services would be taxable.
The book questions whether multiple rates with preferential treatment for necessities reduce regressivity. Looking at food and clothing, the book states that although the poor spend a larger percentage of consumption dollars on these two items, the wealthy spend far greater dollar amounts per capita. In high-income countries such as the United States, the exclusion of food would reduce taxes more at higher income levels, resulting in a significant revenue loss.
C. Who Bears Burden of Tax
In addressing the question of who bears the burden of a VAT, the book considers three questions:
* Would consumers bear the burden of a new VAT
through higher prices?
* Would U.S. businesses bear the burden of a new VAT
in higher costs and lower profits?
* Would foreign businesses — i.e., firms that export to
the United States — pay for the majority of a new
VAT?
The book concludes that it is unlikely that consumers will bear the full burden of a VAT, since in order for this to happen, prices must rise by the full amount of the tax and consumers must continue to purchase the same quantity of goods and services as they did before the tax was introduced. The book states that, under textbook conditions, this might occur, but that in the real world it is highly unlikely.
With regard to whether business bears the burden of a VAT, the book distinguishes the actual incidence of tax from its initial effect by comparing the repercussions of the two main forms of VAT on businesses. Regarding a credit-method VAT, the book addresses the perception that a tax calculated on a transaction basis and explicitly stated on an invoice is easier to pass through to consumers than a subtraction-method VAT. In the latter case, the taxes initially affect businesses — a result requiring a conscious decision to raise the base price of products to recover the tax cost from customers.
The book also discusses the notion that the major burden of the tax may fall on foreign-owned entities. It concludes that this may depend on whether the tax is a substitute for or a credit against other existing taxes, such as the employer obligation under the Federal Insurance Contributions Act (FICA). Inasmuch as imports would be subject to VAT and foreign manufacturers would incur no creditable FICA obligation, a significant portion of the tax may be borne by foreign competitors of U.S. products.
D. State Government Concerns
The book discusses the concern of most state governments that a federal VAT would intrude upon their traditional tax base. Citing a 1990 General Accounting Office report that surveyed 261 state tax policy makers and 50 state tax administrators, the book reports that these groups generally oppose the imposition of a broad-based federal consumption tax.
The book explains that during the last decade, state and local governments have lost federal revenue sharing and have seen reductions in federal grant funds. In addition, the federal deduction for state sales taxes has been repealed, which has created increased resistance to state and local sales taxes. In the realm of property taxes, too, the States have faced growing opposition. Hence, the States feel buffeted from all sides and are concerned that the imposition of a federal consumption tax would adversely affect their revenue-generating ability.
The book also summarizes the States’ administrative concerns about a federal-level VAT. First, it discusses concerns that a federal VAT could effectively compel the States to adopt the same tax base, which could restrict the States’ ability to tailor their sales tax to local social and political conditions. Secondly, the book reports on the States’ concern about the potential taxpayer (and retailer) confusion between state and federal consumption taxes.
The book does not attempt to resolve this debate. It does list, however, some of the “sweeteners” that were suggested by the General Accounting Office when it studied this question, including the federal government’s sharing consumption tax revenue with States and piggybacking (i.e., allowing States to add on a percentage to the federal VAT rate while the federal government administers and collects the entire tax).
E. Trade Implications
The book also discusses the “competitiveness” issue. Instead of accepting the argument that a VAT would automatically make the United States more competitive, the book suggests that if the United States desires to emulate the tax systems of its competitors, it should strive to achieve a better balance between direct vs. indirect taxation.
Under the General Agreement on Tariffs and Trade (GATT), indirect taxes — including value-added taxes — can be legally refunded at the border. Such refunds are referred to as border tax adjustments. The argument goes that the United States’ reliance on income taxes, which are not border adjustable, makes U.S. goods uncompetitive. This is because the price of U.S. goods arguably contains a greater direct tax burden that cannot be refunded at the border when compared with the goods of foreign competitors, which rely more heavily on VATS that are refunded at the border when goods are exported to the United States.
The book identifies several flaws in this argument. For instance, if a VAT is introduced as an add-on tax, then it is only this additional amount that will be refunded at the border, leaving the original (tax-affected) price of the exports unchanged. Alternatively, if a VAT replaced a portion of the personal income tax, it is not clear that a border adjustment would affect the original price (since it is unclear that personal income taxes are reflected in the price of goods). It is only if a VAT replaced some tax on corporations that a border adjustment would produce the desired effect. The book also observes that the demand for U.S. dollars could increase owing to increased demand for U.S. products. This would raise the cost of the U.S. dollar and, in turn, the cost of U.S. products. This foreign exchange effect could negate some or all of the benefit caused by increased demand for U.S. exports.
The book focuses on another factor that strongly influences international competitiveness — the cost of capital. Citing statistics showing that the cost of capital for U.S. firms is twice that for their Japanese counterparts, the book states that the preponderance of the evidence is that tax structures can affect the cost of capital. It notes, however, the conclusion of a 1989 Federal Reserve Report that the income tax structure has little influence on the overall cost of capital. The VAT book suggests that government dissaving caused by the budget deficit is a factor that could be directly influenced if revenue from a VAT were earmarked to reduce the deficit.
The book identifies the problems that might arise if a subtraction-method VAT were adopted, inasmuch as such VATS are figured in the aggregate and it is virtually impossible to determine the exact tax content of an exported good without detailed records. The recordkeeping burden negates a primary benefit of a subtraction-method VAT over a credit-method VAT — administrative simplicity.
Lastly, the book addresses the popular idea of substituting a VAT for the employer’s portion of FICA. It observes that such an offset could expose the United States to a challenge under GATT. Specifically, it notes that unless a portion of the VAT revenues were set aside for the Social Security trust fund, the offset mechanism could be viewed as giving employees of U.S. export industries partially free benefits, while taxing foreign workers (import industries) who are not entitled to benefits. This argument applies to the various forms of consumption taxes under discussion in the United States. If employees’ wages were not included in the tax base, the same GATT challenge could result.
F. Presumed Effects on Economy
The book identifies the imbalance between savings and consumption in the United States as a major economic problem. It observes that a primary advantage of a consumption tax over an income tax is its neutrality between the decision whether to save or consume. Concluding that the effect on savings would be the same with either a credits or subtraction-method VAT, the book examines the role of personal choice in the decision to consume or save and questions whether the tax system really influences this decision.
The book also looks at a common criticism leveled at the introduction of a VAT — that it would be inflationary. It cites a study performed by Alan Tait, Deputy Director of the Fiscal Affairs Department of the International Monetary Fund, which reached the following conclusions:
* In 21 out of 31 countries, the imposition of a VAT had
no effect on prices.
* In 6 out of the remaining 19 countries, there was a
one-time shift in prices.
* In only 4 countries was there an acceleration of inflation.
The Tait Report notes, however, that in all 31 countries the introduction of a VAT was accompanied by a reduction in other taxes. The VAT book concludes that implementation of a VAT is likely to result in a one-time price increase, but that in terms of greater capital formation and economic efficiency, the benefit of a VAT would be permanent.
IV. COMPARISON OF VAT SYSTEMS
Part IV of the VAT book reviews the VAT systems of the European Community (EC) member countries — Belgium, Denmark, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, and the United Kingdom — as well as the recently implemented systems of Canada and Japan. The following topics are covered in the book, (1) General Overview of the EC VAT, (2) By Country, (3) Comparison Charts, (4) EC Directives on Tax Harmonization, (5) Challenges to Complete Tax Harmonization, and (6) Implementation Features of Canadian and Japanese VATs.
The information in Part IV has value to tax professionals both in terms of providing high-level reference material for planning and compliance and in providing a frame of reference for assessing the efficacy of a VAT. Issues likely to arise if a VAT were proposed in the United States — especially those issues affecting tax executives — can be better evaluated if considered in the context of the treatment of similar issues in countries whose legislators and citizens have practical experience implementing VATs.
To facilitate presentation and avoid repetition, the EC countries’ VAT systems are discussed collectively in this summary. The book’s by-country profiles provide reasonable detail on the historical evolution of each country’s VAT and fundamentals of the tax as implemented in each country. The fundamentals include information regarding registration, administration, rates, tax base, percentage distribution of tax revenues by tax source and, where available, the cost of VAT administration as a percentage of tax revenue.
A. By Country
1. EC Countries
The EC countries all employ invoice-based credit-method VAT systems utilizing the destination principle. Each EC country, however, takes a different approach to VAT registration and administration. Some countries require all taxable persons to register, whereas others have at least a small threshold of annual turnover before registration is mandatory. Various countries allow an optional or elective registration in circumstances where a small taxpayer wishes to be in the system. The book analyzes the major requirements of each country.
Compliance requirements — especially the frequency of filing returns, required records, and the process for claiming and paying refunds — depend on the size and circumstances of the taxpayer. VAT is typically administered by a department of the Ministry of Finance, the same organization that administers income taxes. The degree of integration and coordination of VAT and income tax administration varies by jurisdiction.
Political, administrative and social policy considerations usually result in special VAT treatment for several categories of goods and services. The special treatment may depend on the nature of the customer (e.g., sales to NATO) or the type of good or service (e.g., medical services or supplies). EC countries address these considerations through a wide array of exemptions and multiple rates. All EC members (except Denmark) use multiple rates to alleviate regressivity. The book identifies the rate structure in each country and the goods and services to which special rates apply. Standard VAT rates in the EC range from 12 percent in Luxembourg to 22 percent in Denmark. Reduced rates range from 0 percent in some countries (e.g., the United Kingdom) to 17 percent in Belgium. Luxury rates are employed by h the EC Members and range from 22 percent in France to 38 percent in Italy.
EC countries use both zero-rating and “exemption with credit” for selected goods and services. The by-country profiles identify the types 6f goods and services that fall into each category. Examples of goods and services that typically are exempt with credit (or zero-rated) are exports, goods or services provided to NATO member armed forces, certain financial services, and selected financial transactions. Examples of goods and services that typically are exempt without credit are immovable property, transportation and communication, and medical and dental services.
2. Canada
Canada’s Goods and Services Tax (GST) is a credit-method VAT computed on the destination basis. The tax became effective on January 1, 1991. The GST differs from EC-style VATs in that vendors are not required to issue invoices, though they must attest that the tax has been paid and maintain records of taxes paid on purchases in order to claim the input tax credit. The GST is imposed at the single rate of 7 percent on the supply of goods and services (with various exemptions) and is administered at the federal level by Revenue Canada. With minor exceptions, every person engaged in a commercial activity in Canada must register. The usual multi-phased and occasionally elective compliance rules based on levels of sales apply. For example, small suppliers (less than C$30,000 in sales) are exempt from registration and monthly filings are required for taxpayers with annual revenues of more than C$6 million.
There are three categories of supplies within the GST system: taxable, tax free, and tax exempt. Tax-free supplies are taxable supplies to which a zero tax rate is applied. Examples of tax-free supplies are exports, groceries, and prescription drugs. Tax-exempt supplies include items such as health and dental services, domestic financial services, sales of existing housing, and supplies made by charitable organizations.
Total tax revenue from the GST was budgeted at C$18.5 billion for 1991. The book indicates it is too early to calculate administration and compliance costs for the GST, but 1991 start-up costs were estimated to be C$250 million increasing to C$350 million in 1992.
3. Japan
The Japanese Consumption Tax (JCT) was enacted in 1989. The 3-percent JCT is a destination-principle, subtraction-method type VAT. The JCT differs from other subtraction-method VATS discussed in the book. The tax is computed on a periodic basis by subtracting the amount of JCT on purchases from the amount of JCT due on sales, as opposed to netting purchases from sales and then applying the tax rate. The tax is computed solely from the taxpayer’s books of account with no additional documentation requirements. The book describes the formulary approaches used to compute liability for taxpayers with both taxable and non-taxable sales.
The JCT is administered by the National Tax Administration Agency (NTA), which administers all other national taxes in Japan. In comparison to EC VAT systems, the JCT has an extremely broad tax base, though in the tradition of VATS it exempts selected goods and services such as postage stamps, foreign exchange transactions, certain medical services, some educational related activities, and insurance premiums. Exports are not subject to JCT and exporters are entitled to credit for JCT incurred.
B. Comparative Charts
The textual discussion in the book is supplemented by six comparative charts on various aspects of VAT. Table 1 provides a list of VAT rates and the percentage of total tax revenue raised by the VAT. Table 2 details the basic choices regarding VAT types and which combinations have been chosen by various countries. Table 3 lists which taxes were replaced upon implementation of the VAT. Table 4 provides a non-exhaustive explanation of how each country handles certain special sectors (including housing, food, medical care, insurance, financial, government, non-profit, and small businesses). Table 5 is a comparison of the percentage of revenue earned from the major tax sources in each of the countries, including the United States, in fiscal 1985. Finally, Table 6 summarizes some of the goods and services that are exempted or zero-rated in the VATS of the various countries. Tables 1, 5, and 6 from the book are reproduced below and on the following pages.
[TABULAR DATA 1, 2, 3, 4 AND 6 OMITTED]
Table 5
Percentage Distribution of Tax Revenues by Major Source
1988
Taxes on Social
Income Security and Taxes on All
Country and Profits Payroll Taxes Consumption Other
Belgium 38.9 33.8 23.1 4.2
Canada 46.1 13.2 26.3 14.4
Denmark 58.6 2.5 31.7 7.2
France 17.4 45.1 28.6 8.9
Germany 34.2 37.4 24.2 4.2
Greece 17.9 33.6 43.6 4.9
Ireland 38.6 15.4 40.4 5.6
Italy 35.7 33.8 25.7 4.8
Japan 47.3 29.0 10.8 12.9
Luxembourg 41.7 25.4 24.6 8.3
Netherlands 27.9 42.5 23.7 5.9
Portugal 22.2 27.0 47.0 3.8
Spain 29.6 35.7 29.4 5.3
United Kingdom 37.5 18.5 29.6 14.4
United States 43.1 29.7 14.7 12.5
AVERAGE 35.8% 28.2% 28.2% 7.8%
Source: Adapted from OECD, Revenue Statistics of OECD Member Countries, 1965-198
9.
government in instituting its sales tax reform were (1) deficit
reduction, (2) enhancing international competitiveness, and
(3) improving tax fairness.
C. EC Directives on Tax Harmonization
The book discusses the troublesome tax harmonization aspect of the ongoing effort to integrate the EC markets (denominated EC-1992). This effort began with the Treaty of Rome which established the European Economic Community in 1957. The book concentrates on those directives of the European Council on Economic Community that address the desired EC VAT system. As of the date of the book, 30 directives had been proposed or passed, most dealing with indirect taxes. The key Council Directives discussed in some detail are the First, Second, and Sixth.
The First Council Directive specified the need for a common system of VAT based on the destination principle and abolition of the existing cumulative multi-stage taxes. The Second Council Directive established the preferred form of VAT as a tax-credit method, consumption-style system that relies on invoices for records and correct calculation of the tax. The Sixth Council Directive set forth a uniform basis of assessment. The book identifies the Sixth as the most noteworthy of the directives because it sets forth the scope and definitions of the tax.
D. Challenges to Complete Tax Harmonization
The book expresses the view that total indirect tax harmonization of the EC countries is highly unlikely. The EC Council is described as now aiming for VAT approximation rather than harmonization. A non-binding agreement has been reached on a minimum standard VAT rate of 15 percent, as well as application of one or two reduced rates to a limited list of goods and services. Among the challenges discussed in the book are considerations of national sovereignty, lack of homogeneity among EC country tax bases and rates, and the treatment of intra-community trade. Examples are cited of recent EC failures to implement legally binding agreements with respect to the standardization of tax rates and use of reduced rates. Since unanimous Member State agreement is required to implementany harmonization proposals, the modest expectations for progress are understandable.
The book makes reference to a United Kingdom suggestion that tax and base harmonization be achieved by market forces rather than the exertion of political power through legislation. The book describes a border tax distortion within the EC in the town of Martelange (“the Martelange Factor”). This town lies on the border of Belgium and Luxembourg. Business apparently flourishes on the Luxembourg side of main street where the tax rate is 12 percent, but flounders on the Belgium side where the tax rate is 19 percent. The book concludes that, “In the long run, market forces may prove just as capable in bringing about harmonization as an EC Council mandate. In addition, market forces tend to avoid political wrangling.”
E. Implementation Features of Canadian and Japanese VATS
The book provides an in-depth review of the implementation issues of the Canadian and Japanese VAT systems. The experiences of these two important trading partners may be instructive to the United States if it should consider a VAT. The actions of Canada and Japan represent the most recent VAT implementations by industrialized countries.
1. Canada
The book reviews Canada’s process in enacting and implementing the GST. Consideration of sales tax reform began in 1987. Various alternatives were considered including a subtraction-method VAT. The credit-method GST was chosen over a subtraction style because of the flexibility permitted in providing special treatment to selected goods and services.
One of the primary reasons for Canada’s decision to enact a VAT was the desire to replace the existing federal sales tax (FST). The book summarizes six major structural shortcomings of the FST. Among these were the FST’s negative effect on international competitiveness, its narrow base, and its complexity. Three stated goals of the Canadian
As with many of the individual U.S. States, Canada’s Provinces have separate provincial sales taxes (PST). Some Provinces have concluded that PST is due on prices inclusive of GST, whereas others calculate the provincial tax on a tax-exclusive basis. That retailers have to cope with two sales tax systems is one of the disadvantages of the GST. The federal government did attempt to coordinate the development of GST with the Provinces. Having failed to secure provincial participation during development, the federal government has since offered the Provinces the opportunity to utilize the federal tax base. To date, only Quebec has done so. When fully harmonized with the federal system, Quebec will be responsible for administering both the GST and the PST. Harmonization of GST and the Quebec PST will put the Canadian federal government (at least with respect to Quebec) on an equal footing with Germany, which is the other major example of VAT operating in a federal system. The potential for large savings in administration and compliance costs is a principal benefit of federal and provincial coordinated tax bases.
The book notes that while there are similarities between the United States and Canada, there are also differences to be considered when evaluating tax reform. Four of these differences are discussed in some detail. One such difference is the more decentralized structure of the Canadian government. Because provinces have had more revenue-raising requirements and more social service responsibilities, there is a longer history of the federal and provincial governments’ sharing income and sales tax bases.
The book discusses how Canada dealt with certain implementation and transition issues. For example, Canada addressed the issue of regressivity of GST by allowing a refundable credit against income tax for income levels up to C$24,800 (above which the credit phases out). Owing to the immediate effect of the GST on disposable income, eligible taxpayers are permitted to apply for the credit on a quarterly basis. The principal transition rules dealt with refunding FST on tax-paid inventory held at January 1, 1991. Other major transition rule areas included new housing, fixed-price contracts, and transactions that straddle the implementation date.
The book concludes that Canada’s largest long-term economic benefit from implementing the GST may well be that a portion of the additional revenue generated will be used for deficit reduction.
2. Japan
The reasons advanced for tax reform in Japan were to spread the tax burden more evenly and to alter the mix of direct to indirect taxes (prior to reform that mix was a 7:3 ratio). The book observes that an unstated reason for tax reform may well have been deficit reduction.
Prior to enactment of the JCT, consumption tax proposals had been circulating in Japan since 1950. Once enacted in December 1988, the JCT was implemented within three months. The book discusses the reasons advanced for the rapidity with which Japan was able to implement the JCT, including (1) the use of existing records for computation and administration of the tax (i.e., the same records required of taxpayers for income tax purposes), (2) a positive public relations effort leading to a high-level understanding of the tax by businesses and consumers, and (3) training of the tax officials. The low rate of the tax apparently minimized concerns relative to regressivity. The JCT did not supplant any existing prefectural (local government) taxes and, in fact, allowed for revenue sharing. Several minor taxes were repealed or decreased when the JCT was enacted.
When implemented, it was intended that the JCT would be pushed forward through the production/distribution chain to consumers. Early survey results confirm that a majority of businesses have shifted the tax forward “mostly or to a certain extent.” A unique feature of the JCT was the lack of extensive transitional rules. The book describes the four basic rules that were applied.
There is some question whether the JCT qualifies as an indirect tax that is border adjustable under GATT. To date, there has not been a challenge of the GATT-legality of the JCT.
V. ANALYSIS OF SYSTEMS RECENTLY PROPOSED IN THE UNITED STATES
This summary opens with a discussion of the most recent VAT activities in Washington — specifically, the Danforth-Boren advisory group and the Nunn-Domenici “Strengthening of America Commission.” The book was, of course, written without the benefit of these developments. The analysis, however, does summarize the seven major VAT proposals submitted to Congress up to early 1991: the ABA Model Statute (1989); the Ullman Proposal — H.R.7015 (1980); the Roth Proposal — S.1102 (1985); the Hollings I Proposal — S.442 (1989); the Hollings II Proposal — S.169 (1991); the Schultz I Proposal — H.R. 4598 (1986); the Schultz II Proposal — H.R.3170 (1991); and the Dingell Proposal — H.R.16 (1991).
The ABA Model Statute is a credit-method, destination-principle VAT. It was used by Senator Hollings in crafting his 1991 VAT proposal. The Ullman Proposal also incorporates a credit-method VAT, as does the Dingell Proposal (though the Dingell Proposal uses a 5-percent VAT primarily as a funding mechanism for a proposed national health care program).
The Ullman and Hollings proposals are comprehensive packages for tax reform that include a credit-method VAT, individual income tax rate reductions, reductions in FICA tax, corporate income tax reductions, savings incentives, depreciation reform, and a limitation on the growth of federal spending.
The Roth and Schultz proposals do not utilize credit-method VATs, but rather involve subtraction-method VATs. These proposals are known as the Business Transfer Tax (BTT) and the Uniform Business Tax (UBT), respectively. Both contain payroll tax credits and the UBT was billed as a replacement for the corporate income tax.
VI. SOME OBSERVATIONS
The book concludes by observing that if a VAT were enacted in the United States, the following key criteria should be met:
* The tax should be as broad based as possible for
economic and equity reasons.
* The tax should be optimally levied at one rate.
Whether the rate is high or low will depend on other
aspects of the system (a low rate means higher administration
and compliance costs when measured as
a percentage of revenue).
* The tax should be based on the destination principle
in order to border-adjust exports and to be consistent
with international practices.
* Simplicity is the key to administration and compliance.
To minimize costs, there should not be multiple
rates and exemptions and the use of special treatment
for certain sectors should be limited. Relying
on current books of account may produce administrative
savings. Regarding the other major tax policy
issues, the book concludes that exclusive of a one-time
price rise, a VAT does not appear to be inflationary
in and of itself. A VAT is regressive when viewed
on a yearly basis, yet less so when viewed over a
consumer’s lifetime.
The book concludes that the choice of method of calculating a VAT may determine who bears the majority of the tax burden in the short run, but in the long run, the incidence of a VAT will be shared by consumers and businesses. Although the States are likely to be concerned regardless of the type of VAT imposed, those concerns may be less under the subtraction-method. The book concludes that, if proponents are correct in arguing that a VAT will eliminate double, taxation of savings and that savings will increase, then the choice of method is of no consequence. The book also suggests that there would be relatively minimal benefits from introducing a VAT as an add-on tax. An add-on tax would definitely increase prices, have little to no effect on the rate of savings,, be of no benefit to international competitiveness or the balance of trade, and undoubtedly increase administration and compliance costs. It is only where a VAT is a substitute for part of the current system that benefits would accrue.
TEI’s book on value-added tax systems concludes with the following statement, which seems especially poignant as the 103rd Congress convenes and a new President is inaugurated:
The time seems ripe . . . for the United States to begin a process of carefully considering ways to improve its overall tax system. Regardless of the outcome, a properly structured VAT would seem rightly included among the tax system alternatives to be considered…. In the final analysis, a VAT is not something that should be capriciously added to the tax system. It can be an extremely efficient, economically neutral tax that may help to put American firms on a more balanced footing to compete internationally. These salutary results would be achieved, however, only if special treatment is kept to a bare minimum.
GARETH E. GLASER is Tax Counsel for ARCO Chemical Company. He is a member of TEI’s Philadelphia Chapter and of the Institute’s Consumption Tax Committee. Mr. Glaser received A.B. degree from the University of Pennsylvania, his J.D. degree from Boston College School of Law, and his LL.M. (Taxation) degree from Villanova Law School. He is also a member of the American Bar Association, the International Fiscal Association’s Mid-Atlantic Region Executive Committee, and chairs the Chemical Manufacturers Association’s Consumption Tax and State Tax groups.
RICHARD L. SARTOR is Manager-International Taxation for The Boeing Company. He is a member of TEI’s Seattle Chapter and of the Institute’s Consumption Tax Committee, as well as its International Tax Committee. Mr. Sartor received his B.A. degree from Boise State University and his J.D. degree from the University of Idaho. He is a certified public accountant and a member of the International Fiscal Association. (1) A co-author of this review, Gareth E. Glaser, is a member of this group, as are a number of other members of Tax Executives Institute.
COPYRIGHT 1993 Tax Executives Institute, Inc.
COPYRIGHT 2004 Gale Group
