| To be justified, taxes should satisfy a few | | | | as his poorer counterpart - but the tax will constitute a |
| conditions:Above all, they should encourage economic | | | | smaller part of his income. This is the best definition yet |
| activity by providing incentives to save and to invest. | | | | found for regressivity.On the face of it - and for a |
| Savings - transformed into investments- enhance | | | | very long time - VAT served as a prime example of |
| productivity and growth of the economy as a whole.A | | | | regressive, unfair taxation.For a very long time, that is |
| tax should be simple - to administer and to comply | | | | until the development and propagation of the Life |
| with. It should be "fair" (progressive, in professional lingo) | | | | Cycle Theories. The main idea in all these theories was |
| - although no one seems to agree on what this | | | | that consumption was not based on annual, current |
| means.At best, it should replace other taxes, whose | | | | income only. Rather, it took into consideration future |
| compliance with the above conditions is less rigorous. In | | | | flows of income (income expectations). People tended |
| this case it will, usually, lead to budget cuts and reduce | | | | to be constant in their level of spending (in different |
| the overall tax burden.The most well known tax is the | | | | periods in their lives) - even as their annual income |
| income tax. However, it fails to satisfy even one of the | | | | vacillated. With the exception of millionaires and |
| conditions above listed.To start with, it is staggeringly | | | | billionaires, people spent most of their income in their |
| complicated. The IRS code in the USA sprawls over | | | | lifetime.VAT was, therefore, a just and equal tax. If |
| more than 8,000 pages and 500 forms. This single | | | | income equalled consumption in the long run, VAT was |
| feature makes it expensive to enforce.Estimates are | | | | a form of income tax, levied incrementally, with every |
| that 100 billion USD are spent annually (by both | | | | purchase. It reflected a taxpayer's ability to pay (=to |
| government and taxpayers) to comply with the tax, to | | | | consume). It was a wealth tax. As such, it necessitated |
| administer it and to enforce it.Income tax is all for | | | | the reduction in other taxes. Taxing money spent on |
| consumption and against savings: it taxes income | | | | consumption was taxing money already taxed once |
| spent on consumption only once - but does so twice | | | | (as income). This was classic double taxation - a |
| with income earmarked for savings (by taxing the | | | | situation which had to be remedied.But, in any case, |
| interest on it).Income taxes discriminate against | | | | VAT was a proportional tax when related to a |
| business expenses related to the acquisition of capital | | | | lifetime's income - rather than a regressive tax when |
| assets. These cannot be deducted that same fiscal | | | | compared to annual income. Because consumption |
| year. Rather, they have to be depreciated over an | | | | was a parameter more stable than income - VAT |
| "accounting life" which is supposed to reflect the useful | | | | made for a more stable and predictable tax.Still, old |
| life of the asset. This is not the case with almost all | | | | convictions die hard. To appease social lobbies |
| other business expenses (labour, to name the biggest) | | | | everywhere, politicians came up with solutions which |
| which are deductible in full the same fiscal year | | | | were unanimously rejected by economists.The most |
| expended in.Income taxes encourage debt financing | | | | prevalent was exempting a basket of "poor people's |
| over equity financing. After all, retained earnings are | | | | goods" from VAT.This gave rise to a series of |
| taxed - while interest expenses are deductible.We can | | | | intricate questions:If food, for instance, was exempted |
| safely say that income taxes in their current form | | | | (and it always is) - was this not a subsidy given to rich |
| were somewhat responsible to an increase in | | | | people as well? Don't rich people eat?Moreover, who |
| consumer credits and in the national debt (as | | | | will decide what is or isn't food? Is caviar food? What |
| manifested in the budget deficits). They also had a | | | | about health food? It was obviously going to be very |
| hand in the freefall in the saving rate in the USA (from | | | | hard to reach social consensus.If tax on these |
| 3.6% in the 80s to 2.1% in the 90s). And money | | | | products were zeroed - taxes on other products |
| evading the tax authorities globalised itself using means | | | | would have had to go up to maintain the same |
| as diverse as off-shore banking and computer | | | | revenue. And so they did. In most countries VAT is |
| networking. This made taxing sophisticated, big money | | | | levied on less than 45% of the GDP - and is reckoned |
| close to impossible.No wonder that taxes levied on | | | | to be twice as high as it should be.Some sought to |
| consumption rather than on income came to be | | | | correct this situation by subjecting services to VAT |
| regarded as an interesting alternative.Consumption | | | | but this proved onerous and impossible to implement in |
| taxes are levied at the Point of Sale (POS). They are | | | | certain sectors of the economy (banking and |
| a mixed lot:We all get in touch with Excise Taxes. | | | | insurance, to name two).Others suggested to dedicate |
| These are imposed on products which are considered | | | | VAT generated revenues to progressivity enhancing |
| to be bad both for the consumer and for society. | | | | programs. But this would have entailed the imposition |
| These products bring about negative externalities: | | | | of additional taxes to cover the shortfall.It is universally |
| smoke and lung cancer, in the case of tobacco, for | | | | thought, that the best method to "compensate" the |
| instance. So, when tobacco or alcohol are thus taxed - | | | | poor for their regressive plight is to directly transfer |
| the idea is to modify and reform our behaviour which | | | | money to them from the budget or to give them |
| is deemed to be damaging to society as a whole. | | | | vouchers (or tax credits) which they can use to get |
| About 7% of tax revenues in the USA come from this | | | | discounts in education, medical treatment, etc. These |
| source - and double that in other countries.Sales taxes | | | | measures will, at least, not distort economic decisions. |
| have a more modest calling: to raise revenues by | | | | And we, the less lucky taxpayers, will know how much |
| taxing the finished product in the retail level. | | | | we are paying for - and to whom.This is one of the |
| Unfortunately, so many authorities have the right to | | | | budgetary items which increase with the introduction of |
| impose them - that they vary greatly from one location | | | | VAT. Research shows that there is a strong |
| to another. This adds to the confusion of the taxpayer | | | | correlation between the introduction of VAT and |
| (and of the retailer) and makes the tax more | | | | growth in government spending. Admittedly, it is difficult |
| expensive to collect than it should have | | | | to tell which led to what. Still, certain groups in the |
| been.Moreover, it distorts business decisions: | | | | population feel that it is their natural right to be |
| businesses would tend to locate in places with lower | | | | compensated for every income reducing measure - |
| sales taxes.Sales taxes have a malignant effect on | | | | by virtue of the fact that they don't have enough of |
| the pricing of finished goods. First, no tax credit is | | | | it.But VAT is known to have some socially desirable |
| allowed (sales taxes paid on inputs cannot be | | | | results, as well.To start with, VAT is a renowned |
| deducted from the sales tax payable by the retailer). | | | | fighter of the Black Economy. This illegitimate branch |
| Secondly, the tax tends to cascade, increase the | | | | of economic activity consists of three elements:The |
| prices of goods (taxable and not, alike), affect | | | | non official sales of legal goods (produced within the |
| investments in capital goods (which are not exempt). It | | | | tax system)The sales of illegal goods (which never |
| adversely affects exports and domestic goods which | | | | were within the tax system)The consumption of |
| compete with imports.In short: sales taxes tend to | | | | money not declared or disclosed to the tax authorities |
| impede growth and prevent the optimization of | | | | VAT lays its heavy paws on all three activities.VAT is |
| economic resources. Compare this with the VAT | | | | self enforced. As we said, VAT offers a powerful |
| (Value Added Taxes): simple, cheap to collect, contain | | | | (money) incentive not to collaborate in tax scams. |
| no implicit taxes on inputs. VAT renders the pricing | | | | Every tax receipt means money begotten from the |
| structure of goods transparent. This transparency | | | | tax authorities.VAT is incremental. To completely |
| encourages economic efficiency.VAT is used in 80 | | | | evade paying VAT on a product would require the |
| countries worldwide and in 22 out of 24 OECD | | | | collaboration of dozens of businesses, suppliers and |
| countries, with the exception of the federal ones: the | | | | manufacturers. It is much more plausible to cheat the |
| USA and Australia.There are three types of VAT. | | | | income tax authorities. VAT is levied on each and |
| They are very different from each other and the only | | | | every phase of the production cycle - it is possible to |
| thing common to them all is the tax base: the value | | | | avoid it in some of these phases, but never in all of |
| added by the taxpayer.Economic theory defines Value | | | | them. VAT is an all-pervasive tax.VAT is levied on |
| Added as the sum of all the wages, interest paid on | | | | consumption. It is indifferent to the source of the |
| capital, rents paid on property and profits. In the | | | | money used to pay for it. Thus, it is as easily applied to |
| Addition VAT method, these four components are | | | | "black", undeclared, money - as it is to completely legal |
| taxed directly. The State of Michigan in the USA uses | | | | funds.Surely, there are incentives to avoid and to |
| this method since 1976. Experience shows that this | | | | evade it. If the amount of inputs in a product is very |
| method yields more predictable tax revenues and is | | | | low, the VAT on the sale will be very burdensome. A |
| less susceptible to business or industry cycles.The | | | | business non-registered with the VAT authorities will |
| Subtraction method, employed in Japan and a few | | | | have a sizeable price advantage over his registered |
| much smaller countries, is admittedly the simplest. It | | | | competitor.With a differential VAT system, it is easy to |
| taxes the difference between a taxpayer's sales and | | | | declare the false sale of zero-rated goods or services |
| its taxed inputs. However, it becomes very | | | | to linked entities or to falsify the inputs, or both. Even |
| complicated when the country has a few VAT rates, | | | | computers (which compare the ratio of sales to inputs) |
| because the inputs have to be separated according to | | | | cannot detect anything suspicious in such a |
| the various rates.Thus, the most widely accepted | | | | scheme.Yet, these are rare occurrences, easily |
| system is the Credit Invoice. Businesses become | | | | detectable by cross examining information derived |
| unpaid tax collectors. They are responsible to get tax | | | | from several databases. All in all, VAT is the ultimate, |
| receipts from their suppliers (inputs). They will be | | | | inevitable tax.Moreover, it is virtuous. By making |
| credited with the VAT amounts on the receipts that | | | | consumption more expensive, it would tend to divert |
| they have collected, so they have a major incentive to | | | | capital into investments and savings. At least, this is |
| do so. They will periodically pay the tax authorities the | | | | what our intuition tells us.Research begs to differ. It |
| difference between the VAT on their sales and the | | | | demonstrates the resilience of consumers, who |
| VAT on their inputs, as evidenced by the receipts that | | | | maintain their consumption levels in the face of |
| they have collected. If the difference is negative - they | | | | mounting price pressures. They even reduce savings |
| will receive a rebate (in certain countries, directly to | | | | to do so. We say that their consumption is rigid, |
| their bank account).This is a breathtakingly simple | | | | inelastic. Also, people do not save because it "pays |
| concept of tax collection, which also distributes the | | | | better" to save than to consume. They don't save |
| costs of administering the tax amongst millions of | | | | because the relative return on savings is higher on |
| businesses. In the fiscal year (FY) 1977/8 in the UK - | | | | savings than on consumption. They save because |
| the tax productivity (cost per 1 dollar collected) was | | | | they are goal oriented. They want to buy something: a |
| 2%. This means that the government paid 2 cents to | | | | car, a house, higher education for their children.When |
| collect 1 dollar. But businesses paid the remaining 10 | | | | the yield increases - they will need to save less money |
| cents.If introduced in the USA, VAT will cost only 3 | | | | to get to the same target in the prescribed period of |
| billion USD (with 30,000 tax officials employed in a | | | | time. We could say that, to some extent, savings |
| separate administration). To collect 1 dollar of income | | | | display negative elasticity.Markets balance themselves |
| tax costs 0.56% in the USA. But, to collect VAT in | | | | through a series of intricate feedback loops and "true |
| Norway costs 0.32%, in Belgium - 1.09% and, on | | | | models" of economic activity. Take an increase in |
| average, 0.68%. In short, VAT does not cost much | | | | savings generated by the introduction of VAT: it is |
| more than income taxes to collect.Yet, what is true for | | | | bound to be short lived. Why? because the equilibrium |
| government is not necessarily so for their subjects.The | | | | will be restored.Increased savings will increase the |
| compliance cost for a business in the USA is $49. It is | | | | amount of capital available and reduce the yields on |
| $53-282 in other countries.Small businesses suffer | | | | this capital. A reduction in yield would, in turn, reduce the |
| disproportionately more than their bigger brethren. It | | | | savings rate.Moreover, narrow (differentiated, |
| cost them 1.94% of VAT revenue in FY 1986/7 in the | | | | non-ideal) based VATs lead to higher rates of VAT |
| UK. Rather more than big firms (0.003%!).Compliance | | | | (to generate the same revenue). This reduces the |
| costs are 40 times higher for small businesses, on | | | | incentives to work and the amount of income available |
| average. This figure masks a larger difference in retail | | | | for savings.In a very thorough research, Ken Militzer |
| and basic industries (80 times more), in wholesale (60 | | | | found no connection between the introduction of VAT |
| times more) and in manufacturing and utilities (45 times | | | | and an increase in the rate of saving in 22 OECD |
| more).It was inevitable to think about exempting small | | | | countries since 1965 (VAT was first introduced in |
| business from paying VAT.If 16 out of 24 million | | | | France in 1954). He also found no connection between |
| businesses were exempted - the costs of collecting | | | | VAT and changes in corporate (profit) and income |
| VAT will go down by 33% - while the revenues will | | | | taxes.In Europe VAT replaced various turnover taxes |
| decline by only 3%. KPMG claims that businesses with | | | | so its impact on anything was fairly insignificant. It had |
| less than $50,000 annual turnover (18 out of 24 million) | | | | no influence on inflation, as well. VAT apparently has |
| exempted in the USA, revenues would have declined | | | | two conflicting influences: it raises the general price |
| by 1.5%. About 70% of the tax are paid by 10% of the | | | | level through a one time "price shock", on one hand. On |
| businesses in the UK. For 69% of the businesses there | | | | the other hand, it contracts the economy by providing |
| (with turnover of less than 100,000 USD annually) the | | | | a disincentive to consume. If VAT does influence |
| costs of collection exceed 60% of the revenues. For | | | | inflation - its impact will be echoed and amplified |
| 96% of the businesses (with less than 1 million USD a | | | | through wage indexation and the linking of transfer |
| year) - the costs exceed 50%. Only in the case of | | | | payments to the Consumer Price Index (CPI). In this |
| 30,000 companies - are the costs less than 20%. | | | | case, maybe its effects should be sterilized from the |
| These figures do not include compliance costs (=costs | | | | calculations of the CPI.But research was able to |
| borne by businesses which comply with the tax | | | | demonstrate only the potentially dangerous contracting, |
| law).No wonder that small businesses borrow money | | | | deflationary (stagflationary, to be exact) influences of |
| to pay that VAT bills. Many of them - though exempt - | | | | this tax. The recommendation is surprising: the Central |
| register voluntarily, to get an endless stream of | | | | Bank is advised to increase the money supply to |
| rebates. This is a major handicap for the tax system | | | | accommodate the reverberations of the introduction |
| and reduces its productivity considerably. In a | | | | of this tax.Finally, VAT is a "border adjustment" tax |
| desperate effort to cope with this law-abiding flood, | | | | (under the GATT and WTO charters).This means that |
| tax authorities have resorted to longer periods of | | | | VAT is rebated to the exporter and imposed on the |
| reporting (instead of monthly). Some of them (in the | | | | importer.Prima facie, this should encourage exports - |
| UK, for one) allow annual VAT reports.Part of the | | | | and equally discourage imports.Surprisingly, this time the |
| problem is political. There is little disagreement between | | | | intuition is right - albeit for a limited period of |
| economists that VAT is a tax preferable to income | | | | time.Despite a raging debate in economic literature, it |
| taxes. But this statement comes with caveats: the tax | | | | seems safe to say the following:VAT increases the |
| must have one rate, universally applied, without sector | | | | profits of exporters and producers of import |
| exemptions. This is the ideal VAT.The world being less | | | | substitutes.VAT increases the investments in the trade |
| than ideal - and populated by politicians - VATs do not | | | | sector.VAT increases exports and decreases |
| come this way. They contain many rates and | | | | imports.These advantages are, ultimately, partially |
| exemptions for categories of goods and services.This | | | | offset by the movement of exchange rates.If certain |
| mutilated version is called the differentiated VAT.An | | | | sectors are not taxed - investment will flow to that |
| ideal VAT is economically neutral - though not | | | | sector and badly affect the trade sector and the |
| equitable. This means that the tax does not affect | | | | competitiveness of the country in world markets.With |
| economic decisions in ways that it shouldn't. On the | | | | its burgeoning black market, under-developed export |
| other hand, its burden is not equally distributed between | | | | industries, huge shortfall in tax revenues - Macedonia |
| the haves and have nots.VAT taxes value added in | | | | urgently needs VAT.It will do well to learn from the |
| each stage of the production process. It does so by | | | | experience of others and introduce a VAT which is as |
| levying a tax on goods and services - but what is | | | | ideal as socially permissible and politically possible.The |
| really taxed are the means of production, labour and | | | | draft law that I have seen is a copy - almost verbatim |
| capital. Ultimately, shareholders of the taxpaying | | | | - of laws in the European Union and is riddled with |
| businesses pay the price - but most of them try to | | | | exemption to various goods, services and |
| move it on to the consumer, which is where the | | | | sectors.VAT is a good idea - but it seems to be |
| inequity begins. A rich consumer will pay the same tax | | | | starting on the wrong footing in Macedonia. |