The Value-Added Tax - Essay Example

?PUBLIC FINANCE-THE VALUE-ADDED TAX: IS IT GOOD FOR THE UNITED S? Value-added tax (VAT) Value added tax (VAT) or Goods and Service Tax (GST) is an indirect tax in which the tax is imposed on the top of the cost of a product or service. This system was introduced by the tax authority of France, Maurice Laure and it came into effect on 10th April 1954 (EconomyWatch). VAT was introduced to meet the increasing revenue requirements that could not be easily fulfilled by existing turnover taxes and France was the first to adopt VAT however, pace of adopting VAT increased and soon VAT became the requirement for entry to EU (International Tax Dialogue). The structure of VAT varies from country to country therefore, in the initial years, VAT could not be imposed throughout the European Commission because of lack of uniformity however, and in 1977 a consistent rules for VAT in European Community (Kearney). Until 1988, value-added tax became a tax revenue instrument for 50 countries of the world and it was contributing to 5.1 percent of their Gross Domestic Product (Hassan and Zeljko). In 2006, 136 countries have implemented VAT including the OECD member companies except the United States and in these economies it contributes to one-fifth of their total tax revenues (OECD). Around 70% of the world’s population is residing in the countries where value-added tax has been imposed (Kardar). Until June 2010, 150 economies of the world have adopted VAT which has significant uniformity however; VAT of Japan is different (OECD). In the context of trade liberalization, VAT was recognized as a preferred alternative as compared to customer duties because of its neutrality of principle towards international trade (OECD). VAT works by charging the tax at every stage of supply as an output tax and it can be deducted as an input tax by businesses and the businesses passes on to the government the difference between the output and input tax. All companies that sell to the final consumers or other businesses remit VAT and it is calculated by multiplying the gross revenues by VAT rate which varies from country to country and then taking a credit for VAT that has been already paid to suppliers (Fox). VAT is different from sales tax because it is levied on goods and services whereas sales tax is charged on goods. Moreover, it is a multistage but single point tax and it does not have cascading effect like sales tax (FBR Gov). Therefore, VAT appears to be a general tax on consumption that is collected at different stages of production of the products or services and it is passed on to the consumers. Moreover, the revenue collected through VAT is the tax revenue of the government. Since United States is the only OECD member state which has not adopted VAT, therefore, in this report, the merits of imposing VAT in the United States have been discussed. Pros and cons of imposing VAT Around 150 world economies have imposed VAT because of the simplicity, neutrality and lack of visibility of this system. There are various other advantages and disadvantages of adopting VAT in an economy. Value-added tax has been accepted as a source of revenue because it has the ability to raise more revenues as compared to sales/turnover tax and on theoretical grounds value-added tax is a neutral tax which eliminates tax on tax and also enables a zero rating of exports (Kardar). The neutrality of VAT is considered important because in public finance, the more neutral is the tax, the less is the influence on the private economic decisions and more efficient is the economy (Bickley). The research study of Hassan and Zeljko found that VAT produces more revenues in the countries with single VAT rate as compared to the countries with multiple VAT rates. Toder has identified four pros of VAT including international compatibility, exemption of small businesses, reduction of burden on capital income and self-enforcement mechanisms. VAT is considered to be more vulnerable to high profile criminal attacks for example; “carousel fraud” exploited the provisions for the taxation of intra-community trade within EU up to an amount of 1.5-2.5% of the new revenue (Keen and Lockwood). Bringing variations in VAT is not possible and it is evident from the failed attempts of Britain and European Union in the past (Sather). Another disadvantage of VAT is its high bureaucratic cost of administration because government spends huge amount of money to administer it and companies spend many hours to keep the records of their tax returns, therefore, in the absence of VAT the individuals can spend their time on better ways of creating wealth (McGee). Toder identifies four major cons of VAT including the distribution of tax burden, exploitation of tax, difficult access to tax sectors like financial institutions and administration and compliance costs. VAT puts high inflationary pressures on wages and prices in an economy (BTRC). Another factor which is considered as a major disadvantage of VAT is its lack of visibility which is considered as unethical because average consumers are usually not aware of this tax. Merits of imposing VAT in the United States Whether imposing VAT in the United States or not is a hot discussion in the U.S. since the creation of value-added tax system. In the previous years, the strong economic health of U.S. has been discouraging the policymakers from introducing value-added tax reform, however, the current economic problems of the U.S. A significant research has been conducted to the study the merits and demerits of imposing VAT in the U.S. In 2010, Holcombe conducted a research to analyze how VAT could contribute to reduce the budget deficits of the United States however; his findings suggested that unlike other states VAT could never be a good fit for U.S. He argues that imposition of VAT in the U.S. will increase intergenerational inequities and administrative costs. It will slow down the economic growth because if VAT is introduced in the U.S. in 2010 then by 2030, the total revenues collected through VAT will offset the declines in other sources of tax revenues. However, various merits of imposing VAT in the United States have been also identified. VAT is considered to be a source of revenue for the government of the U.S. The federal government of the United States has improved the social safety programs like social security, Medicare, Medicaid and insurance subsidies in Obama’s health care overhaul without expanding the sources of funds (Mankiw). VAT can increase tax revenues for the U.S. government thereby, providing them ways to fulfill the improved social safety programs. One reason because of which VAT is considered as inefficient for the U.S. is the potential harmful impact of VAT on current after-tax saving of U.S. retirees (Tittle). Bickley argues that for 2011, for each 1 percent levied, broad-based VAT can raise around $55 billion in the United States and most of the developed economies are depending on broad-based consumption taxes for revenues. All other nations which have brought tax reforms over the past quarter century except the United States have adopted VAT (Zodrow and Mieszkowski). By introducing VAT, a greater internal capital and dividend can be generated from the industries which are profitable and are earning high returns however, it will be parallel to the withdrawal of capital from the declining sectors (Davies). The current situation of the United States is very critical because the government’s fiscal gap is expanding and the deficit for 2009 was $1.4 trillion and it is expected to reach up to $1.6 trillion within one year, therefore, Bruce Bartlett argues that U.S. needs a money machine and VAT can actually support the economy (MoneyWatch). Therefore, imposing VAT can bring various benefits to the U.S. economy however; the costs of imposing the VAT appear to be major concerns for the U.S. government. The current fiscal position of the United States is close to crisis as evident from the widening budget deficit and the current tax system is not meeting the required amount of revenues therefore, appear to be inefficient. In consideration to the merits of imposing VAT in the U.S. in my opinion, imposing VAT can be an efficient tax reform in the U.S. By imposing VAT not as a substitution to current income tax but as another tax instrument, U.S. government can increase its sources of revenues. It is recommended that U.S. can keep the starting VAT level at very low level however, once its efficiency is proved, the rate can be increased. If U.S. replaced the current income tax system, it will not only reduce the tax revenues for the government but it will also threaten the budget deficits. Since most of the other economies have achieved huge benefits by introducing the value-added tax system therefore, U.S. can also achieve significant benefits because of the simplicity and lack of visibility of this tax system. Moreover, as discussed above, there are various cons of adopting value-added tax however, the pros of imposing value-added tax overweighs its cons. Bibliography Bickley, James M. Should the United States Levy Value Added Tax for Deficit Reduction? 25 January 2011. 7 February 2011 . Bickley, James M. Value added tax: concepts, policy issues, and OECD experiences. New York: Nova Publishers, 2003. BTRC. Generally Accepted Pros and Cons Of A Value Added Tax. 5 February 2011 . Davies, David G. United States taxes and tax policy. Cambridge University Press, 1986. EconomyWatch. Value Added Tax (VAT). 5 February 2011 . FBR Gov. VAT FAQs. 5 June 2010. 5 February 2011 . Fox, William F. History and Economic Impact. 13 March 2002. 6 February 2011 . Hassan, Fareed and Bogetic Zeljko. Determinants of Value-Added Tax Revenue. World Bank Publications, 1993. Holcombe, Randall G. The Value Added Tax: Too Costly for the United States. June 2010. 6 February 2011 . International Tax Dialogue. The Value Added Tax: Experience and Issues. March 2005. 6 February 2011 . Kardar, Shahid. Value-added Tax (VAT) as an instrument. 22 March 2010. 5 Februrary 2011 . Kearney, M. Introducing Value-Added Tax. 2003. 6 February 2010 . Keen, Michael and Ben Lockwood. The value-added tax: its causes and consequences, Issues 2007-2183. International Monetary Fund, 2007. MANKIW, N GREGORY. Much to Love, and Hate, in a VAT. 30 April 2010. 6 February 2011 . McGee, Robert W. The philosophy of taxation and public finance. USA: Springer, 2004. MoneyWatch. VAT: Will the U.S. Adopt a Value-Added Tax? 7 April 2010. 7 February 2011 . OECD. INTERNATIONAL VAT/GST GUIDELINES. February 2006. 6 February 2011 . OECD. Value Added Tax. June 2010. 6 February 2011 . Sather, Trevor. Pros And Cons: a Debater's Handbook, Edition 18. Routledge, 1999. Tittle, Martin B. Federal Tax Could be Harmful for Retirees. 31 July 2006. 6 February 2011 . Toder, Eric. Is a VAT in Our Future. 26 June 2009. 5 February 2011 . Zodrow, George R and Peter M Mieszkowski. United States tax reform in the 21st century. U.S: Cambridge University Press, 2002. Read More