Value Added Taxation: Mechanism, Design, and Policy Issues

Introduction The idea of the value added taxation (VAT) traces back to the writing by von Siemens, a German businessman, in the 1920s. Not until 1948, however, was the tax first applied in France. At the beginning, France applied the GNP-based VAT covering up to the manufacturing level and subsequently replaced it with a consumption VAT in 1954. Theory and practice indicate that to be efficient, the VAT must be consumption-typed, broad-based, and applied through to the retail stage. Empirical studies have shown the interlinks between the VAT performance of a country and its level of development. The revenue gains from VAT are likely to be higher in an economy with higher level of per capita income, lower share of agriculture, and higher level of literacy (Ebrill et al. 2001). 1 VAT proves to be an efficient tool for revenue collection; its performance, therefore, has direct impact on fiscal mobilization, macroeconomic stability, and development. Compared with alternatives in indirect taxation, the VAT has more revenue potential: it is generally more broad-based and entails a trail of invoices that helps improve tax compliance and enforcement. Note also that the VAT may eliminate the cascading problem, which is typical for the turnover tax. Heady (2002) observes a clear, consistent trend for greater use of the VAT to collect sales tax revenues among OECD countries: " [The VAT becomes] the sales tax of choice in OECD countries " (p.4). While these countries continue to rely heavily on income tax collection, the VAT revenues have 1 One should caution, however, that the IMF study also indicates significant negative impact of the interactive VAT and trade liberalization on the revenue collection: the introduction of VAT, which replaces trade taxes during the course of trade liberalization, is likely to reduce the overall tax revenues. The results imply that the VAT may not be as effective as trade taxes in raising revenues. 2 risen steadily in both absolute and relative terms: the general consumption taxes (mainly VAT—in recent years) increased sharply from 12 percent of the total tax revenues in A similar trend is applied to developing countries, which typically rely more on sales tax than OECD countries. The IMF assesses the growing importance and worldwide expansion of the VAT as follows: " [The VAT has become] a key source of government revenue in over 120 countries. About 4 billion people, 70 percent of the world's population, …