Value Added Tax Advantages, Disadvantages and Economic Effects
Value Added Tax Advantages, Disadvantages and Economic Effects
Value Added Tax Advantages, Disadvantages and Economic Effects
Conclusion
Introduction
Recently Iranian taxation organization reviewed the existing taxation laws at the context of third economic, social and cultural plan of government and in the sake of improving the existing taxation system, introduced a new kind of taxation model which is called "value added tax". Value added tax by transferring the tax basis from income to consumption increases the motivation of investment and prepare the required resources for investment by encouraging the saving of people and discouraging the transfer of capital from production sector to services sector. By practicing the new taxation system, the distortion in production and investment decisions will be decreased and the tax incomes of government due to the vast character of tax basis of this model will be increased.
The following equation shows that at the national scale the value added is the other coin side of gross national product. GNP= interest + wages + depreciation + rent final sale (total transaction intermediate transaction) value added
According to the above equation it can be said that the total value added produced by all the business units in different stages of an economy is another kind of definition of gross national product. Therefore the tax basis of value added tax is equal to the total incomes of sales minus the cost of buying the production factors from other business units, which by excluding whatever bought by business units from the outside taxpayer from tax calculation, it is refused from multi tax collection. In other words, the tax is obtained from total sales of business units and simultaneously the tax credit of buying from other business units transfer to the next business unit. In fact the taxes paid by the preceding units are subtracted from the tax of the final business unit. So using the value added tax system and calculating tax on value added of business units requires keeping the record all business units invoices, because each business unit in order to get his taxation credit should be able to declare and show all the taxes paid by his previous supplier. This feature of VAT and this need encourage the buyer to force his supplier to pay the taxes (which were already invoiced to him) to the government.
added tax according to the basis of origin, starting point or destination can be calculated. According to the origin of starting point, value added tax include the worth of all goods and services produced in national economy in the calculation of tax, but in the origin of destination, value added tax just include all the goods and services consumed in the national scale.
In product-value added tax (P-VAT), the total tax calculated on sales. In general, this kind of value added tax can be either calculated on the consumption and investment goods basis. In this method, investment goods and their depreciation are not free from taxation; in other words, we can say that the tax credit doesn't include the purchaser or buyer of investment goods, so this kind of value added tax decrease or weaker the investor motivation.
The tax basis in this model is equal to total payment of government to production factors after deduction of government wages expenses and for this reason this kind of tax is called income value added tax. In general, in this kind of value added tax, the total tax basis, is equal to incomes of production factors. Income value added tax is different from consumer- value added tax model; because in the first model (I-VAT), the business units can exclude the depreciation cost from tax calculation, but in the second type (C-VAT), the business units has the right to exclude the gross investment cost from tax calculation. So the tax on income-value added tax model at the same amount of the differences of gross investment and depreciation is more than the amount of tax on the consumer value added tax model.
From the above 3 kind of value added tax model, product- value added tax (P-VAT) generate the largest tax basis, and the consumer- value added tax (C-VAT) generate the smallest tax basis.
As the product value added tax (P-VAT), include the gross purchases of investment goods (without excluding the depreciation), in fact it create an obstacle for investments. In addition if the tax calculation in this model calculated on the basis of invoices, that group of activities which has not succeeded to transfer some portion of their investment costs to next accounting or taxation period, will cause a multi tax payment, which in income- Value added tax model ( I-VAT) this problem lower in minimum. From the 3 type of value added tax, the consumer value added tax (C-VAT), which create the smallest tax basis in fact, it is a general tax on consumption (if it use the origin of start point, the net worth of export should be include in tax calculation).therefore, from the above 3 mentioned type, the majority of countries chose the consumer value added tax model. It should be noted that under this type of value added tax for creating the ideal income return required to the highest tax rate, and for this reason , some of the countries try to enlarge the tax basis of consumer value added tax by including some portion of investment goods.
Tax incomes Indirect tax incomes Tax on import Custom duties Others Tax on commodities and services Total tax incomes The ratio of commodities and services tax on total tax incomes
In the introduction of feasibility report of the value added tax bill which was approved by committee of government, the reasons of implementing the value added tax system are described as follows: 1. Increasing the government tax incomes with the relay on new and reliable sources and on the consumption basis. 2. Decreasing the tax screw on production sector and productive investment by restructuring the tax rates on income.
3. Increasing the efficiency of taxation system by decreasing the costs and time of collecting tax incomes. 4. Concentrating all the activities of the collection of taxes and omission of all other fees and indirect incomes in one organization. 5. Increasing the co-operation of people in collecting tax incomes and encouraging the self assessment.
In order to better understand the reasons of using the value added tax system by the countries that are choosing it as their taxation system in the following sections we discussed each of the above advantages in more detail.
4-1-
Due to the vastness of tax basis of value added tax system which usually includes the majority of goods and services, this kind of taxation called by governments as a "money producing engine". The reason of using this metaphor is the tax basis in this model which includes the vast groups of goods and services and also the large and floating incomes which it generates for the governments. Taxes which were collected by the objective of balancing the distribution of incomes or achieving economic efficiency usually has the smaller tax basis and higher tax rates. On the other hand, increasing the tax rates due to the fact that decreases the investment and production motivation causes the black-market and prepares the situation for tax evasion and ultimately decreases the government income. But due to the vastness of tax basis in value added tax system, the governments can use the lower rates of taxes on all the final sales related to all economic sectors and as a result can generate more income for covering their expenses without decreasing the investment motivation.
One of the main reasons of opposition of VAT, is the practical difficulties of implementing the VAT. These problems are as follows: 1234The difficulties of calculating the VAT of retailers and small professional jobs The way to deal with agricultural foodstuff The way to deal with capital commodities The problems of calculating VAT of services firms such as banking and insurance
The explanations of the above problems are as follows: Problem 1: This problem exist in many countries especially in under developing countries, because the number of retailer in these countries are too high. Therefore the solution is a reengineering in economic and cultural structure.
Problem 2: The experiences of countries that used the VAT , shows that the majority of countries which used the VAT for two reasons exclude the agricultural foodstuff from tax basis: 1) due to the social equity and the policy of supporting the low income groups and 2) the implementation problems of this kind of taxation.
Problem 3: In relation of capital commodities, the under developing countries due to the need of motivating investment, excludes the capital commodities from tax basis or decreased the tax rates of this group of commodities to the minimum or zero. Or the tax fees correspond to capital goods of business units will be deducted once or proportionally from their sales tax.
Problem 4: In relation of financial services units ( especially banking and insurance companies), these group of business units are excluded from tax basis due to the following reasons: The difficulties of assessment of value added in this kind of businesses The lack of specified and clear criteria for assessment of the value added of this group of businesses, the assessment of value added done by the method of tax agent self judgment. The transferring of financial investments due to the taxation costs will be decreased. The assessment cost of value added in these businesses is greater than the resulted income.
inflation rate and only in 6 countries or 17 % of them the use of VAT followed by an increase in inflation rate, because in these later countries the use of VAT simultaneously followed by a monetary and wages inflation policies and due to this fact it can't be reached to this conclusion that the use of VAT cause the inflation. The result of international monetary foundation ( IMF) shows that , the use of VAT in majority of countries which used it, has no inflation effects , but even if the use of it cause an increase in inflation rate, it can be justified by price controlling polices.
In general taxation is one of the important tools of governments for motivation and directing investments. For example; the government policies in tax abatement and tax discounts can be increase the final efficiency of investment and as a result increase the profitability of the investments and in this way can increase the motivation of investments in economy. In addition if the financial policies of governments be in a manner which increases the effective demand on certain goods, the motivation of increasing the rate of capital formation of capital will be increase. On the other hand in analyzing the effect of taxation on motivation or dimotivation of investment, factors such as the aim of investment, the reaction of people in saving, domestic and external investors toward capital flow on international scale and the motives of taxation should be considered. Those who are agree with VAT , believed that this kind of taxation motivate the investment. By tax excluding the capital commodities or by tax shielding the capital goods bought and used in the flow of production ,the level of the saving and investment will be increase in economy. The experience of countries shows that by excluding the capital goods from tax basis the investment rate increase in economy.
The neutralization of any economic polices means that, it has no effects on economic resources; because it made no changes on relative prices. This character shows itself on value added tax, because it requires a fixed rate of taxation not only in section of economics, but also in all sectors. In other words, if the tax rate in one sector be higher than the other sectors of economy, or tax reduction or zero tax rates exist in a economy will influence the resource allocation and then it can't be said that is neutral. Any way, if the aim of tax basis on VAT system is vast and the tax rates have no differences , the degree of neutralization of VAT will be greater.
In Majority of developed countries, value added tax system is a substitute of the tax on consumption and other taxes, especially company tax. By using the VAT , it is expected that this substitution make an positive effects on production and economic growth. Now, the question is, if in a certain economy this kind of taxation, introduced for the first time and the aim of using it be achieving to the increase of government income from taxation, is this expectation be valid ? In fact, the effects of VAT on economic growth depend on the design and especially the aim of substituting it for the other methods of taxation, and it can't be foreseen from the beginning.
In relation of the VAT on economy efficiency, some of the economist believes that due to the fact that value added is calculated from the following equation, using this kind of taxation system doesn't work against none of the production factors. And thus it increases the economic efficiency. Value added = wages + interest + rent + profit
On of the indirect effect of VAT, is the positive effect of it on the balance of payments of the VAT user country. It is obvious that this conclusion can be made, when the VAT cause a change on the relative prices of importing commodities than on exporting commodities; in other word if after using VAT , the exporting goods prices become cheaper and the importing goods prices become expensive or unchanged, then we can hope that the balance of payment will be improve. As in this case, we can't expect any changes on foreign exchange rates and the only possible change will be from using VAT. This conclusion depends on many factors, although , it is possible that the experience of some countries prove this positive effects of VAT on balance of payment, but it's theoretical base doesn't prove it as a definite result in a certain direction.
Some of the critics believed that using the VAT will cause the enlargement of public sector and the power of financial decision maker will be increase. According to this critic , any decrease in government incomes can be substitute by increasing the tax basis or tax rates. In addition , it is said that, the substitution of value added tax in stead of taxes on limited tax basis, due to the largeness of tax basis, will be increase the tax incomes. On the other hand, using the higher rate of taxes may be motivate the
producer to work more and by development of productions, the tax incomes of government will be increases. On the other hand, due to the two side controlling character of VAT system, the opportunities of tax evasion will be decrease. All the above mentioned factors are reasons of increasing the government incomes and the enlargement of public sectors.
Conclusion:
Value added tax is a kind of taxation on multiphase sales, which is calculated on the base of a percentage of value added on each stage of production. The VAT has three type : production, consumption and income. The production type ( P-VAT), has the largest tax basis, and the consumption type ( C- VAT) has the smallest tax basis , many of the European countries as well as other developed countries use this type of value added tax system. The income type of VAT ( I-VAT) calculated on the basis of gross national product. Value added tax has it's own advantages and disadvantages. The advantages of VAT are : the neutrality , the minimization of the opportunity of tax evasion, the minimum negative effects on resource allocation, the facilitation of entering in regional protocols, the ability of income generation for government and etc..The disadvantages of VAT are: the diminution effect of VAT, increasing the price level and the difficulties of implementation. The VAT, has economical effects on macro and micro level; variables such as efficiency, price level, balance of payment, investment, and saving . The main reasons of using VAT by governments are : increasing the income tax of governments, decreasing the tax screw on production and investment on productive sector and also the increase of efficiency in taxation system.