Value added Tax Advantages, disadvantages and economic effects

Transcription

1 Value added Tax Advantages, disadvantages and economic effects Table of Contents Introduction 1- The concept of value added tax 2- Different kind of value added tax 3-The reasons of practicing the law of value added tax in Iran 4- The advantages of value added tax 5- The disadvantages of value added tax 6- The economic effects of VAT 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.

2 1- The concept of value added tax Value added tax is kind of indirect tax on consumption and domestic sales of goods and services; this kind of taxation is a multiphase taxation that in each phase of production cycle until final consumption will be collected according to the value added creation. Value added tax is multiphase sales tax which frees the buyers of intermediate goods and services from tax payment. The value added of a business unit is the difference of sales income of goods and services minus total costs or payments for buying the intermediate goods and services. At the scale of national economy, gross national product is in fact the total sum of value added of all business units of the country, because total final sales transaction minus total intermediate transaction is equal to value added. Therefore the value or worth of final sales is equal to the worth of wages, interest rate, rent, depreciation and other payments to the production factors at nation scale which is equal to gross national product. 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. 2- Different kind of value added tax There are three kind of value added tax: value added tax of production type, value added tax of income type, value added tax of consumption type. Each type of value

3 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 product- value added tax In general meaning, product value added tax of the starting point origin, include all the government expenses in the gross national product at the calculation of tax (except government expense for wages which can not be included in calculation of value added tax). By considering the assumption of using the starting point origin, export which has the internal origin will be included in tax calculation; but import which has the external origin excluded from tax calculation. Therefore, we can say that the basis of productvalue added tax (P-VAT) is equal to all the government expenses in the gross national product except government wages expenses. 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 Consumer- value added tax (C-VAT) In consumer- value added tax (C-VAT), depreciation and investment costs are excluded from tax basis calculation. In fact, by excluding the investment cost from production cost, what is remaining is equal to the value or worth of the production of consumption goods. The value added tax system which is used by European community members is the type of this kind, and the tendency of some of the developing countries is to this kind of value added tax model, especially due to the freeness of investment goods from tax which increase the motivation of investment. In addition, this kind of value added tax (C-VAT) from practical point of view is easier than the two other types Income - value added tax (I-VAT) In income - value added tax (I-VAT), depreciation doesn't include in tax calculation and thus the net investment costs doesn't include in tax calculation.

4 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. 2-4 The comparison of three type of value added tax 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.

5 3-The reasons of practicing the law of value added tax in Iran The necessity of reforming Iranian taxation system with a group of course of actions such as foundation of an taxation organization, restructuring the law of direct taxation and introducing and implementing the value added tax as a complimentary of existing direct law of taxation and as an efficient and co-ordinate tools with the economical situation of the country has been foreseen in the third socio-economic, and cultural development plan (3 rd -E.S.C.P) of Iran. In reforming the law of direct taxation system due to the decreases of different rates of taxation- in the sake of increasing the investment and the opportunity of employment and also increasing the productive activities resulted decease of government income. On the other hand, the government of Iran for achieving the objectives forecasted in the 3 rd plan need to the new sources of income. In achieving this objective implementation of new law of value added tax as a one kind of general tax on consumption and sales in the same direction of decreasing taxation load on productive sectors can increase the government tax incomes. Another reason of suggesting the implementation of the law of value added tax, it can be point to the fact that it is a good replacement for many other fees and indirect taxes, which has the vast distortion effects in the productive sectors and on the welfare and behavior of the consumers. As you can see in table 1- omission of indirect taxes and fees causes a great decrease in government income. Thus, value added tax in addition of reparation of the income decrease of government can also increase the government tax incomes according to the forecasted amount in the 3 rd plan. Table: 1 the comparison of indirect tax incomes with the total tax incomes of government in 2000 and Actual 2000 Actual Tax incomes Indirect tax incomes Tax on import Custom duties (11378) (20472) Others (400) (800) 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.

6 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. 4- The advantages of value added tax During the last 40 years that the value added tax system has been used, the number of countries which added to the user of this kind of taxation system increased to more than 120 countries. This taxation system which was used at the beginning only by European countries, gradually with an increasing rate used by many developed and under development countries. By reviewing the reports of those countries which has been using the value added tax system, all of them demonstrate their satisfaction of using it. The advantages counted for the value added tax system are as follows: Income generator for covering the government expenses Stability Minimizing the tax evasion The ease of auditing control Disciplined trade Improving foreign trade Rebuilding the economy Effective support The minimum negative effect on allocation of resources Facilitating the entrance to regional protocols Resolving the negative effects of taxation on economy Etc... 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 Income generator for covering the government expenses

7 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. 4-2 minimizing the Tax evasion In the value added tax model due to the lower rates of taxes in comparison to other type of taxation system with the limited tax basis, the tax evasion decreases and as a result the a reliable source of income made for governments. On the other hand if one firm (seller) "cheats" it means another firm ( the buyer) loses, because both firms have to report their transactions and they have opposing interests, the system is selfenforcing and that makes evasion difficult Facilitating the entrance to regional protocols Some of the regional protocols due to the reasons such as: The necessity of unified model of taxation system in economical relations between the members of protocols, creation of unified tax screw, motivating the members toward efficiency, development of industries, using the benefit of neutralization and increasing the internal competition, made the admission of the value added tax as one of the criteria for acceptance of the members in protocol restructuring and improving the taxation system As the structure of economy growth and become more complicated, the necessity of keeping accounts in different small and big size business units increases. Thus, in value added tax system, each business unit required to keep it's account in a comprehensive manner, so the use of computers for record keeping and processing data in order to produce timely information is more than the traditional tax system models and thus it will result the renewal and deep change in old and traditional taxation system and a dramatic improvement in times and jobs of tax system personnel.

8 4-5- The ease of auditing control Due to the fact that in value added tax system, the invoices of sales are the base of tax calculation and the amount of sales of goods and services recorded in the specified columns of invoice and according to that value added tax calculated and collected and also because the invoices recorded in the general journal and ledgers of the firms, so (especially in the case of unique tax rate) the system of auditing is simple and effective The minimum negative effect on allocation of resources From economical point of view, value added tax is a neutral tax; because it has no effects on production factors ( investment, employment and etc..) and also has the minimum negative effects on economical decisions of the business units. The reason is because in value added tax system the tax calculated on value added generated by production factors in production cycle and thus it hasn't any bias to an any kind of production method. According to the above mentioned points,it is said that the value added tax has not any distortion on market forces in relation of optimized allocation of resources. The neutrality of value added tax is one of the key reasons of acceptance of it by the central and eastern European countries. 5- The disadvantages of value added tax Usually the governments and their policy maker who have the value added tax system in their agenda, due to the following reasons are worry about the implementation of it as their taxation system: 5-1- the diminution effects of value added tax As the value added tax in practice is a tax on consumption and usually calculated with a fix rate on predetermined commodities, therefore the screw of taxes on low income peoples is greater than the other groups of income. So it is why those countries that starting to use VAT for the first time are worry about the diminution nature of it. There is an answer to above critics and that is as follows: 1) value added tax is not following the social equity objective and the inequity of tax rates by implementing other supporting polices of governments from low income groups can be justified. 2)It can be asked the same question from the opposition of VAT, Do the traditional tax systems really completely fulfill their social equity objectives? and finally because a portion of governments incomes are indirect taxes, the effects of diminution of VAT in comparison to the other kind of taxation especially tax on sales in different stages is significantly lower.

9 5-2- The effects of value added tax on increases of prices level Some times the above mentioned sentence appear as a criticism against VAT, but the experience of those countries which implement and used the VAT shows that there is not any thing to be worry about, because first of all the opposition of VAT can't propose any rational reasons for increasing the general price levels and secondly using the VAT system cause a deflation on economy and as a result has a deflation effects on economy Practical difficulties of implementing VAT One of the main reasons of opposition of VAT, is the practical difficulties of implementing the VAT. These problems are as follows: 1- The difficulties of calculating the VAT of retailers and small professional jobs 2- The way to deal with agricultural foodstuff 3- The way to deal with capital commodities 4- 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.

10 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. 6- The economic effects of VAT The economical effects of value added tax system can be categorized in two groups: 1) the macro economic effects such as the effects of VAT on economic growth, level of prices, investments, government incomes, consumption and etc and 2) the micro economic effects such as the effects on efficiency, social equity and etc 6-1- The effects of VAT on prices level Some of the countries said that one of the main reason why they didn't use the VAT,is because they think there is a positive relation between the VAT and inflation rate. On the other hand, the experience of countries which have been using the VAT doesn't show the correctness of the above reason; but the financial experts believed that using the VAT like other kind of taxation systems, is a deflation policy, therefore the use of VAT will be resulted a decrease in monetized economy. So we can say that the use of VAT has a deflation effects on economy. Other experts believed that if by using the VAT the total demand increases more than total supply,it will cause a an increase in prices level, but the demand surplus and the shortages of supply may be the result of many other reasons and it is not fare to relate it only to VAT. In addition, the International Monetary fund (IMF) had a survey on 35 countries which are using the VAT and reached to the following results: The use of value added in 22 countries hadn't any major effects on price level of goods and services or had a minimum effects. In 8 countries the use of VAT was resulted by an increase in whole seller indices of goods and services but among these 8 countries only in one case the inflation rate increase and in other 7 countries the trend of price levels didn't show any abnormal increases. In other word, the use of VAT, in 29 countries or 83% of the countries reviewed didn t cause increase in

11 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 Motivation of investments 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 character of VAT 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. 6-4 Increase of economic growth

12 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. 6-5 The efficiency of economy 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 6-6- Balance of payments 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. 6-7 The enlargement of public sector 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

13 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.