Time to Add Value (Added Tax)?Posted July 26th, 2011
Why is This Topic Important to Wealth Managers? This blogticle discusses the Value Added Tax or VAT. As our debt limit debate continues, we examine one avenue the government may consider to close the deficit.
General dissatisfaction with the federal tax system by the taxpayers has contributed to a debate about U.S. tax reform, including proposals for a national consumption tax. One type of proposed consumption tax is a value added tax (VAT), widely used around the world.
A VAT is levied on the difference between a business’s sales and its purchases of goods and services. Typically, a business calculates the tax due on its sales, subtracts a credit for taxes paid on its purchases, and remits the difference to the government. VAT liability is typically calculated in industrialized countries using what is known as the credit invoice method. Under this method, businesses apply the VAT rate to their sales but claim a credit for VAT paid on purchases of inputs from other businesses (shown on purchase invoices). The difference between the VAT collected on sales and the credit for VAT paid on input purchases is remitted to the government.
Example: VAT with a 10 percent rate. A lumber company cuts and mills trees and has sales of $50 to a furniture maker. Assuming no input purchases from other businesses, to keep the illustration simple, the company adds the tax to the price of the goods sold and remits $5 in tax to the government. The purchase invoice received by the furniture maker would list $50 in purchases plus $5 in VAT paid.
If the furniture maker has sales of $120 to a retail store, $12 of VAT would be added to the sales price but the furniture maker could subtract a credit for the $5 VAT paid on purchases and remit $7 to the government. The retailer would receive an invoice showing purchases of $120 and $12 of VAT. Similarly, if the retailer then has sales of $150, $15 of VAT would be added but the retailer could subtract a credit for the $12 paid on purchases and remit $3 to the government.
Yes, there is revenue for the government in the VAT tax, but what will the costs of administration be? A VAT, like any tax system, will require government resources to administer. The drivers of administrative costs in many tax systems include the number of taxpayers (businesses, individuals, or both) subject to the tax, how often they file returns, and the percentage of taxpayers audited. In the case of a VAT, administration requires the government to process tax returns and provide certain services to businesses.
Even a simple VAT warrants education and assistance services, in part to address compliance risks. Tax administrators also need to spend significant resources on audit and enforcement activities.
Some available data from the Government Accountability Office indicate a VAT may be less expensive and easier to administer than an income tax. In 2006, the tax administration agency in the United Kingdom measured administrative costs for the VAT to be approximately half a percent of revenue collected compared to over one and a quarter percent for the income tax.
Tomorrow’s blogticle will discuss issues related to regulation.
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