Methods of governments to balance their budgets are a shift from direct to indirect taxation, increase of VAT rates and tax authority scrutiny.
“The global spread of Value Added Taxes (sometimes referred to as Goods and Services Taxes) has been the most remarkable development in taxation over the last 50 years. Operated in less than 10 countries in the late 1960s, VAT now raises one fifth of the world’s tax revenue and still more countries are adopting it. The increasing importance of VAT as a source of government revenue is likely to continue as countries deal with fiscal consolidation pressures in the wake of the economic crisis while seeking to restore growth.” Jeffrey Owens Director, Centre for Tax Policy and Administration at the Organisation for Economic Co-operation and Development
From an economic point of view the question is what the impact will be on the economy in the downturn. Increase of prices and often the same or even lower available consumer’s budgets will result in less spending.
Levy of VAT and impact on shareholder value:
“(UK) Budget 2012: Greggs shares fall on VAT blow. More than £20m was wiped off the value of bakery company Greggs on Thursday, following the Government’s announcement that all hot takeaway food would be subject to VAT.” The Telegraph
US Value Added Tax Is Considered
The effectiveness of indirect tax revenue is – based on considerable amount of tax literature and Reuters‘ article of March 14, 2012 (by Stella Dawson and its quotes are used) – also seen in the United States. Several prominent commentators, politicians past and present have suggested that the introduction of a VAT or GST may be the “least worst” option open to the US government to raising revenue and to combat the deficit.
“Very large changes are necessary. They need to be structural, they need debating, and this is the year to start the process,” Paul Volcker, former head of the Federal Reserve
” About tax reform: the one thing that unites people right now. It is not only central to reducing the budget deficit and increasing growth, but also vital to economic fairness and social cohesion in a society that has largely lost faith in the political system. The richest 1 percent cannot expect a tax cut, and the U.S. budget deficit cannot be reduced by cutting spending alone. A creative approach to taxes must be part of the solution. We should be open to every possibility” Larry Summers, former U.S. Treasury Secretary and Democrat.
“a value added tax should be on the table. We need a combination of tax increases and spending cuts. But we need quality rather than quantity,” Larry Lindsey, a Republican and former Fed governor
“Growth-oriented tax reforms would generally involve shifting revenue from corporate and personal income taxation or social security contributions onto consumption and property taxes, including housing taxation.” Recent OECD analysis of growth- oriented tax reforms concluded that “A revenue-neutral tax reform that shifts the balance of taxation more toward consumption and recurrent residential property taxes could […] strengthen the growth of output over the medium term.” as “… corporate taxes are the most harmful type of tax for economic growth, followed by personal income taxes and then consumption taxes, with recurrent taxes on immovable residential property being the least harmful.” (OECD (2010), Tax Policy Reform and Economic Growth, OECD Publishing).
Some Highlights Of European Union Value Added Tax System
What does it actually mean: an ‘European’ Value Added System?
In its most elementary form a business will charge VAT (‘output tax’) on its sales (‘supplies’), but will be entitled to deduct the VAT (‘input tax’) that it has paid on its costs and purchases (a multi-stage tax). We note that VAT can only be deducted if the invoice meets the invoice requirements (the conditions for this are summarized in national VAT Act) and is reclaimed in the right country (e.g. Italian VAT must be reclaimed in Italy) in the correct period. If these requirements are not met there is a substantial risk of additional VAT assessments increased with penalties and/or interest as a result of e.g. a VAT audit.
In the European VAT system one of the basic principles is that input VAT (VAT paid) can be off sett against output VAT (VAT charged). In case of a surplus of input VAT a refund of tax is claimed and often paid by the authorities.
Neutrality can only be achieved – better is the word earned – if certain formal and material requirements are met.
That means in practice that input VAT deduction and output VAT has to be managed separately to avoid substantial VAT assessments, penalties and interest payments. It is risky business to monitor only the balance between output VAT and input VAT.
Allowing businesses the opportunity to collect and retain large amounts of tax can leave the system open to fraud and manipulation by dishonest taxable persons. VAT fraud is for a while a key issue for all European Member States.
“11 percent of VAT revenue is lost annually through fraud – principally ‘missing trader’ or ‘carousel fraud’ – which equates to in the region of €100 billion” PwC report
Macroeconomic Effects – National Retail Organization Report
The National Retail Organization published their report about introduction of a VAT system and the macroeconomic effects. It was on their request written by Ernst & Young LPP, Tax Policy Advisers LLC and Baker Institute for Public Policy and Economic Department, Rice University.
The executive summary:
- “As a consumption-based tax, an add-on VAT would be shifted forward to consumers through higher consumer prices. As a result, private consumption would fall. By increasing consumer prices, the VAT also reduces real or inflation-adjusted wages, which would cause labor supply to fall as well.
- An add-on VAT would have particularly adverse effects on the retail industry. There would be an especially pronounced reduction in retail spending because nearly all retail goods would be subject to double-digit VAT rates, while many other consumer purchases would be exempt under a narrow-based VAT. In addition, some consumers would evade the tax – experience in other countries suggests 12 percent non-compliance with the VAT – driving up the VAT rate.
- Moreover, an add-on VAT leaves the economy considerably worse off than a similarly-sized reduction in government spending on income transfers. With an add-on VAT, GDP would initially be lower and the economy would lose jobs; by comparison, GDP and employment would increase with a reduction in spending. Although lower deficits and debt would have positive long-run economic effects for the economy, most middle income Americans who are working age or older at the time of enactment of the VAT would be worse off.
- Perhaps the most troubling aspect of a deficit-reducing VAT is that, if enacted in the near future, its negative effects on GDP, consumer spending, and employment would occur in the face of the current economic climate of weak economic growth, high unemployment, and low consumer confidence. The near-term drop in output, loss of jobs, and sharp decline in consumer spending described by this report would raise additional economic worries, rather than shoring up the weak economy. With the CBO projecting unemployment to not fall below 7 percent until 2013, the initial reduction in employment from a VAT, estimated to be roughly equivalent to 850,000 jobs, would make full economic recovery much more difficult.” – National Retail Organization –
Is the time right?
Some quotes from Reuters article:
“While tax reform as part of a budget overhaul is unlikely immediately after the November elections, progress needs to be made in crafting solutions” Larry Summers, former U.S. Treasury Secretary and Democrat.
“There is a realistic chance that Republicans and Democrats after the election would be ready to strike a bipartisan accord on the budget deficit and taxes” Robert Rubin former U.S. Treasury Secretary and Democrat”
- Based on the macroeconomic data is it smart to introduce a VAT system in the downturn?
- Is the first priority not to realize economic growth, establish trust in the market and therefore should the focus not be on findings ways to increase consumer spending?
- Is the introduction of a VAT system not counterproductive?
“Raising the standard VAT rate has often been considered as the easiest way to increase revenues from the tax, particularly at a time when many governments are seeking ways to address large fiscal deficits. Some countries have even explicitly linked rate increases to the objective of fiscal consolidation. For instance the Slovak Republic has temporarily increased its VAT rate until the deficit will be reduced to below 3% and in Poland the VAT rates will automatically increase if the public debt to GDP ratio increases above a certain level.” Jeffrey Owens Director, Centre for Tax Policy and Administration at the Organisation for Economic Co-operation and Development
How do you see this?
When somebody wins, somebody else must lose. Without any doubt indirect tax is the right and maybe only way to combat the deficit, unless of course the US government is going to cut their spending substantially. I don’t consider that likely. Do you?
Who might feel a loss and what do politicians need to manage to make it happen?
Besides the end consumer, companies might consider it a loss. The implementation and compliance costs (e.g. managing ongoing the VAT numbers) and associated tax risks are bottom line costs of companies and a decrease of corporate income tax is above the line. The question is whether the shift from direct (e.g. lowering corporate income tax) to indirect tax introduction is seen still as a positive.
The retail industry in general will face real costs and it is not a real surprise that the negatives are highlighted in the executive summary of the report of National Retail Organization. It seems that the lobby against has already started. The drop of Greggs share value is a good war story to use in that quest.
Public support for a VAT introduction – assuming it exists – will likely be lost when anti-fraud/tax evasion legislation causes disruption to daily business and is the cause effect of substantial implementation costs.
How do you see this?
Erik van der Hoeven started a discussion on March 9, 2009 with a simple question” Will the US introduce a VAT” on the LinkedIn group “The Indirect Tax Network“. This will be his attempt to break the longest discussion ever on LinkedIn as the topic is and will stay hot for the next couple of years. Click on The Indirect Tax Network and give your view as well.
Some Comments After I Posted My Big4.com Guest Blog
John Mikesell, Chancellor’s professor at the Indiana University:
“Interesting blog post, Richard. And it will be interesting to see what the Gregg share reaction will be in the next several days, as the market adjusts and figures out what applying the tax will actually mean. I’m going to use it in my tax policy class next week. It also illustrates the basic principle about levying a tax — the purpose of the tax is to move resources from private use to public use and the private sector is going to be hurt if the tax does what it is supposed to do. The objective of tax policy is damage control, not damage prevention.”
Mark Houtzager, US VAT Inc.:
“Richard has a good point re: the retail industry. But have a look at how France deals with their (potentially) upcoming VAT rate increase – payroll taxes are lowered (or eliminated) at the expense of a higher VAT. The idea behind it is to improve France’s export position / trade balance, by lowering cost of labor (which is admittedly crazy high in France). I think that if the U.S. would ever introduce a VAT or federal consumption tax, the introduction must be accompanied by significant federal tax cuts for businesses and especially the retail sector. Assuming that businesses are smart and don’t immediately pocket the tax cut, the retail prices would not increase by 5% (but by say 2%). John’s point of tax policy as a tool for damage control would then be met.”
Michael Bindner, Principal, Bindner Analytics/Center for Fiscal Equity:
“My proposal for a VAT-like Net Business Receipts Tax is an example of damage prevention. It is also an attempt to allow the private sector to accomplish public purposes if it can do so more cheaply and with better quality. In my latest comments for the record, I have it replacing the employer payroll tax for Social Security, decoupling the contribution from the employee contribution so that each eligible worker gets the same amount credited to their account. There would be no income cap. If there is a personal account option (holding employer voting stock plus an insurance fund of similar employee-owned companies), then the NBRT is the appropriate vehicle. If there are no such accounts, then a straight up VAT is more appropriate. The NBRT approach would also be useful for health care for both employees and retirees, provided there are opt outs for private coverage. If we had single-payer with no opt outs (like companies hiring doctors and running hospitals – don’t laugh – GM could pull it off), then a VAT is appropriate. With opt outs, the NBRT is. I could go on to include most social welfare entitlements on the federal and state levels as NBRT possibilities.”
John Mikesell, Chancellor’s professor at the Indiana University:
“Has anyone quoted Larry Summers recently in the discussion? The US will get a VAT when the Republicans realize that the tax is regressive and the Democrats realize that it can produce piles of money. Another quote for which I don’t have the source: A VAT for the US is five years away, always has been and always will be.”
Kris Boucquez, European VAT Manager at Umicore:
About above PwC quote.
“In my opinion, the PwC-quote should be read in the light of the Reckon Report On The VAT Gap and the PwC-study on alternative VAT collection methods. The Reckon-report estimated the VAT Gap at about 106 billion per year (12% of full theoretical VAT revenue). This detailed study for the EU Commission triggered the political and populistic perception that the annual VAT losses due to VAT fraud is about 100 billion a year. This is not exactly what the report says. In the Reckon-report the VAT Gap also includes other VAT losses further to other reasons than VAT fraud like VAT-avoidance, non-fraudulent insolvencies and unintentional mistakes. In the Reckon-report there is also a long list of assumptions and caveats because there is very little reliable data available to calculate the level of VAT fraud. PwC did not make such Reckon like study. In the area of “fight against VAT fraud” PwC made study for the Commission on methods for better collection of VAT through different methods like ‘split payment’ etc. Those alternative (and business-unfriendly) collection methods mainly aim at reducing the VAT GAP by making missing trader fraud impossible… Such studies are only worth doing if you believe that VAT fraud is principally ‘missing trader’ or ‘carousel fraud’. Such belief is scientifically not verifiable to be right nor wrong to date.”
Richard Cornelisse is CEO of the KEY Group and worked previously as Big4 Partner in the Tax Performance Advisory and Indirect Tax Practice and blogs on Tax Function Effectiveness and Tax Control Framework developments.