Running head: VALUE ADDED TAX

Value-added tax (VAT)

Name:

Institution:
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Value Added Tax

Concept of VAT

Valued added tax is an indirect tax normally on domestic consumption of commodities

(goods and services), apart from the Zero rated ones such as drugs and food (Bird & Gendron,

2007). The principle of awarding tax credit underlying value added tax ensures that once the raw

materials passes various stages of manufacturing and the finished good passes various stages of

distribution, tax is only levied on the value-added at each and every stage not on gross sales

price. In so doing, the same product cannot be taxed repeatedly.

The tax burden is thus passed once the commodities are sold, and this process continues

till they are consumed by the very end users.

For instance, once a computer is manufactured by an organization, it is charged VAT on

all supplies it bought for producing the computer. After the computer reaches the shelf, a

consumer who buys it is expected to pay the VAT that is applicable to him. The consumer

ultimately pays value-added tax since the set purchase price includes this cost (Ebrill, 2001). In

VAT, taxation is collected in a number of ways. However, the two most rampant methods are

subtraction methods, otherwise referred to as business transfer tax and credit invoice method.

Pros and Cons of VAT

1. Economic efficiency and neutrality issues

A uniform and broad based VAT promotes economic efficiency and promotes neutrality

in comparison to others forms of taxes such as corporate and individual income tax. Since it

taxes consumption instead of income, value added tax have a tendency of not interfering with
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individual decisions to not work or work, save or consume, hence enhancing economic

efficiency (Tait, 1988).

Nevertheless, to an extent deviation from the idyllic VAT taxation are applied through

devices such as exemptions, preferences and multiple tax rates, efficiency and neutrality can be

affected adversely. Tax administration also becomes quite difficult and complicated to enforce.

For some social, political or economic reasons, most VATs tend to exclude various services and

goods or taxpayer classes from it (Bird & Gendron, 2007). Moreover, certain services and goods

are excluded from value added tax due to intricacies in measuring consumption incidences or

value added amounts.

2. Administrative issues

Value added tax on particular services is quite easy to levy and ascertain, such as on

accommodation, equipment and automotive rentals, public utilities, professional services (legal,

engineering, accounting and consultation) and repairs. However, there are other services, which

posses some, practical problems that make administration, measuring and assessing of VAT

quite hard. This has resulted to a number of countries exempting particular services such as

insurance, banking and other financial services from value added tax (Seidman, 1997).

Some individuals consider VAT to be beneficial as it offers a simple, economical and

convenient method of payment for consumers and calculation. Normally, VAT is calculated at a

point of sale for the customers where they pay for them as a part of their purchase price. VAT

also provides a stress free computation in comparison to income tax from the standpoint of a

business. For administrative convenience, particular sellers, like small scale sellers are exempted

from registration with a government and remit and collect the value added tax.
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In addition to the industry sector, as well as, the consumer administrative concerns, some

people opposes imposition of VAT on services and goods, claiming that it might create

complexity similar to those encountered by local and state government as impose sales tax on

diverse bases. This could make it extremely hard to piggyback such taxes, in addition to, causing

complications in the administration of sales to consumers.

3. Issues of fiscal responsibility

While proponent of VAT sees it as an effective and efficient method of raising revenues,

the opponents opposes it contending that VAT is an effective method of raising revenue which

would promote decreased expenditure discipline on the very part of a government. This would,

however, be boosted with a simpler increase in the rate.

4. Global issues

In the global economy, the value added tax may be utilized in allocating tax to a

destination country, where the services or goods are consumed, whether abroad or here. This is

done through border adjustment where tax is removed from the exports and then imposed on

imports, hence leading to similar taxation as the produced goods in the destination country,

making them competitive with one another.

5. Incidence issues

People advocates VAT contending that it is fair as it taxes the similarly situated

consumers all in a similar manner. Nevertheless, others criticizes it saying it is unfair and

inherently regressive, since most middle and poor class people have a tendency of spending high

percentage of their salaries on purchases in comparison to their wealthier counterparts, leading to

taxation of high fraction of their salaries.

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There can be a number of options used to restore the progressivity degree to this sort of

taxation system, comprising of things such as provision of refundable credit via income tax

system, augmenting government transfer payment and exempting particular services (particularly

necessities) such as medicine and food from taxation. Some systems of value added tax also

attempts to inject the degree of progressivity through imposition of high tax rates on luxurious

item and goods which might be purchased heavily by wealthier people.

Regressivity, nevertheless, is not the sole source of opposition in respect to the VAT. The

elderly and the retired are also prone to take issues with it. When they used to work, they

obviously paid some tax on their respective income. Now that they are retired, they shall also be

expected to be taxed once they spend their retirement kitty and savings. As with the options of

restoring progressivity to the value added-tax tax system, there are means through which this

concern would be solved. For instance, it could be solved through exemption of the chronically

ill, disabled and elderly taxpayers from VAT (Tait, 1988).

Merits of VAT in the US

Imposing VAT in the United States would bring about several merits. For instance, VAT

could help in solving the current federal deficit problems in the US. Furthermore, it could also

boost the household saving, in addition to reducing excessive borrowing.

Opinion on whether to Impose VAT in US

If VAT is adopted as an alternative for US’s income tax system, some far-reaching rules

must be implemented and designed, and would need considerable lead time to put into practice.

As such, it would not be a good idea. Similarly, as the add-on tax, it would entail some
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significant efforts and cost in setting up the extra government structures so as to administer and

accommodate it parallel to income tax, including training and hiring of considerable numbers of

officers to enforce it.

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References:

Bird, R. M., & Gendron, P.-P. (2007). The VAT in developing and transitional countries.

Cambridge: Cambridge University Press.

Ebrill, L. P., & International Monetary Fund. (2001). Taxing and pleasing: Design,

implementation, and impact of the VAT. Washington, DC: International Monetary Fund.

Seidman, L. S. (1997). The USA tax: A progressive consumption tax. Cambridge, Mass. [u.a.:

MIT Press.

Tait, A. A. (1988). Value-added tax: International practice and problems. Washington, D.C:

International Monetary Fund.