Indirect Taxes

Ian Crawford (Surrey / IFS)
Michael Keen (IMF)
Stephen Smith (UCL)
Introduction

Developments in theory since the Meade report have
considerably altered our understanding of the
contribution that can be made by indirect taxes to
revenue-raising efficiency.

The VATs of EU member states have now run for some
35 years. Time for a review?

The elimination of internal frontiers in the EU has
brought new issues of administration, enforcement and
tax competition.

There have been suggestions that the existing VAT
struggles to handle some recent developments in
business activity and organisation, such as the growth of
services and e-commerce.
Outline and key issues

Theory, and empirical results
• The rationale for indirect taxes.
• Uniform vs differentiated commodity taxes

Indirect tax systems
• VAT versus Retail Sales Tax, etc

International aspects of indirect taxes
• VAT treatment of international trade in goods and services

Conclusions: what future for indirect
taxes?
Principles

The rationale for indirect taxes.

Why do we have them at all?

Equivalences between indirect taxes and other taxes

Uniform vs differentiated commodity
taxes

Efficiency

Equity

Administrative considerations

The incidence of indirect taxes: who
bears the burden?
Empirical evidence / results

The key parameters: What does the
empirical evidence show?

Summary of the state of knowledge about elasticities of
demand, cross-elasticity with labour supply, etc.

VAT, excises and income distribution

Simulation of uniform VAT versus UK
zero-rating.
Indirect tax systems

VAT versus Retail Sales Tax

(and, more briefly, different forms of VAT)

Practical compromises

VAT registration threshold

Treatment of financial services

other hard-to-tax goods and services

VAT and capital goods

Enforcement and compliance aspects

Evidence on VAT compliance costs

VAT evasion

Specific versus ad valorem taxes
International aspects 1

Origin and destination principles
• Conditions for equivalence, etc

Different VAT mechanisms for cross-
border trade
• export zero-rating
• VAT-inclusive exporting (as Commission 1987)
• VIVAT, etc

VAT and international business
organisation
• The Commission's 1996 definitive regime proposals, based on a "single
place of taxation"
International aspects 2

Indirect taxes and cross-border shopping

implications for revenue-maximising tax rates

case for rate harmonisation?

VAT and internationally-traded services

Reasons for complexity, and growing
significance of the problem

Basic principles

E-commerce
Conclusions: what future for
indirect taxes?

VAT will remain central component of tax
system

Substantially greater revenue potential than RST

The UK’s VAT zero rates

Hard to justify. Main focus of our empirical simulation.

VAT treatment of international trade

Strong case for moving to a system that does not break
VAT chain at borders (eg “exporter rating”, or VIVAT)
Applied Issues

Knowledge of demand responses is important

What do we know?

Not a huge amount

Elasticites are heterogeneous

They are hard to measure

Getting income effects right at different points matters

There are few (zero?) published papers reporting
large scale, household-level UK demand systems

So we have decided to estimate one
Applied Issues

We used the Quadratic Almost Ideal Demand
System (Banks, Blundell and Lewbel, 1999)

It’s Rank 3 (so we can get the income effects right)

It’s integrable (so we can do welfare analysis)

It allows a degree of heterogeneity in elasticities.

Data: 25 years of the UK Family Expenditure
Survey (176,068 households)

20 commodity groups (we don’t model leisure)
Applied Issues
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Applied Issues
• Mean elasticities are for the most part moderate
• Classic inelastic commodities appear to be
inelastic
Tobacco: -0.839
Petrol & Diesel: -0.314
• But
Wine & Spirits: -2.995
Applied Issues

We simulated the effects of ending zero rating
and having uniform 17.5% VAT

The tax revenues have been burned

For each household we calculate the welfare
loss:
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h h
m V m V − ∆ +
Applied Issues
Indirect Taxes
Ian Crawford (Surrey / IFS)
Michael Keen (IMF)
Stephen Smith (UCL)