Multiple rates affect efficiency, increase complexity

Taxes have been with us for as long as civilisation, so the VAT, at 61 years, is relatively young. Although appealing in terms of rising revenues, VAT has reached a turning point as countries reflect on the need to raise revenue to deal with the significant increases in public debt caused by recent economic and financial crises. Literature on comprehensive tax reform generally recommends a fiscal regime with significant reliance on consumption-based taxation. This results in more saving and investment with a higher growth rate compared to a tax regime weighting heavily toward income taxation. A higher value-added tax (VAT) rate is related with lower compliance. This tradeoff limits revenue-maximising VAT rate to below 25% and compliance is also considerably lower with multiple VAT rates. An extra dollar spent on administration, lifts up revenue by $12, and longer experience with managing a VAT also raises compliance. Destination-based VATs are normally thought to encourage exports, as exports are free from tax while imports are taxed.
Research shows one standard deviation rise in fluidity of political participation and durability of political regime, increase VAT collection efficiency by 3.6% and 3.1% respectively. And one standard deviation increase in trade openness, urbanisation, and share of agriculture change, VAT collection efficiency increases by 3.9%, 12.7% and 4.8%, respectively. Additionally, one standard deviation rise in GDP/Capita increases tax efficiency by 8.1%. Keen (2007) considers three of the most famous series of attacks on VAT. One is fear that VAT essentially does too good a job of increasing tax revenue; second is the vision that VAT does a bad job of taxing informal sector and that for developing countries tariff might be a more suitable revenue-raising instrument. Finally, the third attack, the most factual, is by criminals rather than theorists: sophisticated VAT fraud, aiming its refund provisions, has become a serious concern in European Union and elsewhere. Keen concluded that VAT is, in fact, simply a uniform tax on final consumption, toward which all our simple textbook models in principle are valid. But a less than absolutely functioning VAT is a logical mess, with particularities of compliance behaviour and production relationships. A large number of indirect taxes results in increasing gap between the rich and the poor leading towards exploitation of the labour class. Developing countries are failing to decrease its fiscal deficit regardless of large parts of country's economy, with rich landlords, not being taxed. Unegbu and Irefin (2011) examined the impact of VAT on human and economic development of emerging nations from 2001 to 2009 and found that VAT is becoming a significant source of revenue. The research of Ebeke and Ehrhart (2011) revealed that countries with VAT implication generally experience tax revenue instability forty to fifty per cent lower than the countries which do not have VAT system.
Lawyers are indispensable in making the VAT operationally possible. Unambiguous legislation is essential if a VAT is to be effectively implemented. Under any law, particularly tax which is based on voluntary compliance, there should be clear definition as to who should be taxed, on what, where, when, and to what extent. In legal jargon, terms such as ''taxable person,'' ''taxable and exempt supplies,'' ''place and time of supply,'' and ''taxable value'' should be minutely prescribed. VAT is a transactions tax. As implied by the brief description of VAT rules, the legal profession is adamant about viewing VAT as 'tax on transactions by registered entities against consideration'. Cnossen's (2011) discussion on economists' view shows that the only difference between a consumption tax and an income tax concerns the tax treatment of the normal risk-free return on capital, which is exempt under a consumption tax but taxed under an income tax. It follows that a VAT can be converted into an income tax by disallowing an immediate credit for the tax on investment goods against the tax on sales, but permitting this credit to be spread over the economic life of investment goods. Accountants rightly believe that VAT and other consumption taxes are best understood by working through the computations that are required to ascertain their bases and liabilities from the P&L accounts of taxable business firms. Moreover, this makes it possible to compare the consumption tax base directly with the base of the business income tax, which is also derived from the P&L account.
Lessons from worldwide experiences show that economically, VAT is equivalent to a retail sales tax (RST), even regarding the timing of tax collections. VAT is the preferred form of consumption tax. However, because it is collected piecemeal throughout the production distribution process, it does not interfere with the forms and methods of doing business. VAT unambiguously relieves exports of tax, is politically robust, is least vulnerable to evasion and avoidance, and is relatively easy to understand for the business community.
VAT has been popular as it raises revenue in a neutral and transparent manner (Stéphane Buydens, 2006). Some suggest that ''a VAT is the most effective instrument for generating government revenue'' (Delfin, 2005) and that ''the marginal cost of raising funds for public purposes through VAT is generally lower than it would be if other taxes were employed (Richard M. Bird, 2008).''
Multiple VAT rates affect the efficiency  and increase complexity.  When reviewing existing VAT systems, one important element to consider is the number of different VAT rates implemented in many countries. The existence of multiple VAT rates obviously affects the efficiency of a VAT system and will increase complexity, which may, in turn, increase administrative and compliance costs.
There are two different groups of countries, one that have introduced VAT based on the French model and then European model, and the other that have implemented different VAT rates. The first group of countries, many of which are members of the EU, generally applies several reduced rates so that the tax basis subject to standard rate is somewhat limited. EU member states are to have a standard rate that cannot be lower than 15 per cent and up to two reduced rates that cannot be lower than 5.0 per cent. The second group of countries (including Australia, Canada, Korea, New Zealand, Singapore, and South Africa) has a much broader base at the standard rate. The 1986 New Zealand VAT reform introduced a broad-base VAT with a low single standard rate, a low registration threshold, and few exceptions and exemptions. Developing countries seem to have largely favoured single-rate systems. For instance, of 21 African countries that adopted VAT between 1990 and 1999, 14 have single-rate system. Eight of the nine African countries that have adopted VAT since 2000 have single-rate VAT system (Norregaard and Kahn, 2007).
Economists view that OECD reports since 1980s have clearly supported the view that, other things being equal, a broad-base, single-rate VAT is ideal (Hagemann et al, 1987). This view is supported by recent studies. The 2007 Copenhagen Economics Study (European Union, 2007) and the 2008 draft chapter of the Mirrlees Review of UK taxes (Mirrlees, 2008) supported the view that a broad base with a single standard rate would enable significant revenues to be used while decreasing tax administration costs for governments and compliance costs for businesses.
OECD (Organisation for Economic Cooperation and Development) support on broad-base single-rate VAT since 1980 indicated that in many countries, however, the implementation of one or several reduced rates is traditionally justified by the assumption that the poorest households spend a high proportion of their income on essentials. A report from the World Bank showed that poor South African households spend most of their income (61 per cent) on food, whereas high-income households spend 15 per cent (Go, Kearney, Robinson, and Thierfelder, 2005).  Thus, the poor would suffer more from a VAT on food; reduced VAT rates reduce the supposed regressivity of the tax and achieve some level of redistribution to the poorest households. But this neglects the view that the wealthiest also benefit from these reduced rates. The rich typically consume more of the necessities than the poor (OECD Observer, Oct. 2007).
All economists do not necessarily share the view that VAT is regressive. Some believe that the impact of tax should be assessed over the lifetime of an individual and not on an annual basis. In theory, annual income is low when an individual is young, because that individual is still in school or is just starting employment. It should peak in middle age and then start decreasing in old age because of a loss of efficiency or retirement. Analysing the impact of VAT on the basis of annual income thus presents a more regressive result for the young and old, whereas the same analysis carried out over a lifetime's income might lead to a different conclusion (Neil Warren, 2008). This analysis assumes, however, that all individuals have the same life expectancy and earn on average the same income. The salary of a lower qualified person may not reach a peak at middle life.
Marina Kesner-Skreb (1999) study on Coatia identified ten reasons in favour of uniform rate of VAT. These are detailed as regressiveness is hard to define unambiguously; it is impossible to define the extent of the regressiveness precisely. Empirical research about the regressiveness of VAT largely bears out the thesis that it cannot be used to reduce differences. The introduction of several rates requires a detailed definition of taxable products. Unclear definition of products opens the possibilities for tax evasion. Increasing the number of rates will lead to an increase in the administrative costs of collecting the tax. Lower VAT rates are no guarantee of lower prices. However, lower rates of VAT mean less revenue to the national budget. The EU is tending towards a smaller number of rates of VAT. On the other hand, various rates of VAT distort consumer preferences.
Existence of a reduced rate may render a standard rate more acceptable to taxpayers. The World Bank has noted that South Africa's overall tax system is progressive, whereas the South African VAT is mildly regressive (Go, Kearney, Robinson, and Thierfelder, 2005). ''The progressiveness of the complete tax system should be taken into account and one should not look at the distributional impact of VAT in isolation,'' according to the World Bank report (Go, Kearney, Robinson, and Thierfelder, 2005). In New Zealand, the reform was successful because compensating assistance was applied via the income tax and social welfare systems.
Political economy of tax is the expression of a political consensus. Alain Charlet and Jeffrey Owens (2010) noted that tax is the expression of a political will. The English Bill of Rights of 1689 and the French 1789 Déclaration des droits de l'homme et du citoyen have enunciated  the principle of the consent of people for taxation. The first French revolution was provoked by the gathering of a tax assembly, ''les Etats Généraux,'' to approve new tax measures when the King's power, challenged by the nobility and the clergy, was becoming weaker.
The British in North America imposed tax - the 1764 Sugar Act, the 1765 Stamp Act, the 1767 Townshend Acts, and the 1773 Tea Act -because they needed resources to pay their indebtedness resulting from the Seven Years' War. Herein lies the origin of the phrase ''no taxation without representation,'' which became popular in American circles, as many colonists were not willing to pay since they had no representation in the English Parliament. The American Declaration of Independence on July 04, 1776, also embodies the principle that governments derive their powers from the ''consent of the governed.'' In compensating the losers that VAT might not be a social tool, whereas targeted benefits financed by a broader base (or, as the case may be, a combination of a broader base and an increase of the standard VAT rate) would provide greater benefit for the poor without benefiting the wealthy.
For attaining Vision 2010 suggestion of an uniform national VAT rate for India,  Arvind Virmani (2002) noted that  an ideal indirect structure for the country would consist of two sets of indirect taxes (a constitutional amendment would be needed for this purpose): a single uniform-rate National VAT on all goods and services (except for a limited number of pre-specified exemptions) and State sales taxes on a dozen specified goods with a pre-specified upper limit on the sales tax rate for each of these goods. The Central government would have the responsibility of setting the national VAT rate in consultation with the States and for administering it with the help of the States as needed. Preliminary calculations suggest that a VAT of 15% may be sufficient to ensure revenue neutrality with respect to existing Central & State indirect taxes.
Khan and Nagma (2013) in their study on the "Impact of Value-Added Tax (VAT) Revenue in Major States of India" show that  introduction of State-level VAT is the most significant tax reform measure at State level. The State-level VAT, now being implemented, has replaced the erstwhile sales tax system of the States. Under Entry 54 of list II (State List) in the seventh Schedule to the Constitution of India, "tax on sale or purchase of goods within a State" is a State subject.
Jamaluddin Ahmed PhD, FCA, General Secretary of the Bangladesh Economic Association, is Chairman, Emerging Credit Rating Limited.  [email protected]