The issue of popular acceptance of a tax system

ADMINISTRATIVE ISSUES:  A broad-based VAT would cost less to administer than the current income tax. For example, in the United Kingdom, administrative costs of the VAT were less than half of that of the income tax, measured as a share of revenue. Similarly, the New Zealand revenue department was required to intervene in just 3.0 per cent of VAT returns, compared to 25 per cent of income tax returns (GAO 2008).  VAT has compliance advantages over a retail sales tax, which aims to collect all revenue at the point of sale from a business to a household. Since revenue collection for VAT is spread across stages of production, with producers receiving a credit against taxes paid as an incentive for compliance, the VAT in practice is less likely to be evaded. Gale (2005) discusses administrative complications of a retail sales tax and the changes in tax rate resulting from an erosion of the tax base due to evasion.
Some observers argue that VAT is such an efficient and invisible tax that it has been and will be used to fuel government spending increases through a gradually increasing VAT rate. Bartlett (2010a, 2010b) addresses this claim by noting that increased VAT rates in OECD (Organisation for Economic Co-operation and Development) countries were common among early adopters, who operated VAT in high-inflation environments in the 1970s, but far less common among countries that adopted VAT after 1975. Among the 17 countries that instituted VAT during the post-1975 period of relative price stability, four have not changed their VAT rate and four have decreased the rate; the average rate increase across all late-adopters of the VAT is less than 1.0 percentage point. The average VAT in OECD countries has been roughly constant since 1984 at or just below 18 per cent.
ELECTORAL SUPPORT: Politicians tend to be more often the focus of analysis than bureaucrats. Tommasi et al. (2001), for example, seek to explain tax policies as the final outcome of political transactions involving incumbent politicians. The rules of the political game under which politicians are elected and hold office will condition every policy. A median voter argument can be formulated as follows: as inequality increases, voters prefer higher taxes so long as these taxes are followed by state-enacted redistribution (Alesina and Rodrik 1994). Redistribution would, therefore, result from voters forming a majority that presses for progressivity. Similarly, Lledo et al. (2004) argue that once veto players and institutional constraints are accounted for, political optimality theories can provide a solid basis for addressing the political obstacles to reform.
PARTISAN ALLIANCES AND SUPPORT: It has been argued that the relative strength of political parties in parliament can have an effect on the approval of a tax reform, given the possibility of stalemates and conflicts in legislatures (Lledo 2004; Melo et al. 2010). Empirical evidence from developed countries indicates that states run by left-wing parties tend to mobilise higher tax levels and adopt more progressive tax structures than those run by conservative, right-wing parties.
ELITE INFLUENCE: Sokoloff and Zolt (2006) ascertain that, at a political level, severe inequality can be created when powerful groups minimise their relative tax burdens either by directing the policymaking process to the design of specific tax instruments, or by controlling tax administration so as to permit substantial tax evasion. Similarly, Bernardi et al. (2007) argue that social inequality may lead to "elite groups" making every effort to introduce tax legislation that pushes a major portion of the fiscal burden onto lower income sectors.
Fairfield (2010) explores the power of the business sector which is exerted through organised associations or by individual firms and investors. In order to protect the interests of upper-income groups as well as corporations during the reform of the tax system, businesses are keen to engage in deliberate political action.  More generally, a bias in tax policymaking favouring business interests can be created through recruitment of business leaders into government, government-business coordination, and partisan linkages. Recruitment into government provides an opportunity for business leaders to take direct part in policymaking by occupying high-level positions in the executive branch. Cross-sector coordination in the form of regular government consultation and collaboration with a range of business associations can produce incentives to avoid conflict over taxation. The partisan linkages can provide representation of business interests in parliament with veto power on taxation matters. Tax policy is thus shaped by powerful interest groups that lobby to keep the tax burden unevenly distributed.
POLITICAL LEGITIMACY: Tax literature raises a rather different (though related) issue of popular acceptance of a tax system. Di John (2008) argues that, in the context of intense inequality, implementing more progressive taxes may be a more efficient strategy for promoting legitimacy of the tax system than adopting more neutral value-added taxes. Other works support this view. Sokoloff and Zolt (2006) argue that, the incidence of taxes (i.e. where the tax burden falls) has an effect on both the distribution of income nationwide and the final configuration of public support for a full range of projects. Justino and Acharya (2003) add that, a real decrease in social and political inequalities can only be accomplished by (i) introducing progressive tax systems, (ii) promoting equality of opportunities, and (iii) reducing discrimination.
POLITICAL SURVIVAL: Developing countries face the basic challenge of raising revenue in a way that is not only equitable and economically efficient but also ensures the political survival of the policymakers (Bird, 2008). Because politicians' political survival depends on their constituencies' support, it might be expected that political groups which are more successful in introducing pro-growth reforms remain in power longer, yet the opposite seems to be true. Martínez-Vázquez (2001) argues that, what pushes developing countries to reform their tax structure or tax administrations depends more on politics than the economics of taxation. That is, successful reform efforts depend on abilities, such as arranging a coalition in support of the reform while hampering the rise of other coalitions that oppose it. There must be a politically viable way to move beyond the difficulties of reforming a tax system.
The current literature of political economy on tax reform demonstrates that, in addition to domestic and international pressure, government approaches to tax policy have been in large part shaped by the following political elements: (i) mobilising electoral support; (ii) the strength of political parties and coalitions in the legislature; (iii)  elite control of tax policymaking or tax administration;  (iv) the degree of popular acceptance of tax policy; (v) political survival that depends on a winning coalition of supporters.
Democracy and bureaucracy take a significant portion of the literature. It is observed that taxation status quo is the result of governments attempting to take whatever they could, even in a non-democratic environment. There seem to be two different views on the matter. Sachs (2000), articulating one view, asserts that throughout much of Latin America, leaders who lack popular legitimacy have most tenaciously opposed tax reforms. Huber (2005) gives an explanation for the Argentine case, where large-scale modifications in the tax system (to increase indirect taxation) were accomplished during the military regime, and a series of follow-on measures have not resulted because of significant popular protest. Overall, the widespread democratic transition in Latin America has not significantly reduced the regressive characteristics of the region's tax systems.
A range of political constraints, coupled with conflicting interests in reform outcomes, create hurdles that weak governments are unable to overcome, particularly: (i) political patronage and clientelism; (ii) executive-legislative deadlocks; (iii) failure to win popular support for the reform;  (iv) the weakness of the state vis-à-vis upper income groups;  (v) difficulties in overcoming coordination problems;  (vi) policy-makers' ideological stance; (vii) political influence within the tax administration. Clearly, politics is a key variable that continues to influence tax reform in the developing countries. That said, it is worth noting that some relevant changes are gradually occurring and, as Tanzi (2000) observes, tax systems of the last decade are different to an important degree from those of the 1980s.
FISCAL BUREAUCRACY WITH ECONOMIC KNOWLEDGE: In New Zealand, strong economic specialisation and open recruitment policies within the civil service produced tax policy bureaucrats identified as economists (Johan Christensen, 2011). The 'economists' had a high level of economic expertise and were very receptive to the neo-liberal ideas from the economics discipline. They took an activist approach to policy advice. Through the formulation and advocacy of reform ideas, officials influenced the policy preferences of politicians and led tax policy change in a neo-liberal direction. In Ireland, the persistence of a generalist civil service with closed recruitment policies created a tax policy bureaucracy that is identified as civil servants. They had little economic expertise and was oblivious to micro-economic ideas about taxation, and took a passive approach to policy advice. These features allowed tax policy-making to be completely dominated by the ideas and concerns of politicians, giving rise to a tax policy of low rates, narrow bases and specific tax incentives.
INSTITUTIONALISATION OF ECONOMIC KNOWLEDGE WITHIN THE STATE: Weir and Skocpol's main argument is that the access of economic experts to policy-making and the substantive content of their ideas are shaped by state structures. They argue that various specific structures of the state affect the "processes of intellectual innovation" and "pattern the ways in which experts and their ideas enter into public policy making", thereby affecting "the possibilities for new economic ideas to be formulated and applied to innovative government policies" (Weir & Skocpol 1985, pp.109, 119).
DIGITALISATION OF VAT: Thomson (2006) suggested digitalisation of VAT is a technologically intensive, fully automated VAT that is made available or mandated for the large taxpayers. All invoices, statements, reports, returns, and notices are electronic. All payments, refunds and most audit functions will be digital. The Digital VAT (D-VAT) requires uniform digital identification of each good or service transaction in the economy. Nationally defined, internationally harmonised product and service codes will be used. The D-VAT will certify service providers (CSPs) whose automated invoicing, tax calculation, collection and return preparation and funds payment systems will conform to the highest international standards as set out by the OECD. The D-VAT will allow outsourcing of all VAT compliance obligations to trusted third parties, thereby improving accuracy and efficiency. As under the Streamlined Sales and Use Tax Agreement (SSUTA) use of a CSP will be at no cost to the taxpayers, and except for misrepresentation or fraud, will immunise users from liability for calculation or reporting errors. The D-VAT will also certify third-party software systems (CAS), and proprietary systems (CPS).
UNIFORM VAT RATE VERSUS MULTIPLE VAT RATES: The theoretical goal of a single-rate VAT system is not a high rate but the largest possible tax base, thus distributing the tax burden over the economy while favouring optimal budget performance and avoiding competition between goods.
A reduced VAT rate should take into account the national goal of poverty reduction by increasing the purchasing power of poor households but the distributional impact also depends on the national structure of the demand. The establishment of a reduced rate on a few sensitive items could provide a way to avoid multiplying ad hoc or permanent exemptions while avoiding penalisation of the consumers of these products with a full tax rate. It should also be more progressive than the uniform rate. Ahmad and Stern (1984, 1987) conclude that multiple VAT rates or a uniform VAT system with exemptions is more progressive; Jenkins (2006) shows that the existence of the under-tax sector improves the VAT's progressivity. Alderman (2002) underlines that the progressivity of this type of measure is still limited compared to subsidies. Indeed, exemption or reduced VAT rate applies to a good and is not targeted at a specific group in the population.
Jamaluddin Ahmed PhD, FCA, General Secretary of the Bangladesh Economic Association, is Chairman, Emerging Credit Rating Limited.
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