Rethinking Value Added Tax theory

It is time to rethink the Value Added Tax (VAT) theory in line with lowest possible single rate and widest possible coverage, eliminating huge accounts, removing input tax credit and doling out a portion of the collected

tax to the poor, writes 

The concept of Value Added Tax (VAT) emerged in Europe in the 1920s in the backdrop of the need for eliminating tax on tax and shifting tax burden of this genre of the consumption tax upon the ultimate consumer. In the mid-1930s, VAT was introduced in France in a limited scale and in 1950s, France expanded VAT to all levels, i.e. import, manufacturing, wholesale and retail. Meanwhile, following the end of the World War II and decolonisation of Asia, Africa and Latin American colonies, the European countries felt the need for regional cooperation that was absent there for centuries and with this objective they formed the European Economic Community (EEC) to harness potentials for regional integration aiming at their common development. It was felt that harmonisation of physical and economic infrastructure and regulations were necessary for effective regional integration. VAT, meanwhile practised and well resulted in France was then considered a better system of taxation on consumption; so, it was recommended for all members of the EEC to be introduced soon. Thus, VAT quickly expanded in Europe. Meanwhile, International Monetary Fund (IMF) and the World Bank (WB) accepted the idea of VAT and started urging for its application aiming at tax reforms in the countries seeking IMF and WB loans. Thus, VAT quickly expanded globally and today 166 countries are practising VAT in one form or another.

VAT developed as a preventive measure against tax on tax. Government needs to collect revenue in a convenient manner, no matter from which source it is generated. Government has fixed different bases for different taxes. For instance, income is the base of income tax. Use of road by vehicles is the base of road tax. House, factory, building, establishment is the base of holding tax. Import is the base of import tax. In some countries, there is inheritance tax where inheritance of parental property is the base. Value addition while selling goods and services is the base of Value Added Tax. It is commonly believed that tax cannot be the base of any tax. We do not find such notion in our VAT law or in the constitution. Though widely desired, tax on tax could not have been completely eliminated anywhere. Import tax is being added with the cost of the goods before sell. So, the notion of tax on tax is again leniently explained as there should not be tax on the same tax, i.e. no VAT on VAT, no Supplementary Duty on Supplementary Duty etc. If government cannot collect tax on the base of tax, then it shall try to find some other ways to collect tax. Ultimately, people will have to pay tax in any form. So, we do not find any harm in it to collect tax on the base of tax if it is easier. After all, simplification is an important pillar of taxation system.

The other day, in a gathering of accountants, one said that VAT means vast accounting task. In our country, VAT accounting has become more complex than general accounting. A business is to comply with all relevant laws of the land, i.e. company law, tax law, labour law, environment law etc.; of them VAT law demands maintenance of more accounts compared to all other laws. Justification of keeping so many accounts for VAT purpose has been checking the propriety of input tax credit that has been introduced to prevent tax on tax. As mentioned earlier, tax on tax cannot be completely prevented. In an effort to remove tax on tax, maintenance of huge VAT accounts has made the VAT system unbearably complex, laborious, time-consuming and costly compelling businesses to hire consultants. Maintenance of so much accounts for VAT purpose has made strong dent on the ease of doing business.  

If tax can be easily collected on a base where another tax is marginally included, we find no harm in it. After all, tax has to be paid by the people in any form. Maintenance of huge accounts for ensuring input tax credit to remove tax on tax appears to be needless at an age when proper automation can guarantee the trails. Tax requires to be collected in the simplest possible way. Simplicity demands less accounts. Our present VAT system demands more accounts mainly to ensure availing proper amount of input tax credit by the tax-payer. Input tax credit has been designed to remove tax on the base of tax, though after performing all these strenuous exercises, people are paying the tax at some other places. Things appear to have become unnecessarily complex, widespread application and retention of collected tax has become challenging because a large portion of the paid tax is taken back by the tax-payers as input tax credit.

In my opinion, the solution lies in the basic premise of VAT - lowest possible single rate and widest possible coverage. If the rate of the tax is the lowest, then demand for input tax credit shall not rise, it shall be easier for people to pay tax. Single rate shall draw tax equally from the rich and the poor. So, a portion of the collected tax shall require to be given back to the poor as safety net packages to ensure equity and justice. It is time to rethink the Value Added Tax (VAT) theory in line with lowest possible single rate and widest possible coverage, eliminating huge accounts, removing input tax credit and doling out a portion of the collected tax to the poor. Thus, more revenue can be collected and administration of VAT can be made simpler too.   

Dr. Md. Abdur Rouf is a VAT expert, currently working as Director General, Customs Intelligence and Investigation Directorate. Opinion expressed in this article are his personal.

[email protected]