The GST revisited

Remember when one of Peter Costello’s killer arguments for replacing the GST with a WST was that Swaziland had a wholesale sales tax (WST)? As one of the minority of economists who opposed the GST but thought a broad based consumption tax was a good idea, I argued that a multi-level tax was a dumb idea. So I was intrigued to see this NBER paper about the problems with a GST in Russia. My main concern about the GST is the transactions costs involved in adding a couple of extra items to every invoice issued for every transaction. (Think about how little one would need to add to the cost of each additional invoice for it to turn out to be a dumb idea to introduce a multi-stage tax on every transaction like that).

But I thought all that stuff about stamping out the black economy was a bit rich. For although the multi-stage nature of the tax involves some prospect of each link in the chain of transactions ‘policing’ the other, it’s also clear that where one is selling services to someone who can’t claim the tax credit – and therefore won’t be keeping or claiming against their tax invoice (if they get one) you can put your prices up by 10% and then pocket the GST you’ve charged on your price.

Sure enough these are the problems that are being magnified by rampant corruption in Russia – which is considering moving away from Russia – and is considering a tax structure a tad more like – well Swaziland. (OK one fancies it will be more broadly based than that). Anyway, over the fold is the abstract.

We discuss recent policy debate in Russia on moving from the present value added tax to a sales tax structure covering households, government and exports. What is distinctive in this debate is the range and nature of problems identified with the VAT, most of which stem from its multistage credit-invoice mechanism. These include false credit and refund claims, delays and difficulties in obtaining legitimate input credits and refunds reflecting responses of tax authorities to false claims, difficulties for large firms dealing with small firms, and resulting uneven effective tax rates between energy and manufacturing sectors. For the Russian economy being heavily dependent on oil and gas exports and seeking diversification, the VAT effectively places industrial companies at a significant disadvantage, particularly compared to exporters of energy resources. These problems are all intensified by the relatively high statutory rate of 18% in the Russian VAT.

We describe and document the debate, discussing in detail what the perceived Russian problems with the VAT are. We suggest that many of the difficulties reflect the multi staging in the credit-invoice mechanism in the VAT, rather than the VAT per se. We discuss the possible use of the subtraction and addition methods in the VAT as an alternative to the sales tax proposed. We also report estimates of possible changes in effective tax rates across sectors if the sales tax were enacted.

The final outcome of this debate is not yet known. A special commission of the Presidential Executive Office of the Russian Federation was to report on the matter in 2009, however, due to the economic crisis a decision on VAT/sales tax has been postponed. Despite this, in the near future a change to a sales tax could possibly follow. We suggest that were this to occur this would be a precedent setting move away from the value added tax. With IMF and World Bank conditionality no longer the force that it was for policy change in large economies such as Russia, India, China and Brazil, similar re-examinations could follow elsewhere.

In its introduction the paper adds this:

1ven in some OECD economies such as Canada the VAT remains an unpopular tax and some of the difficulties discussed in the Russian case (such as export rebates) are also present. While it is premature to talk about a reversal of the VAT fiscal bush fire that has swept the world in the last 50 years, we nonetheless suggest that this Russian debate and its new element of the credit-invoice VAT facilitating corrupt practices may at least be the beginnings of a questioning of the VATs supremacy, or even a partial reversal of trend.

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derrida derider
derrida derider
14 years ago

The less developed the country, the less developed the collection infrastructure, so the more weight should be put on the last part of Adam Smith’s tax triad (equity, efficiency and simplicity). That’s why so many of the former socialist countries have gone for a flat income tax system, f’rexample.

So if you have a problem counting transactions, tax things that are easy to count. Tax selected physical goods at one point – the opposite of the “broaden the base to lower the rate” approach you use in more developed countries.

14 years ago

On reading the abstract only, DD’s right. It sounds too me much more about the lack of rule of law and efficient institutions in Russia than it about VAT. The extrapolation to Canada strikes me as absurd.

There are numerous issues with VAT – I don’t think that even cynics imagined that carousel fraud could take on the scale it seems to have in Europe. Similarly there are now almost more GST cases in Australia than income tax cases. Actually, that isn’t even nearly true, but the GST does manage to raise about as much revenue as the corporate income tax (IIRC).

As DD says, complexity is the price we pay for equity, and Russia and its ilk can’t afford equity.

After all, can you seriously see Russia as an economic or institutional precedent for anyone let alone Brazil, China and India who are all leaving Russia in the dust??

14 years ago

As a CONSTITUTIONALIST I for one have maintained that the GST is unconstitutional and have canvassed this extensively in my books published in the INSPECTOR-RIKATI