Posted on

Value Added Tax (VAT)


The Value Added Tax (VAT) is not very old. It was probably first introduced in France in 1948 and has since spread to the vast majority of countries accounting for about 25 percent of their revenue.

Ironically the only two groups of countries to have been slow in adopting VAT have been the oil rich Gulf States and small islands like SVG. In the case of the islands the reason has been that their economies are so small and uncomplicated that it was felt that a consumption tax would serve just as well as any VAT. The impetus for change has come from two sources. The first is the current emphasis on Free Trade which means import duties must be eliminated and an alternative tax found. Secondly, as we move from a commodity to a service based economy we have to start taxing services more heavily in order to maintain the existing level of revenue. {{more}}

The VAT concept is fairly easy to grasp. A wholesaler wishes to sell goods for $100 but VAT is 10 percent so the price is $110 from which he must pay $10 as tax to the Government. The retailer who bought the goods now wishes to sell them for $200 but VAT is 10 percent so the price is $220. One would think that the tax he should pay is $20 but he is given credit for the $10 already paid to the wholesaler and so now only pays $10. This is the whole point of the tax. It seeks to avoid double taxation or cascading as it is officially called. The aim is to ensure that you only pay on what has been added and hence the term VALUE ADDED TAX.

Ultimately it is consumers who will bear the burden of the tax but it is the firms with an annual turnover of $120,000 or more who will be registered and be immediately responsible for paying it over to the Inland Revenue of which the VAT office is now a part. The IMF says that usually countries settle for a level of turnover that is less than that recommended. The reason for this is that small businesses with less than the stipulated turnover find that they have to pay VAT on the items they buy but cannot reclaim since they are not registered. They therefore lobby the Government to lower the level of turnover required for registration.

In SVG we have gone the other way by putting the level at double the $60,000 recommended. However businesses below the level can voluntarily request to be registered. It will be interesting to see the impact this has on the amount of VAT collected.

Internationally VAT rates tend to cluster between 11 per cent and 19 per cent. We have settled for a single rate of 15 per cent with the exception of hotel accommodation which will be 10 per cent.

In developing countries that are heavily dependent on tourism the introduction of VAT always poses a problem. Tourism is a very competitive business and no one wants to do anything that would drive the tourists into the arms of their competitors. In SVG we have striven to leave things very much as they are. Presently we have a hotel accommodation tax of seven per cent. The calculation is that if we put the VAT at 10 per cent and hotel operators can deduct the tax they have paid on inputs then we should be back to seven per cent.

The use of a single rate of 15 per cent has advantages and disadvantages. One advantage is that it minimizes the need for the classification of goods which is absolutely necessary when you have a lot of different rates. It also means that there is less scope for exercising discretion. All this makes for easier administration. Tough administration of tax is difficult in our small face to face society where no one wants to be a pariah.

One disadvantage of a single rate set at the moderate level of 15 per cent is that it could lead to a drastic fall in revenue. This is so particularly in SVG where we rely on indirect taxes for 55 per cent of our revenue. And it is these very indirect taxes that the VAT is meant to replace. To get around this, motor vehicles, alcohol and cigarettes will, in addition to VAT, be subject to excise duties.

Another disadvantage of a single rate is that it does not discriminate. Poor and rich have to pay the same rate. This is what is meant when they say VAT is a regressive tax. One of the cardinal principles of taxation is that people must be charged according to their ability to pay. This is easily achieved in income tax, where the higher your income the higher the rate you will have to pay. With import duties the same objective is attained by charging a low rate of duty on basic items which both the rich and the poor need but a high rate on luxuries which we are not bound to have.

With VAT however there is only one rate. In order to make the system fairer, that is, more equitable, certain basic commodities have been completely excluded from VAT. In fact two types of goods are excluded from the payment of VAT, zero rated goods and exempted goods. The zero rated goods include water, some electricity, fuel and many of the basic food items consumed by Vincentians.

The exempt items are similar to those that are excluded in other countries. They include education, health and financial services, agricultural products and inputs as well as passenger transport.

Exclusion of some electricity charges from VAT is not very common. Indeed in small countries it is the VAT collected on imports, electricity and telephony that accounts for the bulk of revenue from this source. Our problem is that the rise in oil prices has sent electricity bills soaring and there is an understandable reluctance to make matters worse. This makes it all the more imperative for us to get at least 50 per cent of our electricity from alternative sources such as wind and water.

Recently Hungary and other Eastern European countries have been reminded that democracy does not always mean confrontational politics.

As Western European countries have shown there is a time too for consensual politics. We in St Vincent would do well to bear this in mind when we have to deal with fundamental problems confronting our fragile economies.