Introduction to Value Added Tax System.ppt

The lecture on VAT

1. 1
Taxes on Consumption & Income and
Introduction to VAT
Hrushikesh Mallick

2. Sources of finance
–Tax
–User charges
•Prices charged for the delivery of certain public goods and
services
•Examples: Toll roads, public swimming pools
–Administrative fees
•Definition of service/benefit is broad & imprecise
•Examples: licences, parking fees
–Borrowing
–Disinvestment Receipts

3. Benefit Principle of Taxation
•Unlike ability to pay principle, benefit principle links
tax obligation to the value of services received in
exchnage.
•Adam Smith suggested a proportional income tax , a
sort of benefit tax.
•Because, the tax payment is “proportional to the
revenue enjoyed under the protection of the state”.
•State’s social, legal and economic framework makes
it possible to earn and keep one’s income and the
value of services can be assumed to be proportional
to that income.
•Example of benefit taxes: taxes on gasoline, property
taxes.
3

4. Tax base and rates of taxation
•Tax bases
–Income
–Wealth
–Consumption
•Tax rate
–Proportional
–Progressive
–Regressive.

5. Properties of a ‘good tax’
–Adequacy: Generate sufficient revenue to finance budgeted
government expenditure. Sensitive to economic growth. At least
one tax with a broad base is an essential part of the revenue
system for each level of government.
–Equitable: Fair distributional impact
–Economically efficient: A tax is said to be efficient if it does not
change any of economic decisions that firms and households
would have made in the absence of tax.
–Administratively efficient: Some taxes are complicated or
expensive to collect (collection cost).
–Flexible:
–Stability: Revenue flows should not unduly sensitive to
fluctuations in economic activity. Stability has a price. A revenue
source that is stable over the business cycle tends to be
unresponsive to growth in population, income and price level
(inflation).

6. Is visibility desirable?
•Visibility: How obvious the amount of tax is top
taxpayers and others.
•Depends on one’s perspective. Those who think
government is too large prefer that taxes be
highly visible so that pain of paying taxes will be
weighted carefully against the benefits from
government services.
•Example: retail sales taxes are more visible than
Value added taxes.
•Property taxes are more visible as they are paid
in lump sum and annually.
6

7. A good revenue system
•Relies on a diversity of sources: A good tax system is
one which uses a mix of sources with different desired
characteristics.
•Taxes that minimize unintended distortions of
decisions in the private sector while steering
taxpayers toward desired choices involving
externalities.
•Designing taxes that achieve both equity and
revenue objectives is important.
•Efficiency and equity remain at the top of the
list.
7

8. Types of Taxes
–Single-stage commodity tax
–Multi-stage commodity tax
–Excise duties:sometimes called a duty of excise special tax , is an inland tax on
the sale, or production for sale, of specific goods or a tax on a good produced
for sale, or sold, within a country or licenses for specific activities.
–Customs duties: taxes on importation. Excises are inlandtaxes, whereas
customs duties are bordertaxes.
–Sumptuary taxes:Any tax on a socially undesirable class of products. Example:
Alcohol and tobacco
Indirect taxes: Taxes that are imposed on commodities or market transactions.
Indirect taxes:
Direct taxes:taxes on wages, profits, interests, rents, royalties, and all other forms
of income and taxes on the ownership of real property, company taxes etc.
Direct taxes

9. Indirect Tax
•Excises are typically imposed in addition to another indirect tax
such as sales tax or VAT.
•In common terminology, an excise is distinguished from a sales tax
or VAT in three ways: (i) an excise typically applies to a narrower
range of products; (ii) an excise is typically heavier, accounting for
a higher fraction of the retail price of the targeted products; and
(iii) an excise is typically a per unit tax, costing a specific amount
for a volume or unit of the item purchased, whereas a sales tax or
VAT is an ad valorem tax and proportional to the price of the good.
•Examples of excise duties : taxes on gasoline and other fuels, and
taxes on tobacco and alcohol (latter is referred as sin tax).
•Value added tax : A multi-stage sales tax levied on the value added
at different stages of production.
9

10. Specific vs. Ad valorem taxes
•Specific tax: Imposed on the basis of some quantity
measure –units, volume, or weight.
Example-A tax of Rs 5 on a pack of cigarettes, & Rs 12 on
gallon of wine, or Rs 50 on imported cashew nuts.
•Ad valorem taxes: imposed as a percentage of price or
value.
Example: State retail taxes like taxes on telephone service
and automobile tires etc.
10

11. 11
VAT has spread around the world more quickly than any other
new tax in the modern history
•Tax on consumption usually refers to tax on goods and services acquired
by individuals for their personal use or satisfaction.
•It is important for a business operating internationally to know the sales
tax system and its implication on international trade.
•USA does not have a sales tax or VAT except at the state and local levels
of government. However, a US business operating or shipping goods or
transferring services to developed or developing countries with VATs
must consider VAT implications of exports to or imports from those
countries.

12. 12
Evolution of Consumption Tax
•Taxation of goods changed as firms were organised to produce
goods and sell them through distributors to retailers. It became
common in Europe, to impose taxes on business turnover (gross
receipts). Thus, a cascading turnover tax was imposed every time
that the goods were transferred in the process of production and
distribution to the final consumer.
•Cascading taxes can’t be reclaimed by the purchaser, so that tax
component of the price of goods becomes larger and larger the
more stages are there between producer to consumer –with
obivious distortionary effects.

13. 13
•Businesses must pay turnover tax on all purchases/inputs. At
each subsequent turnover of goods (i.e. sales), the taxes
previously paid and the values previously taxed are again
subjected to tax in a process often referred to as pyramiding or
cascading (or just as tax-on-tax).
•This element can be reduced in retail sales if the there can be
vertical integration among different input producing operations
for manufacturing a commodity.
•Adam discussed a value added concept in US in 1921 to reduce
the tax on sales by the taxes already paid on business inputs in
order to avoid tax-on-tax effect and to remove the incentives to
vertical integratea business along the line of “improved
turnover tax” developed in Germany(by Wilhelm Von Siemens).

14. 14
•“Improved” turnover tax is imposed and collected at each stage of
production and distribution of goods and services whenever there is a
transaction but the net tax liability represents only the tax on value
added by selling business at that stage.
•By granting a reduction in tax liability for the tax imposed on the taxable
purchases (input tax credit), the tax base at each stage basically limited to
the value added by the employment of labour and capital.
•Before widespread use of multistage VATs, countries usually were
imposing single stage consumption taxes.
•Single stage taxes at the retail level still are in use by almost all states in
US and several provinces in Canada. More commonly, a single stage tax is
imposed at the manufacturer’s (Canada formerly) or wholesaler’s level
(Australia before its GST).

15. 15
Direct & Indirect Taxes on an Income or Consumption Base
•Both taxes can be imposed on an income or consumption base. But the
distinction is that:
•A direct tax is one that is assessed upon the property, business or income of the
individual who is to pay the tax.
•Conversely, indirect tax is levied upon commodities before they reach the
consumer who ultimately pays the taxes as part of the market price of the
commodity.
•This distinction based on incidence of tax is criticized, as modern theory points
out income taxes may be shifted.

16. 16
JS Mill’s Classical Principles
•Distinction between direct and indirect taxes relates to whether the
person who actually pays the money over to the tax collecting
authority suffers a corresponding reduction in his income. If he does,
then –in traditional language -impact and incidence are on the same
person and the tax is direct, if not and the burden is shifted and the
real income of someone else is affected (i.e. impact and incidence are
on different individual) the tax is indirect.
•In the field of international trade, WTO defines direct taxes as taxes
on wages, profits, interests, rents, royalties, and all other forms of
income and taxes on the ownerships of real property and indirect
taxes as sales, excise, turnover, value added, franchise, stamp,
transfer, inventory and equipment taxes, border taxes and all taxes
other than direct taxes and import charges.

17. 17
Income and Consumption Base for Tax
•An annual tax can be imposed on an income base or on consumption base.
•Thomas Hobbes advocated consumption as an appropriate base for taxation.
People should pay tax based on what they consume (withdraw from society’s
limited resources) rather than on what they earn in income (contribute to
resources through labour). Both receive protection from the government.
•Income and consumption can be viewed as different aspects of consumption in
a broad sense. Income represents potential power to consume and consumption
represents the exercise of power by consuming goods and services.
•Consumption-based taxes can be imposed on or collected by business, its
workers and individuals.
•If tax is imposed on business, can be measured by sales or by value added by
business firms at ach stage of production and distribution. Tax can be imposed
both on business and its workers. Under this tax, the base for business is sales
less both tax-paid purchases and tax-paid wages.
•Wage portion of value added base is taxed to the wage earners and reported on
returns filed by them. If a consumption-based tax is imposed only on
individuals, tax base is income less savings.

18. 18
•Directtaxesareimposedonanincomebaseincludeindividualandcorporate
incometaxandpayrolltaxes.Adirecttaxlikeincometaxcanbeimposedona
consumptionbasebyremovingreturnstocapital(suchasinterest,dividendsand
capitalgains)fromtaxbase.
•ApersonalexpendituretaxwasusedbrieflyinIndiaandSriLankaandwas
proposedintheUSin1995.Manyformsofindirecttaxescanbeleviedona
consumptionbase,includingexcisetaxes,turnovertax,singlestagesalestaxora
multistagesalestaxlikeVAT.
•Unlikeindividualincometaxesimposedonincomeorhybridincome-consumption
base,consumption-basedtaxesimposedontransactions(likeVAT).However,
individualincometaxesaremoreflexibletoachieveprogressivity.
•VATisregressiveastaxisimposedonalargerpercentageofincomeofalow-
incomehouseholdthanahighincomehousehold.

19. 19
•TotheextentVATincreasespricesofgoodsthatpoorbuy,itisproperforpublic
policytoprovidereliefthroughpublicspendingmeasurestailoredtotheneedsof
thosetargetedforrelief.
•Advocatesofconsumption-basedtaxesclaimthatincome-basedtaxesdiscourage
savingsbydoubletaxingit.Savingsitselfdoesnotattracttaxbutgivesriseto
incometaxassaversgainadditionaleconomicresourcesbylendingorinvesting
theirmoney.Thus,returnonsavingsistreatedexactlylikewagesoranyother
accretiontoone’scommandovereconomicresources.
•Consumptiontaxesencouragesavingswhichisdesirableindeveloping
economies.Thenetreturnobtainedonsavedorinvestedincomeishigherthanit
isunderanincometax.Withcomparabletaxrates,postponementofconsumption
postponespaymentofconsumptiontaxeswhiledoesnotpostponepaymentof
incometax.

20. 20
Tax Structure in Developing Economies
•Developingeconomieswithanagrarianbasehavelimitedscopeforpersonal
taxes.Itisoftenlimitedtopublicemployeesandemployeesoflargefirms.In
manycountries,salestaxatretailormanufacturerlevelsarecomplicatedwith
numerousexemptionsonimportsanddomesticsalesarebeingreplacedbybroad
basedretailsalestaxorVAT.
•Developingcountriesimportasignificantportionofgoodssoldindomestic
marketandrawmaterialsandsuppliesusedindomesticproduction.Taxeson
import(customdutiesandVAT)mayrepresentamuchlargerpercentageof
revenuethantaxesondomesticsales.MajorityofVATwouldbecollectedby
CustomsandExcisepersonnelattheborderandremainderofVATwillbe
collectedbytheagency(ifseparatefromCustoms)responsibleforVAT.
•DevelopedcountriesimposehighertaxesasapercentagetoGDPandtendto
relymoreondirectpersonalincomeandpayrolltaxes.USAandJapanimpose
lowesttaxesongoodsandservices.

21. 21
Broadening the Tax Base
•Taxrevenueofacountrycanbeincreasedeitherbyaddingnew
taxesorbyexpandingthebaseoftheexistingtaxes.
•Narrowerthebase,thehighertheraterequiredtogenerateagiven
taxrevenue.Highertherate,thegreaterthebenefitsofavoidingor
evadingtax.Taxevasionerodesthetaxbaseandhenceamountof
revenuegenerated.
•Withsinglestagesalestaximposedonlyatthemanufactureror
retaillevelthatisriddledwithexemptionsmayexpanditssalestax
basebyextendingtaxtoalllevelsofproductionanddistributionwith
aVAT.
•Alternatively,itcanreducenumberofexemptionsonparticularsales
orimportsandalsoimposetaxesonnewentities/sectorsthatare
excludedfromsalestaxbase.

22. Exemptions under VAT
22
•VATcanbedesignedinawayentitiesareexemptedfromtaxestoachieve
non-revenueeconomic,socialorpoliticalgoals.
•Smallbusinessmaybeexemptforadministrativereasonsastheymay
operatewithoutrecordkeepingorhavelowsalesturnover.
•Non-profitorganisationandunitsofgovernmentmaybeexemptasthey
provideservicesnormallyprovidedbygovernmentortaxingthemmerely
shiftstaxesfromonepartofgovernmenttogeneralrevenue.
•Food,housing,andmedicalcaremaybeexempttoreduceburdenon
necessitiesforlowestincomehouseholds.Someservicessuchasfinancial
servicesmaybeexemptbecauseofadministrativedifficultyintaxing
intermediationservicesthatarenotrenderedforexplicitfees.

23. Goods or service specific taxes:
•Cascading: A part of the value added is taxed
more than once.
–Production decisions and investment decisions are
distorted. This adversely affects income generation
and growth in the economy.
•Shifting of value added to stages of production
and distribution that are not taxed
–Leakage in the tax base.

24. What is VAT?
•VAT:AccordingtoEuropeanCommissionVATisageneralconsumptiontax
designedtobeimposedonallcommercialactivatesinvolvedintheprocessof
producinggoodsorrenderingservices(generaltax)andtaxtobebornebyconsumers
(consumptiontax).
•PrincipleofcommonsystemofVATinvolvesapplicationtogoodsandservicesofa
generaltaxonconsumptionexactlyproportionaltothepriceofgoodsandservices,
whateverthenumberoftransactionstakeplaceinproductionanddistributionprocess
beforethestageatwhichtaxischarged.
•Oneachtransaction,VATcalculatedonthepriceofgoodsorservicesattherate
applicabletosuchgoodsorservicesshallberechargeable,afterdeductionofthe
amountofvalueaddedtaxbornedirectlybyvariouscostcomponents.

25. 25
Contd…
•Each commodity passes through several stages of
production and distribution before it reaches a
consumer.
•Value at the final stage is the sum of values
created/added at each of these stages.
•If value added at each stage of production and
distribution is taxed once and only once the problem of
tax on tax should vanish
–this is what a Value Added Tax aims for

26. 26
Alternatively,
VAT is a method of taxing final consumer spending in stages.
It is a multistage tax levied on the value added at each
stage.
Value at the final stage is the sum of values created / added
at each of these stages
Under VAT, the value added at each stage of production and
distribution is to be taxed.

27. 27
Difficulties with Sales Tax System?
•Levy of taxes at the manufacturer level -the first point sales tax
•base of tax tends to be narrower
•narrow base forces fixing of higher rate
•higher rate induces tax evasion
•Exclusion of services from the sales tax
•Services are an integral part of the modern economies and the
distinction between manufacturing and services are getting blurred
•Bias against goods favouring services
•Distorts producer and consumer choices
•Taxation of inputs and output result in tax on tax
•cascading of taxes
•High level and multiplicity of rates.

28. 28
Effects on Trade, Industry and Revenue
•High cost to industry and trade due to cascading.
•Impediments to the free flow of trade within the country
and development of common market.
•Handicap to exports
•High cost of compliance.
•Loss of revenues

29. 29
•Prevailing sales tax system was mainly origin based.
•Creates inequitable interregional resource flows by allowing
richer producing states to export the tax burden on to the
consumers in poorer consuming states.
•Predominantly, first point tax making the base narrow.
•Multiplicity of rates, surcharge, turnover tax, entry tax,
additional sales tax made the system complex and non-
transparent.
Rationale for VAT?

30. 30
•VAT serves as an alternative principally due to:
•Neutrality
•Simplicity
•Equity
•However the design of VAT is critical. The key issues are
•computation of VAT
•Whether origin or destination based
•How to treat farmers, small producers/ dealers,
•treatment of exports
•consignment transfers
•treatment of interstate sales -CST
VAT as an Alternative

31. 31
Computation of Value Added
•Gross proceeds from sale of output
= cost of inputs purchase + wages and salaries + Rent + Interest +
Depreciation + Surplus (Profits)
•Value Added = Value of Output -Value of inputs.
•How to compute value added?
•Subtraction: Gross income from sale of output -cost of input
purchased
•Addition: Wages and salaries + Rent + Interest + Depreciation +
Surplus(Profits)

32. Contd…
•Since the consumer is finally to pay the tax, the
tax collected at each stage has to be passed on
to the next stage.
–Tax credit method: each dealer collects tax on full
value of sales, retains taxes paid on purchases, and
remits balance to the treasury.
•In the invoice, the dealer would show the tax exclusive
price and the tax element separately

33. 33
•Addition Method
Tax payable= t*(wages and salaries + rent + interest +
Depreciation + Surplus (profits))
•Subtraction Method
Tax payable = t*(value of output-value of input)
•Tax Credit Invoice Method
Tax due = t* value of output -t*value of input

34. 34Producer (Steel)Maker DealerRetailed Tax
Sales 100 200 250 300
Purchases 0 100 200 250
Value Added 100 100 50 50
VAT @ 10 % 10 10 5 5 30
VAT due on sales 10 20 25 30
Less: VAT paid on purchase 0 10 20 25
VAT @ 10 % 10 10 5 5 30
A: Subtraction Method
B: Tax Credit or Invoice Method

35. 35
RelativeSignificance of these methods
•Subtraction Method
•Need to calculate value added at each stage of transaction
•Less transparent than the tax credit method if the tax rate is not uniform
across all commodities
•Effective tax rate under subtraction method is the weighted average of
rates at different stages of transaction, the weights being the proportion
of value added in each transaction.
•Tax Credit Method
•More flexible (except Japan most other countries follow tax credit
invoice method)
•Tax credit is more helpful in relieving the burden of tax totally
(particularly in case of exports).
•Effective tax rate under input tax credit method is equal to the rate at
the last transaction point.
•Both forms of computing the tax yield identical results under a regime of
single tax rate. However, tax rate would differ under both if there are
multiple rates at different stages of pdn. and distribution.

36. 36Primary ManufacturerManufacturerManufacturerTotalAverage
Producer (Steel) (A) (B) (C) Tax Rate
Sales 100 200 250 300
Purchases 0 100 200 250
Value Added 100 100 50 50
VAT Rate 10 10 10 15
Tax Collection 10 10 5 7.5 32.5 10.83
VAT due on sales 10 20 25 45
Less: VAT paid on purchase 0 10 20 25
Tax Collection 10 10 5 20 45 15.00
(When Manufacturer C is taxed at a different rate)
Multiple Rate Example
A: Subtraction Method
A: Tax Credit or Invoice Method

37. 37Primary ManufacturerManufacturerManufacturerTotalAverage
Producer (Steel) (A) (B) (C) Tax Rate
Sales 100 200 250 300
Purchases 0 100 200 250
Value Added 100 100 50 50
VAT Rate 10 15 10 10
Tax Collection 10 15 5 5 35 11.67
VAT due on sales 10 30 25 30
Less: VAT paid on purchase0 10 30 25
Tax Collection 10 20 -5 5 30 10.00
Multiple Rate Example
A: Subtraction Method
A: Tax Credit or Invoice Method
(When Manufacturer B is taxed at a different rate)

38. 38
Choice of Base for VAT: Key Issues
•Theoretically, base of VAT depends on number of factors relating
to its design:
•Whether origin or destination based
•Implemented with credit invoice or subtraction method
•Many or few exemptions
•Ideally, the base of VAT is final consumption on goods and
services. Unless service sectors also brought under VAT, cascading
will not be totally eliminated
•Thus, suffers from the measurement problem and adjustment
for exemptions and zero ratings.
•Practically the tax base depends on how one defines sales and
purchases
•if purchases include capital goods as well as inputs, it is the broadest
definition.
•if sales include all goods and services, it is again the broadest base of
sale.

39. contd.
•Ideally all goods and all services should be
included in VAT. However, there are instances
of difficult to tax sectors/dealers. Within VAT
there are two ways of dealing:
–Zero-rating
–Exemption

40. 40
Base of VAT Contd…...
•Zero Rating:
»Under destination VAT principle, goods going out of the country or
state are relieved of any domestic trade taxes while imports are
taxed at the same way as the domestic products. One of the ways to
operate under the destination principle is zero rating:
Under zero-rating, no tax is imposed on sales, but full refund/rebate is
given on purchase.
Thus, under zero rating effective rate of tax is zero.
•Exemptions :
VAT system usually excludes traders and producers having turnover
below a specified level
Though no tax on sales, taxes on purchases not refunded
Unlike in case of zero rating, exemption does not relieve the complete
tax burden.

41. 41
•Exemption is given to tax sectors:
»Financial Services
»Small Business and unorganised sectors
»Small farmers etc.
•However, exemption at the end of the chain of transaction implies
lower tax revenue as the value added at the last stage is lost.
•Exemption in the middle of the chain of transaction:between two
taxable transactions
»Reintroduces cascading,
»breaks chain of invoices : which in turn destroys self-policing.
»Implies loss of transparency.
Exemptions: The Key Issues

42. Characteristics of VAT by ITC method
•Avoids Cascading in the absence of exemptions
–Reduces costs of operation:
•increase in costs due to taxes is not there.
•markup on such taxes too is not there.
•interest costs to finance these higher costs too is lower.
–No distortions in the production and investment
decisions: market forces and technical
considerations determine the nature of business
organisation, not the tax structure.

43. Characteristics of VAT
•Since all stages of production and distribution
are taxed, incentive to undervalue at some
stages is absent.
•Permits better policing through the trail of
invoices generated
–often called a self-policing tax: purchaser would ask
for an invoice in order to get credit for the taxes
paid.

44. Objectives of a Tax System and VAT
•Taxation following a destination principle of
taxation
–Since VAT permits effectively curbing tax
exportation, it provides a means for achieving the
destination principle.
–In inter-state trade: the exporting dealer need
collect no tax on the sale and has to claim complete
refund of taxes on purchases

45. 45
Countries Implementing VAT
•VAThasbecomeapopularsourceofrevenue.Francehadadoptedprimitiveversionof
VATafterworldwarII.Othermembercountriesagreedtosharetheirnationalrevenues
(includingrevenuefromVAT)tofinancetheoperationofEuropeanEconomicCommunity
(nowtheEU)inTreatyofRome(1957).Treatyrequiredmemberstatestoconverttheir
turnovertaxestoaharmonisedVAT.
•In1985,NewZealandadoptedaEuropeanstyleinvoiceVATwithamuchbroaderbase
thanhadbeenadoptedelsewhere.NZtaxescertaingovernmentservicesandnon-life
insurance.ThisiscopiedinSouthAfrica.
•In1989,Japanintroduceditsconsumptiontax,aVATthatdiffersfromEuropeanstyleVAT
initscalculationofnetVATliabilityanduseofinvoices.
•InJan1991,CanadahasbeenimplementingGodsandservicestax.In2000,Australia
followedit.TheUSamongtheindustrialisedcountriesremainsoneoftheonlycountries
withoutaVAT.
•Overpastcoupleofdecades,IMFhasassisteddevelopingandemergingcountries
(membercountries)intermsofprovidingtechnicalassistancetoconverttheirturnover
taxes,manufacturingtax,retailsalesandotherindirecttaxestoVATs.

46. 46
•There are direct taxes measured by their level of consumption rather
than their income referred as a cash-flow or consumption-based
income tax.
•Most taxes on consumption are indirect taxes. These are collected by
the sellers of taxable goods and services and are expected to be borne
by final consumers.
•This indirect taxes can take the form of a single-stage tax like retail
sales tax or multistage tax like VAT.
•VAT base can be altered by the legislator by removing some sellers or
some goods and services (by providing special treatment to designated
services).
FormsofConsumption-BasedTaxesandAlteringtheTaxBase

47. 47
Consumption-Based Direct Tax
•Consumption-based income tax (or direct expenditure tax) was proposed by
British economist Nicholas Kaldor (1955). He proposed an annual progressive
tax on an expenditure base at graduated rates for an egalitarian society while
improving on efficiency of operation and rate of progress of the economy.
•Under another approach by Irving Fischer, tax base could be calculated by
adding to income monies received from sale of capital assets, depletion of bank
balances etc. and deducting sums spent on purchase of capital assets and on non-
personal or non-chargeable expenditure. Kaldor criticised this appraoch as it
relies on income as the basis of tax.
•Kaldorreliedonpersonalexpenditureasthelegalbasisoftax–thatsatisfiesthe
requirementsofequityandefficientadministration.Taxpayerswouldberequired
todeclaretheirpersonalexpenditureannuallyandpaytaxdirectlytothe
governmentratherthanpaytothesellersaspartofeachsale.
•Ineffect,taxpayerrequiredtoreportallincomeandreceiptsfortheyearand
thendeductallinvestment,thedifferencebeingconsumption.

48. 48
•Difficulties faced with Kaldor’s approach with regard to distinction between
personal consumption and capital wealth, treatment of gifts and bequests and the
need to set an annual exemption threshold for lower income taxpayers, etc. Kaldor
also recognised significant difficulties in moving from individual income tax
measured by annual income to measured by consumption.
Therefore, Kaldor recommended for operating this tax alongside individual
income tax and to apply only those tax payers in top income groups. If successful,
legislature can expand the scope of expenditure tax and reduce the scope for
income tax.

49. 49
Single and Multistage Sales Taxes
•An indirect tax on consumption like sales tax (tax on goods and services) can
be imposed at a single or at multiple stages of production and distribution.
•Single stage sales tax includes retail sales taxes like imposed by most of the
states in US or some of provinces in Canada.
•A single stage tax can be imposed at the manufacturing level such as prior
Canadian Manufacturer’s tax which is replaced by GST or at wholesale level.
•A sales tax also can be imposed at more than one but less than all levels of
production or distribution.
•Modern sales tax is imposed at all levels of production and distribution.

50. 50
Conclusion
•It has been most pervasive tax reform throughout the world during
second half of 20
th
century and 21
st
century and proved major source of
revenue for the government.
•VAT is widely used across developed and developing economies and by
local, sub-national ,national and even supra-national (European Union)
levels of government.
•The base of VAT is predominantly personal consumption of individual,
measured by price paid for goods and services.
•In general, the rate of tax is uniform and base is broad.
•Non-uniform rates and extensive exemptions destroy neutrality and
affect patterns of consumption as well as patterns of production and
distribution while greatly increasing administrative and compliance costs.

51. Readings
•Aian Schenk & Oliver Oldman (2007) “VAT: A
Comparative Approach”, Cambridge .
•Gurumurthi, S. (1999) “Fiscal Federalism Towards an
Appropriate VAT System for a Federal Economy,”
Economic and Political Economy, 2875-2888.
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