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The main disadvantages which have
been identified in connection with the Value Added Tax are:
1) VAT is regressive
It is claimed that the tax is regressive, ie its burden falls
disproportionately on the poor since the poor are likely to spend more
of their income than the relatively rich person. There is merit in this
argument, particularly if it attempts to replace direct or indirect
taxes with steep, progressive rates. However, observation from around
the world and even Guyana has shown that steep tax rates lead to
evasion, and in the case of income tax act as a disincentive to effort.
Further, there is now a tendency in most countries to reduce this
progressivity of taxes as has been done in Guyana where a flat rate of
income tax has been introduced. In any case VAT recognises and makes
room for progressivity by applying no or low rates of tax on essential
items such as food, clothes and medicine. In addition it allows for
steep rates of tax on luxury items, although this can create problems
for administration and open opportunities for evasion by way of
deliberate misclassification, a problem incidentally not peculiar to
VAT, and which takes place extensively in the area of customs duties.
2) VAT is too difficult to operate from the position of both the
administration and business.
(a) The administration
It is often argued that VAT places a special burden on tax
administration. However, it is worth noting that wherever VAT was
introduced one of its effects was the rationalisation and simplification
of the previous indirect tax system and its administration. Each of the
previous indirect taxes such as customs duties, purchase tax and excise
duties replaced by VAT had its own rate structure as well as a different
tax base and separate administrative procedure. The consolidation and
incorporation of numerous indirect taxes into the VAT would simplify the
rate structure, tax base, and administration of the indirect tax system,
thereby eliminating the overlapping auditing practices that had plagued
those systems.
In addition, the abolition of a number of alternative indirect taxes
releases experienced personnel to focus on a single tax. It also means
reduction in the number of forms used, legislation to be applied and
returns and accounts with which the business person has to contend.
(b) Business
It is true that the VAT is collected from a larger number of firms than
under any form of income tax or single state sales tax; to the typical
smaller firms the complexities of the tax and the need for more
extensive records (for example, to justify deductions) are likely to
prove serious.
However, it is often overlooked that businesses already function with
considerable administrative responsibility for a number of laws
including the National Insurance Act and the Income Tax Act.
Under the Income Tax (Accounts and Records) Regulations of 1980 every
person, without exception is required to maintain detailed and extensive
records of all its transactions. Compliance with this will certainly
ensure compliance with VAT regulations, and since there is an actual
benefit to be derived from accounting for VAT paid on input there is an
incentive for proper record-keeping.
As we have noted before, VAT also allows for the exemption of small
businesses from the system.
Under any form of sales taxation, small businesses have to be granted
special treatment because of their inability to cope with the
requirements of keeping adequate records which larger enterprises can
handle at a reasonable cost. The intent of the special treatment is to
reduce the administrative burden on small enterprises, but not the taxes
that normally would be charged on the goods and services they supply.
The revenue loss at the final link in the commercial cycle is limited
only to the value added at that stage ,whereas in the case of income tax
or sales tax the entire tax is lost. To recover the loss from
exemptions, a flat tax on turnover may be applied.
In the larger businesses with proper staff and computers, the task is
really one of double entry book-keeping and any additional work is
hardly ever noticed.
3. VAT is inflationary
Some businessmen seize almost any opportunity to raise prices, and the
introduction of VAT certainly offers such an opportunity. However,
temporary price controls, a careful setting of the rate of VAT and the
significance of the taxes they replace should generally ensure that
there is no increase if any in the cost of living. To the extent that
they lead to a reduction in income tax, any price increases may be
offset by increases in take-home pay.
In any case, any price consequence is one time only and prices should
stabilise thereafter.
4. VAT favours the capital intensive firm
It is also argued that VAT places a heavy direct impact of tax on the
labour-intensive firm compared to the capital- intensive competitor,
since the ratio of value added to selling price is greater for the
former. This is a real problem for labour-intensive economies and
industries.
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