VAT: It's not about tax alone

To dismiss the agitation by traders against value-added tax as all political and only a ploy to avoid maintaining accounts and thereby avoid tax is to miss the sound economic logic that traders have behind disliking this new form of tax.

Whether they should pull down the shutters and go the non-co-operation way is another matter.

Resentment about VAT is not a new phenomenon. It is more so amongst the traders. In many countries, at the time of initial introduction and even much beyond that, VAT has been resented.

In the UK, while VAT was introduced in 1973, even as late as in 1985, the tax was considered "the most serious officially created burden on business; twice as serious as a next tax problem" (Report by Department of Trade and Industry of UK, 1985, p.31).

Even before VAT was introduced in New Zealand, the most widespread concern about the proposed form of GST (VAT) related to a perception that it will impose heavy cost on those obliged to account for the taxes (New Zealand, Report of the Advisory Panel of Good and Services Tax to the Minister of Finance, 1985, p.3). In Canada, a government lost in the election on its pledge to support VAT.

On the pledge to drop VAT, the opposition won the election; it did not drop it but only modified it since by then, VAT had become a performing system. In Australia ever since the idea of VAT was contemplated, it remained a contentious political debate for a long time.

Major political parties were not in its favour. The issue became intolerably politicised in the last year before the adoption of VAT. However, once it was introduced, the resistance ended and the aftermath has been surprisingly quiet.

The introduction of VAT in the entire country in April, 2005 has, however, seen widespread agitation on the part of traders. Part of it can be attributed to political reasons, but the trade has some logic based on economic grounds.

Compliance Cost

Compliance cost is the main consideration, which influences the traders' point of view. It is generally agreed that the costs of complying with VAT are likely to include a significant fixed component, and so may bear most heavily on small traders as compared to bigger establishments.

In the UK, the relatively high burden of compliance costs on small businesses is well documented by two studies conducted in 1977-78 and 1986-87.

The largest disparities are most apparent in the 1986-87 study, where costs for the smallest businesses -- those with taxable turnover of upto £20,500 -- as a percentage of such turnover are 1.94 per cent.

This is 600 times more than the 0.003 per cent figure for the largest business -- those with taxable turnover of £10,000,000 or more. Percentage costs decline rapidly as taxable turnover approaches the £50,000 to £100,000 bracket.

A recent study of compliance costs under the New Zealand Goods and Services Tax provide comparable data (William J Turnier -- Small Business under a VAT p.333, VAT Monitor Nov./Dec. 1994).

That compliance cost comes down with higher production is also corroborated by a recent study in India (Management & Accounting Research, July-Sept. 1998).

For small traders, the compliance cost is not only more but also, it cannot be fully passed on to the consumers, as they do not have the sufficient market power.

This is one reason why small traders are amongst the most vociferous opponents of VAT (Liam Ebrill et al The Modern VAT, p.53, IMF, 2001).

Generally, compliance cost is higher for VAT than for retail tax as found by sample surveys (Alan A Tait  -- VAT, 1988, p.354). While the traders' compliance costs are difficult to assess, they are undoubtedly real.

Book-keeping requirements

Adequate records for VAT are necessary to work out the total tax due to the government. Not only the sales figures but the figures of tax paid on inputs are to be maintained, too.

The existence of two rates and exemptions make it complicated. The dependence on accountants in a shop is a factor that they have to reckon with -- something the traders resent.

Recording in a systematic way of all invoices is a requirement, which needs both time and discipline of mind, which they need to develop. Quite a bit of space in the shop will be necessary for paper work and keeping old papers.

Threshold

The choice of threshold is critical for small traders. The level at which the threshold is set can be raised to exclude from the requirement to charge the tax those traders for whom compliance would be especially burdensome.

The distributional burden is such that those who are just above the threshold may suffer through a disproportionately high compliance burden and those who are just below the threshold benefit by acquiring a distinct competitive edge over the taxed traders.

If the threshold is low like, say, Rs 500,000 in a year in India, which works out to Rs1,670 per day of 300 working days in a year, this will bring in very small traders in the fold of VAT.

A higher threshold would have brought less people under the VAT and would have made it more workable.

Trader relations with VAT officials

Visits by VAT officials often trouble the traders, irrelevant of whether they have anything to hide or not, particularly because it takes time off their allotted work hours.

The traders usually feel they have been chosen for visit for reason of suspicion. Even routine visits are not liked by them because the integrity of VAT officials is not known to be high in developing countries.

One need not agree with all the points of resentment of the traders but it must be understood that they have a point of view, which has some solid grounding in economic logic.

It is not all based on their desire to evade tax, which is what is often made out to be. The tax administration would do well to keep them in mind and to design the tax in a more trader friendly way.