The Value-Added Tax in Developing Countries

The Value-Added Tax inDeveloping Countries

George E. Lent, Milka Casanegra, and Michele Guerard *

FOLLOWING THE ADOPTION of value-added taxes (VAT) byWestern European countries, many developing countries have been

giving increased attention to this form of tax as a means of rationalizingtheir sales taxes and improving their revenues. France is credited withthe first VAT, adopted in 1954, but this extended only to the whole-sale level. It was not until 1967 when the European Economic Commu-nity (EEC) directed its member countries to replace existing turnovertaxes with a VAT that this technique gained widespread acceptance.Although not then a member of the EEC, Denmark was the first Euro-pean country to adopt a VAT extending to the retail level (on July 3,1967); it was followed by France and Germany (on January 1, 1968).Since then, the VAT has been implemented at the retail level by Swe-den and the Netherlands (January 1, 1969), Luxembourg and Norway(January 1, 1970), Belgium (January 1, 1971), and Ireland (Novem-ber 1, 1972). Austria, Italy, and the United Kindom introduced VATsin 1973.

The value-added principle is incorporated in the manufacturers' salestaxes of a number of developing countries, including those of Argentina,Colombia, the Philippines, and member countries of the West AfricanCustoms Union. Several other French-speaking countries, includingAlgeria, Ivory Coast, the Malagasy Republic, Morocco, Senegal, andTunisia, have replaced their turnover taxes with a VAT along the linesof the 1954 French model. But more general systems were not instituted

*Mr. Lent, Advisor in the Fiscal Affairs Department, formerly served asassistant director of the tax analysis staff, U. S. Treasury Department; consultant,Organization of American States; and research associate, National Bureau ofEconomic Research. He has been on the faculty of the University of NorthCarolina and Dartmouth College.

Miss Casanegra, Senior Tax Administration Analyst in the Tax AdministrationDivision of the Fiscal Affairs Department, formerly served as Assistant Com-missioner for Planning and Research of the Internal Revenue Service in Chileand as a consultant, United Nations and Inter-American Development Bank.

Miss Guerard, economist in the Tax Policy Division of the Fiscal AffairsDepartment, formerly served as an economic advisor to the Ministry of Planningin Brazil and as Associate Research Economist, Brazilian Development AssistanceProgram at the University of California at Berkeley.

318

©International Monetary Fund. Not for Redistribution

THE VALUE-ADDED TAX IN DEVELOPING COUNTRIES 319

until after 1966—by Brazil (levied by the states) in 1967, Uruguay in1968, and Ecuador in 1970. Other developing countries have beenexamining the feasibility of a general VAT, and several—includingArgentina, Chile, the Republic of China, Colombia, and Mexico—havedrafted legislation for a VAT to replace existing sales taxes but forvarious reasons have not introduced it.1 This cautiousness can beexplained in large part by the uncertainties that arise in the introductionof any major new tax, and especially one with which the developingcountries have limited experience.

The purpose of this study is to examine the applicability of a VATto developing countries. It will cover the structure of such taxes thatare now in effect and will compare the feasibility of implementing aVAT with other forms of sales tax.

I. Principal Features of Value-Added Taxesin Developing Countries

VALUE-ADDED TAXES

While general sales taxes differ in scope, the stage at which levied,the rate structure, and other characteristics, certain recognizable varie-ties have been adopted by both developed and developing countries.For analytical purposes, these may be classified as follows: (1) multi-stage turnover taxes; (2) single-stage taxes at the retail, wholesale, ormanufacturing level; (3) hybrid retail/wholesale taxes; and (4) value-added taxes carried to the retail, wholesale, or manufacturing level.2 Inlegal concept, sales taxes apply only to the transfer of goods; whenextended to services the application is usually accomplished by supple-mental legislation that identifies the services that are subject to tax. Theconceptual basis of a VAT is described in the following section, andalternative forms of sales tax are compared in Section IV.

The conceptual basis of a VA T

A VAT is a tax on the value that is added to goods and services byenterprises at each stage of the production and distribution process.

1 China plans to introduce its draft legislation in June or July 1973; ifapproved by the legislature, it will go into effect in July 1974. Viet-Nam hasscheduled the replacement of its production tax with a VAT on July 1, 1973.

2 See P. D. Ojha and George E. Lent, "Sales Taxes in Countries of the FarEast," Staff Papers, Vol. XVI (1969), pp. 532-50; John F. Due, "AlternativeForms of Sales Taxation for a Developing Country," The Journal of Develop-ment Studies, Vol. 8 (January 1972), pp. 263-76.


320 INTERNATIONAL MONETARY FUND STAFF PAPERS

The principal ingredients of value added are wages and salaries paid andprofits earned before income tax; additional elements are taxes otherthan those on income, rentals, royalties, and interest. Although the taxpayable by each enterprise could be measured by the total (net) amountof these separate items, that is, the so-called additive approach, thesubstractive technique is universally employed. This can operate in eitherof two ways: (1) by deducting purchases of goods and services fromnet sales and taxing the balance; or (2) by the tax-credit device. Thelatter, which is more widely used, sets off the tax paid on purchasesagainst the tax payable on sales.

Unlike a multistage turnover tax, which is applied to the full valueof a product every time it changes hands in the process of productionand distribution, a VAT is assessed at each stage only on the incrementin value acquired by the product since the last taxable transaction. Atthe end of the chain, the total amount of tax paid on a given commodityis only a function of the rate of tax and of the final price of the com-modity, independently of the number of stages through which it haspassed. What has been collected in fractional payments is equivalent toa single-stage tax on the value of the final product. There is no incen-tive to vertical integration, and no discrimination against products thatembody value added at an early stage versus commodities that receivethe largest part of their value in the later stages of the production andmarketing chain.

The treatment of capital goods varies with the type of VAT employed.The gross product variant makes no allowance for investment; its con-ceptual base is the gross domestic product (GDP). The income variantpermits the deduction of annual depreciation to allow for the fact thata firm's capital equipment gets used up in the production process.Finally, the consumption variant allows a deduction (or tax credit) forthe full value of investment goods at the time of purchase. In tfcis form,the VAT reaches only consumption expenditure, and, if it is carriedthrough the retail level, its base is identical with that of a retail salestax on consumer goods and services.

A VAT that applies only through the manufacturing or the wholesalestage does not offer the advantage of noninterference with market proc-esses to the same extent as one that covers all sectors of the economy,including retailing and services. As long as any stage remains outsidethe scope of the tax, some distortion may result from the incentivesremaining to business firms to integrate forward or backward. For this



reason, the VAT systems in Europe all extend the tax to retail salesand cover most services.

According to the system that is \most widely used, the tax that is dueby a business firm is computed by applying the relevant tax rate tototal sales during a given period, and deducting from the resulting figurethe amount of tax paid by the firm on its purchases of intermediaryproducts and capital equipment (in the consumption variant). Thisprocedure requires that invoices show the amount of tax paid on valueadded at earlier stages. A continuous chain of tax credits thereforeaccumulates as a product moves through the production and distribu-tion process up to the finished product stage and into the hands of thefinal consumer.

The workings of a VAT may be illustrated by the following simplifiedexample based on the various stages involved in the production andsale of bread produced from, say, 500 bushels of wheat.3 The figuresshown are in U. S. dollars.

FarmerMillerBakerRetailer

Purchases

2501,1001,6502,750

Sales(including

VAT)

1,1001,6502,7504,400

10 Per Cent VAT

Gross

100150250400

Credit onpurchases

100150250

Netpaid

10050

100150

400

It can be seen that a 10 per cent tax is assessed at each stage of theprocess on the amount of sale, excluding the VAT, but that credit istaken for tax paid on purchases, leaving a net amount of tax chargeableon the value added at each stage. The cumulative tax—$400—is equiva-lent to a rate of 10 per cent on the final retail sale of the product toconsumers.

Apart from adding administrative complications, an exemption at anypoint along the cycle (except at the very beginning or at the ultimatestage) normally results in a break in the tax-credit chain, which leadsto a loss of neutrality and introduces an element of double taxation tothe extent that the exempt product re-enters the taxable sector at thenext stage.

3 No account is taken of the VAT on purchases of other supplies and services.



With regard to exemptions, an important distinction is sometimesmade between a so-called zero rate and normal exemption from tax.4

When a zero rate applies, sales are exempt from tax and the firm isalso entitled to a credit for taxes paid on purchases, so that no elementof tax is included in the final cost of goods and services. A tax creditmay result in a tax rebate, or it may be offset against tax on taxablesales. On the other hand, a normal exemption does not provide for theremission of taxes paid on purchases. Whether or not the tax is zerorated, European countries usually provide for full rebate of the VATon goods exported.

In principle, a VAT is generally conceived as one that extends tothe retail stage and to virtually all sectors of the economy, includingservices, with minimal exemptions. This is the model that has beengenerally accepted by European countries. Only with a comprehensiveand uniform coverage is it possible to achieve a truly neutral sales tax.

Introduction of the VAT in selected developing countries

Although it has been proposed in many developing countries in recentyears, the actual move to a general consumption tax of the value-addedtype has been made in relatively few of them. The tax structures ofseven developing countries are compared to show the different adapta-tions that have been made to the VAT concept (see Table 1). Thesecountries are Brazil (state levy), Ecuador, Ivory Coast, the MalagasyRepublic, Morocco, Senegal, and Uruguay.5

The average per capita income of these seven countries covers a widerange of income levels associated with various stages of development,from a little more than US$100 in the Malagasy Republic to approxi-mately US$200 in Eucador, Morocco, Ivory Coast, and Senegal,US$300 in Brazil (the per capita income of the more developed statesin Center-South Brazil is twice as high as the national average), andUS$600 in Uruguay.

4 See Alan A. Tait, Value Added Tax (London, 1972), p. 32. The zero ratewas introduced by the Netherlands, and has been adopted by Ireland for aselect list of activities, and also by the United Kingdom.

5 A number of developing countries also collect manufacturers' sales taxes onthe so-called fractional payment basis. However, these levies of the value-addedtype, which usually employ the direct substraction method (reducing the taxablebase by the amount of taxed purchases rather than allowing a credit against taxdue, as in the tax-credit method), are imposed only at the production andimport stages. They are not considered here as a VAT.


TABL

E 1.

SEL

ECTE

D D

EVEL

OPI

NG

CO

UN

TRIE

S: P

RIN

CIP

AL F

EATU

RES

OF

THE

VALU

E-AD

DED

TA

X

Nam

e of

tax

Dat

e in

tro

du

ced

Leg

isla

tio

n

Tax

es r

epla

ced

SCO

PE

O

F

TA

XF

arm

ers

Mer

chan

ts /

Wh

o^s

ale

Ser

vice

s in

gen

eral

Fin

anci

al s

ervi

ces

Bra

zil

(Sta

tes)

Impo

sto

sob

re c

ircu

-Ια

ςαο

de

mer

ca-

dor

ias

Jan

uar

y 19

67F

eder

al L

aw 5

.172

of O

ctob

er 2

5,19

66

Sta

te t

urn

ove

r ta

xes

levi

ed o

n m

erch

an-

dis

e sa

les.

Exe

mpt

in

so

me

stat

es.

Agr

icu

ltu

ral

pro

-du

cer

goo

ds

exem

pt.

Co

vere

d.C

over

ed.

No

t co

vere

d.

Sep

arat

e lo

cal

tax

ongr

oss

rec

eip

ts.

Not

co

vere

d.

Spe

cial

tax

on

fin

an-

cial

tra

nsa

ctio

ns.

Ecu

ador

Impu

esto

a l

as t

rans

-ac

cion

es m

erca

ntil

es

July

197

0D

ecre

e 46

9 of

May

12,

1970

.R

evis

ed:

Dec

reto

Sup

rem

o 1

24,

July

29,

197

0

Tax

on

gro

ss re

ceip

tsfr

om m

inin

g, m

an-

ufac

turi

ng,

con

-st

ruct

ion

, an

d a

num

ber

of s

erv-

ices

.

Exe

mpt

.A

gric

ult

ura

l p

ro-

duce

r go

od

s ta

xed

.

Cov

ered

.C

over

ed.

Not

co

vere

d.

Sep

arat

e ta

x on

gro

ssre

ceip

ts.

Not

co

vere

d.

Ivo

ry C

oas

tM

alag

asy

Rep

ubl

ic

Tax

e su

r la

val

eur

Tax

e un

ique

sur

les

ajo

uté

e; t

axe

sur

les

tran

sact

ions

pres

tati

ons

de s

ervi

ces

Janu

ary

1960

Ja

nuar

y 19

69L

aw 5

9-25

0 of

De-

L

aw 6

8-02

8 of

De-

cem

ber

31,

1959

ce

mbe

r 17

, 19

68

Man

ufa

ctu

rers

'va

lue-

adde

d ty

peof

sal

es t

ax (

dire

ctsu

bst

ract

ion

met

hod) ;

turn

over

tax o

n s

ervi

ces.

Exe

mpt

.S

ome

agri

cult

ural

prod

ucer

goo

dsex

empt

.

Cov

erag

e opti

onal

.N

ot

cove

red.

Cov

ered

, un

less

spec

ific

ally

exem

pt.

Cov

ered

, ex

cept

for

(1)

insu

rance

pol

i-ci

es (

spec

ial

levy

)an

d (

2) c

erta

incr

edit

tra

nsa

ctio

ns

(mos

tly

of o

ffic

ial

inst

ituti

ons)

.

Gen

eral

tu

rno

ver

tax

on g

oods

and

serv

ices

.

Exe

mpt

.A

gric

ultu

ral

pro-

duce

r go

ods

exem

pt.

Cov

ered

.T

ax o

n i

mport

son

ly.

Cov

ered

, un

less

spec

ific

ally

exem

pt

(ass

esse

dat

red

uced

rat

e).

Cov

ered

, ex

cept

for

offi

cial

fi

nanc

ial

inst

ituti

ons.

Mor

occo

Tax

e su

r le

s pr

o-d

uit

s; t

axe

sur

les

serv

ices

Janu

ary

1962

Dah

ir 1

.61.

444

of

Dec

embe

r 30

,19

61

Gen

eral

tu

rno

ver

tax.

Exe

mpt

.S

ome

agri

cult

ura

lpr

oduc

er g

oods

exem

pt.

App

aren

tly

only

part

ial

cove

rage

.

Cov

ered

, un

less

exem

pt

(ass

esse

dat

red

uced

rat

e).

Cov

ered

, ex

cept

for

(1)

insu

rance

con

-tr

acts

(se

par

ate

tax a

sses

sed

in-

stea

d)

and (

2)ce

rtai

n c

redi

ttr

ansa

ctio

ns

(mos

tly

of o

ffic

ial

inst

itut

ions

).

Sen

egal

Tax

e su

r le

ch

iffre

d'af

fair

es

July

196

6L

aw 6

6-34

of

May

25,

196

6

Man

ufac

ture

rs'

valu

e-ad

ded

type

of s

ales

tax

(di

rect

subs

trac

tion

met

hod)

.

Exe

mpt

.A

gric

ultu

ral

pro

-du

cer

good

s ta

xed.

Cov

erag

e op

tion

al.

Not

cove

red.

Cov

ered

, un

less

spec

ific

ally

exem

pt (

asse

ssed

at r

educ

ed r

ate)

.

Cov

ered

, ex

cept

for

(1)

insu

ranc

e po

li-ci

es (

spec

ial

levy

)an

d (2

) ce

rtai

ncr

edit

tra

nsa

ctio

ns

(mos

tly

of o

ffic

ial

inst

itut

ions

).

Uru

guay

Impu

esto

a l

as v

enía

sy

serv

icio

s

Jan

uar

y 19

68L

aw 1

3. 6

37 o

f D

e-ce

mbe

r 21

, 19

67.

Rev

ised

Bud

get

Law

,D

ecem

ber

1972

Man

ufac

ture

rs'

sing

le-s

tage

sal

esta

x;

who

lesa

lers

'va

lue-

adde

d ty

peof

sal

es t

ax ;

turn

-ov

er t

ax o

n re

tail

sale

s an

d s

ervi

ces.

Exe

mpt

.A

gric

ultu

ral

pro

-du

cer

good

sex

empt

.

Cov

ered

.C

over

ed (

not

alw

ays)

.

Cov

ered

, un

less

spec

ific

ally

exem

pt.

Cov

ered

.

323

©In

tern

atio

nal M

onet

ary

Fund

. Not

for R

edis

tribu

tion

TABL

E 1

(Con

clud

ed).

SELE

CTED

DEV

ELOP

ING

COU

NTR

IES:

PRI

NCI

PAL

FEAT

URES

OF

THE

VALU

E-AD

DED

TAX

324

Con

stru

ctio

n

[Sal

esR

eal

prop

erty

{ [Ren

tals

EX

EM

PTIO

NS

Exp

orts

Food

and

oth

er b

asic

nece

ssiti

es

Oth

er

Bra

zil

(Sta

tes)

Tax

on

cons

truc

tion

mat

eria

ls.

Sepa

rate

ser

vice

tax

on b

uild

ing

con-

trac

tors

.N

o ta

x cr

edit

for

busi

ness

pur

chas

esof

new

bui

ldin

gs.

Not

cov

ered

.

Prim

ary

prod

ucts

:fu

lly t

axed

in m

ost

stat

es.

Man

ufac

ture

s :ex

empt

. St

ate

polic

ies

on p

rior

-st

age

tax

cred

itan

d re

fund

s va

ry.

Sche

dule

d to

be

fully

dedu

ctib

le b

y19

74.

Exe

mpt

ion

of f

arm

sale

s in

som

est

ates

, plu

s lim

ited

list

of u

npro

cess

edfo

odst

uffs

in

all

stat

es.

New

spap

ers,

per

iod-

ical

s, b

ooks

.E

lect

rici

ty,

hydr

ocar

-bo

ns,

unpr

oces

sed

min

eral

s (e

xclu

ded

from

sco

pe o

f ta

x ;su

bjec

t to

spe

cial

exci

ses)

.In

dust

rial

mac

hine

ryan

d eq

uipm

ent.

Ecu

ador

Tax

on

cons

truc

tion

mat

eria

ls.

No

tax

cred

it fo

rbu

sine

ss p

urch

ases

of n

ew b

uild

ings

.

Not

cov

ered

.

Exe

mpt

.Fu

ll cr

edit

for

prio

r-st

age

tax

on c

ur-

rent

inp

uts o

nly.

Farm

sal

es e

xem

pt.

New

spap

ers,

per

iodi

-ca

ls,

book

s.

Ivor

y C

oast

Tax

on

cons

truc

tion

mat

eria

ls a

ndbu

ildin

g co

ntra

c-to

rs.

Cre

dit

for

tax

paid

on i

ndus

tria

lbu

ildin

gs.

Sale

s by

regi

ster

edta

xpay

ers

cove

red.

Bus

ines

s re

ntal

sco

vere

d.

Exe

mpt

.Fu

ll cr

edit

for

prio

r-st

age

tax

on c

ur-

rent

inp

uts

and

dedu

ctib

le fi

xed

asse

ts.

Exe

mpt

ion

for

un-

proc

esse

d ag

ricu

l-tu

ral p

rodu

cts,

brea

d, f

lour

, ce

re-

als,

milk

and

dair

y pr

oduc

ts,

and

palm

oil.

New

spap

ers,

per

iodi

-ca

ls,

book

s.So

me

publ

ic u

tili-

ties.

Pass

enge

r tr

ansp

ort

and

frei

ght.

Mal

agas

y R

epub

lic

Red

uced

rat

e on

cons

truc

tion

ma-

teri

als

and

buil

d-in

g co

ntra

ctor

s.C

redi

t fo

r ta

x pa

idon

indu

stri

al, a

gri-

cult

ural

, min

ing,

and

hote

l in

stal

la-

tions

.

Sale

s by

reg

iste

red

taxp

ayer

s co

vere

d.B

usin

ess

rent

als

cove

red.

Exe

mpt

.Fu

ll cr

edit

for

prio

r-st

age

tax

on c

ur-

rent

inp

uts

and

dedu

ctib

le fi

xed

asse

ts.

Exe

mpt

ion

for

un-

proc

esse

d ag

ricu

l-tu

ral p

rodu

cts,

food

s, h

ouse

hold

nece

ssiti

es,

and

scho

ol s

uppl

ies.

New

spap

ers,

per

iodi

-ca

ls,

book

s.Pu

blic

util

ities

, st

ate

mon

opol

y sa

les

ofto

bacc

o, a

ndm

atch

es.

Ext

ensi

ve l

ist

of i

n-pu

ts f

or m

anu-

fact

ure

of e

xem

ptpr

oduc

ts.

Mor

occo

Red

uced

rat

e on

cons

truc

tion

ma-

teri

als

and

build

-in

g co

ntra

ctor

s.C

redi

t fo

r ta

x pa

idon

ind

ustr

ial

build

ings

.

Sale

s by

reg

iste

red

taxp

ayer

s co

vere

d.B

usin

ess

rent

als

cove

red.

Exe

mpt

.A

lso

exem

pt, f

irm

sex

port

ing

85 p

erce

nt o

f ou

tput

unde

r su

spen

sion

rule

for

inp

uts

dest

ined

for

ex-

port

able

out

put.

Exe

mpt

ion

for

basi

cfo

odst

uffs

(fl

our,

brea

d, m

ilk, s

ugar

,fi

sh) a

nd p

resu

m-

ably

for

unp

roc-

esse

d ag

ricu

ltura

lpr

oduc

ts.

New

spap

ers,

per

iodi

-ca

ls,

book

s.St

ate

mon

opol

ysa

les

of t

obac

co.

Cer

tain

min

eral

prod

ucts

, m

eat,

fish

net

s an

d ge

ar,

cert

ain

woo

dpr

oduc

ts,

and

oliv

e oi

l.

Sene

gal

Tax

on

cons

truc

tion

mat

eria

ls.

Low

er s

ervi

ce r

ate

on b

uild

ing

con-

trac

tors

.N

o ta

x cr

edit

for

busi

ness

pur

chas

esof

new

bui

ldin

gs.

Sale

s by

reg

iste

red

taxp

ayer

s co

vere

d.B

usin

ess

rent

als

cove

red.

Exe

mpt

.Fu

ll cr

edit

for

prio

r-st

age

tax

on c

ur-

rent

inp

uts

and

dedu

ctib

le fi

xed

asse

ts.

Exe

mpt

ion

for

un-

proc

esse

d ag

ricu

l-tu

ral

prod

ucts

and

food

stuf

fs i

nge

nera

l.

New

spap

ers,

per

iodi

-ca

ls,

book

s.H

ydro

carb

ons.

Cer

tain

pub

licut

ilitie

s.Pa

ssen

ger

tran

spor

tan

d fr

eigh

t.

Uru

guay

Red

uced

rat

e.

Not

cov

ered

.

Exe

mpt

.Fu

ll cr

edit

for

prio

r-st

age

tax

on c

ur-

rent

inp

uts

and

fixe

d as

sets

.

Exe

mpt

ion

for

shor

tlis

t of

foo

dstu

ffs

and

othe

r ba

sic

nece

ssiti

es.

Oth

ers

at r

educ

edra

te.

New

spap

ers,

per

iodi

-ca

ls,

book

s.T

obac

co a

nd h

ydro

-ca

rbon

s (s

ubje

ctto

spe

cial

exc

ises

).

©In

tern

atio

nal M

onet

ary

Fund

. Not

for R

edis

tribu

tion

325

Bra

zil

(Sta

tes)

INVE

STM

ENT

GOOD

S In

dust

rial

equ

ipm

ent

exem

pt;

full

cred

itfo

r pr

ior-

stag

e ta

xon

inp

uts

sche

d-ul

ed f

or

1974

.

TAX

CR

EDIT

S A

ND

RE

FUN

DS

No

Cre

dit

for

ta

xpa

id o

n in

puts

used

for

exe

mpt

outp

uts,

exc

ept

for

(1)

expo

rts

of m

an-

ufac

ture

s an

d (2

)in

dust

rial

ma-

chin

ery.

No

cash

ref

unds

ex-

cept

on

cred

its

for

(1)

and

(2).

SMAL

L BU

SINE

SSES

Sm

all

reta

iler

s as

-se

ssed

by

forf

ait.

"Sub

stit

ute

taxp

ay-

ers"

use

d by

(1)

who

lesa

lers

for

very

sm

all

reta

il-er

s tr

adin

g in

fix

ed-

pric

e pr

oduc

ts a

nd(2

) pu

rcha

sers

of

agri

cult

ural

pro

d-uc

ts,

in s

tate

sw

here

far

mer

s no

tex

empt

.

Ecu

ador

Tax

on

fixe

d as

sets

fully

cre

dita

ble.

No

cred

it f

or t

axpa

id o

n in

puts

for

exem

pt o

utpu

ts,

exce

pt e

xpor

ts.

Exc

ess

expo

rt c

red-

its,

adju

sted

onl

yaf

ter

six

mon

ths.

No

cash

ref

unds

(tra

nsfe

rs t

o su

p-pl

iers

).

Smal

l fi

rms

exem

pt.

Subj

ect

inst

ead

totu

rnov

er ta

x on

actu

al o

r es

ti-m

ated

gro

ssre

ceip

ts.

Ivor

y C

oast

Tax

on

fixe

d as

sets

fully

cre

dita

ble

exce

pt f

or (

1)bu

ildin

gs f

or o

ther

than

ind

ustr

ial

use,

(2)

tran

spor

teq

uipm

ent,

and

(3)

furn

itur

e.

No

cred

it fo

r ta

xpa

id o

n in

puts

for

exem

pt o

utpu

ts,

exce

pt e

xpor

ts.

No

cash

ref

unds

ex-

cept

for

tax

pai

don

(1)

exp

orts

and

(2)

good

s as

sess

edat

red

uced

rat

e.

Ass

esse

d by

fo

rfai

t.(R

etai

lers

not

cove

red

by t

ax.)

Mal

agas

y R

epub

lic

Tax

on

fixe

d as

sets

fully

cre

dita

ble

exce

pt f

or (

1)bu

ildin

gs o

ther

than

for

indu

stri

al,

agri

cultu

ral,

and

min

ing

inst

alla

-tio

ns, a

nd h

otel

s,(2

) tr

ansp

ort

equi

pmen

t, an

d(3

) fu

rnit

ure.

No

cred

it f

or t

axpa

id o

n in

puts

used

for

exe

mpt

outp

uts,

exc

ept

expo

rts.

No

cash

ref

unds

(tra

nsfe

rs t

o su

p-pl

iers

).

Ver

y sm

all

busi

-ne

sses

exe

mpt

.(R

etai

lers

not

cov

-er

ed e

xcep

t on

im-

port

s.)

Smal

l bu

sine

sses

(in

-cl

udin

g im

port

ers/

reta

ilers

) as

sess

edby

fo

rfai

t.

Mor

occo

Tax

on

fixe

d as

sets

fully

cre

dita

ble

exce

pt f

or (

1)bu

ildin

gs o

ther

than

for

ind

ustr

ial

use,

(2)

tran

spor

teq

uipm

ent,

and

(3)

furn

itur

e.

No

cred

it f

or t

axpa

id o

n in

puts

for

exem

pt o

utpu

ts,

exce

pt e

xpor

ts.

Exc

ess

cred

it a

djus

t-m

ent

at t

he y

ear-

end.

No

cash

ref

unds

(cre

dit

agai

nst

futu

re t

ax l

ia-

bili

ty).

Art

isan

s ex

empt

.O

ther

s as

sess

ed b

yfo

rfai

t.

Sene

gal

Tax

on

fixe

d as

sets

fully

cre

dita

ble

exce

pt f

or (

1)bu

ildin

gs,

(2)

tran

spor

t eq

uip-

men

t, an

d (3

) fur

-ni

ture

.

No

cred

it f

or t

axpa

id o

n in

puts

used

for

exe

mpt

outp

uts,

exc

ept

expo

rts.

Exc

ess

cred

it a

d-ju

stm

ent

only

at

the

year

-end

.N

o ca

sh r

efun

ds e

x-ce

pt f

or t

ax p

aid

on (

1) e

xpor

tsan

d (2

) inv

estm

ent

good

s.

Ass

esse

d by

fo

rfai

t.(R

etai

lers

not

cove

red

by t

ax.)

Forf

ait

taxp

ayer

san

d un

regi

ster

edtr

ader

s m

ay p

ass

on ta

x cr

edits

to

busi

ness

pur

chas

-er

s.

Uru

guay

Tax

on

fixe

d as

sets

fully

cre

dita

ble.

No

cred

it f

or t

axpa

id

on i

nput

s fo

rex

empt

out

put,

exce

pt e

xpor

ts.

No

cash

ref

unds

(tra

nsfe

rs t

o su

p-pl

iers

) .

Opt

iona

l.In

stea

d,

smal

lest

tax

-pa

yers

may

ele

ctsp

ecia

l re

gim

e,pa

rtia

lly

inte

-gr

ated

wit

h V

AT

.

©In

tern

atio

nal M

onet

ary

Fund

. Not

for R

edis

tribu

tion


Manufacturing accounts for a low percentage of the total product(10 per cent to 15 per cent) in six of the seven countries, and in allbut a few of the Center-South states of Brazil. Except in Brazil, theexternal sector plays a major part in the economy, with imports reaching20 per cent to 30 per cent of GDP. The share of taxes in the grossnational product (GNP) is relatively high (18 per cent to 20 per centin most instances and 28 per cent in Brazil).

The VAT was introduced in the seven countries to replace either ageneral turnover tax, or some form of manufacturers' sales tax, or acombination of both. In Ivory Coast, Senegal, and Morocco, the VATreplaced production taxes based on the French system (with fractionalpayments) on manufacturers and importers. The Malagasy Republichad a general turnover tax on goods and services before the introduc-tion of the VAT. In the Brazilian states the VAT also replaced generalturnover taxes levied on merchandise sales. Ecuador, until 1970, had atax on gross receipts from mining, manufacturing, construction, and oncertain services; imports were not subject to sales tax. In Uruguay, thesales tax complex that was replaced by a VAT in 1968 included amanufacturers' sales tax (originally collected by the suspensive method),which was subsequently extended to wholesalers on a value-added basis(indirect substraction method), and was supplemented, after 1963, bya tax on gross receipts of retailers and service enterprises.

THE TAXABLE BASE

The VAT systems employed in developing countries, like their coun-terparts in the developed countries, use broad levies designed to reacha substantial part of domestic consumption expenditure. On the whole,however, they are somewhat less comprehensive in scope. While cover-age varies substantially from one developing country to another, thetaxes generally do not apply to farm sales, sometimes exclude services,and do not always extend to the retail stage, or even to all wholesaleactivities. Capital goods may be only partly removed from the scope ofthe tax. An element of multiple taxation and potential distortion mayalso persist as a result of limitations on the use of credits for tax eitherborne or paid at earlier stages and a fairly widespread reluctance toprovide refunds for excess tax credits. The troublesome problem ofdealing with small businesses is usually solved by resorting to the forfait



assessment method.6 The use of numerous exemptions and multiplerates by some states also complicates administration.

General scope of the VAT

The scope of the VAT is usually defined with reference to both tax-able transactions and taxable persons. In the developing countries underreview, taxable transactions are usually defined broadly as sales bypersons engaged in industrial and commercial activity. Except in theBrazilian states, sales by farmers as well as sales of forestry, hunting,and fishing products are excluded at the outset. Taxable transactionsare further defined to include both the sale of goods and the renderingof services, except in Brazil and Ecuador, where services are subject toa separate tax. Distinctions are also made between movable goods (suchas merchandise) and immovable goods (such as real property), andthe latter are subject to value-added taxation only under certain circum-stances (in Senegal, the Malagasy Republic, and Ivory Coast), or notat all (in Brazil, Ecuador, and Uruguay).

Taxable persons are defined to include producers (both manufac-turers and artisans), importers of taxable goods, sometimes merchants,and service enterprises if services are taxed. Mining, which is not taxedby Brazil, is generally included in industrial production. Construction isusually treated as a service activity and is taxed as such. The treatmentof public utilities varies, but they are largely left outside the scope ofthe tax or are granted specific exemptions.

Sales by farmers

Special problems arise in applying the VAT to sales by farmers.Because farmers normally would be subject to tax on their inputs ofmachinery, feed, seed, fertilizers, pesticides, etc., it would be necessaryfor them to maintain adequate records to claim a credit for tax paidon their sales. However, the large number of small-scale farmers indeveloping countries, many of whom are illiterate, virtually precludesgeneral operation of such a system, with the result that in none of the

6 This is a tax on presumptive taxable sales that is assessed by the tax depart-ment on the basis of information supplied by the taxpayer. A fuller descriptionand evaluation of the forfait assessment method is presented in the section,TREATMENT OF SMALL ENTERPRISES AND FARMERS.



countries under review, with the exception of some Brazilian states, areoff-farm sales subject to a VAT.

The common tax model prescribed by the Federal Government ofBrazil does not provide for farm exemption, but it is in fact granted bythe more developed states in the Center-South.7 The northeastern states,in general, continue to collect tax from the farmer or from his "substi-tute taxpayer," that is, processors or traders who purchase the goods.Revenue lost by exempting farm sales is recouped in any event at theprocessing or marketing stages (except for direct sales to consumers).The problem remains, however, of how to allow for the tax paid byfarmers on their inputs. One way to deal with the problem is to exemptfarm inputs from the tax. The southern states of Brazil have followedthis policy from the beginning, and in 1969 the Brazilian Governmentmade the exemption of farm inputs compulsory in all states.8 IvoryCoast, the Malagasy Republic, Senegal, and Uruguay provide similarexemptions. The Malagasy Republic further exempts an extensive listof raw materials and supplies required for the manufacture of agricul-tural producer goods. Such exemption, in turn, poses a problem formanufacturers of agricultural producer goods of obtaining refunds fortaxes paid on their inputs. This can be accomplished through zero rating.Imports of such goods can, of course, be exempted with no greatdifficulty.

Another way of avoiding the assessment of a VAT on fanners with-out sacrificing credit to taxable processors or wholesalers of farm prod-ucts is the "global credit offset" technique employed by EEC countries.9

Under this method, farmers may elect to pay tax and claim credit fortaxes on purchases on the basis of their accounting records, or theymay elect not to pay tax at all. In the latter case, the purchaser of farmproduce, however, is fully accountable for tax on his sales (usually ata reduced agricultural rate) and is entitled to a credit for tax presumedto be paid by the farmer on his inputs; to provide for this, a standardglobal credit offset is allowed, equal to a specified rate on the farmer'ssales that approximates tax paid on farm inputs. For example, if farmsales of 100 are made, the tax payable by the processor on thesepurchases at a (reduced) rate of 10 per cent is 10, for which he can

7 See Michele Guerard, "The Brazilian State Value-Added Tax," Staff Papers,Vol. XX (1973), pp. 141-42.

8 These items include fertilizers, seeds, pesticides, veterinary products, animalfeed, agricultural machinery, and tractors.

9 For a detailed analysis of this system, see Tait, op. cit., pp. 46-50.



claim a global credit offset of 5, computed at a standard 5 per cent ofthe purchases.10 No comparable device is used in the developingcountries.

Sales by merchants

The tax status of merchants varies widely among the countries cov-ered. In the three Latin American countries, as in the Western Europeancountries, merchants are expressly included in the scope of the VAT,at both wholesale and retail stages (with special provisions forassessing the tax on small retailers). In Senegal and Ivory Coast, how-ever, the VAT extends to only a small part of merchandising activitiesbeyond the manufacturing and import stage, and in the MalagasyRepublic only sales of imported goods are taxed. The same appears tobe true of the Moroccan tax.

In Ivory Coast, only producers, building contractors, and serviceenterprises are required to register as taxpayers (imports are taxed bythe customs office). Merchants may elect to come under the tax, butnormally they will take that option only if they sell to taxable producers,or if they wish to claim tax credits on exports. Otherwise, they areentirely outside the ambit of taxation to the extent that they engageonly in strictly merchandising activities.

The Senegal statute exempts resale of goods not further processedor altered, provided that the tax has already been paid at the produc-tion or import stage.11 Merchants therefore are required to register astaxpayers only if they sell goods that have not yet been subject to tax(for instance, goods bought directly from farmers). As in Ivory Coast,they have the right to opt for the VAT, if they find it advantageous todo so, for passing on to taxable purchasers the credit for tax borne ontheir merchandise. Those who sell only to retailers generally will notelect to be taxed, because retail sales are exempt. However, even ifmerchants in Senegal do not register as taxpayers, they are allowed tostate on their sales invoices the tax paid on their purchases, for purposesof facilitating claims for tax credit by taxable customers.12

10 The processor draws up two copies of an invoice showing the price beforetax (100) and the tax due on purchases (5). One copy is given to the farmer,and the other is signed by the farmer and retained by the purchaser in order tosupport his claim for tax credit.

11 Senegal, Ministry of Finance, Law 66-34, May 25, 1966, concerning thereform of the turnover tax system, Article 5-3 °.

12/Ш., Article 9-1°.



Services in general

Services are included within the scope of the VAT by five of theseven countries (Ivory Coast, the Malagasy Republic, Morocco, Senegal,and Uruguay). In Brazil and Ecuador, on the other hand, services aresubject to a separate gross receipts tax, which in Brazil is imposed bythe municipalities. In the countries where the VAT applies, all servicesare covered unless specifically exempt. A number of exemptions exist,however, the most common being real property rentals, transport andcommunications services, and financial services. The liberal professionsare universally exempt.

Even though the scope of the VAT on services may be limited byexemptions, a substantial part of the value of services may be taxedindirectly when purchased by taxable businesses. Because there is notax credit for these costs, the taxable margins of these businesses areincreased and the VAT payable, accordingly, is greater. Moreover,when a separate tax is imposed on services, as in Brazil and Ecuador,these service inputs are, in fact, taxed twice.13 In the EEC, membercountries are obliged to tax at least those services that, as businessinputs, are likely to have a significant impact on the price of goodsand other services, for example, accounting and engineering services.

Financial services

The tax treatment of financial institutions is not uniform in the sevencountries. The three Latin American countries follow the Europeanpractice of excluding banking, insurance, and other financial activitiesfrom the scope of the tax; they subject them instead to separate levies.14

In the two West African countries and the Malagasy Republic, on theother hand, it would appear from the statutes that financial services are,in principle, within the scope of the tax, although a number of financialtransactions are granted exemption. Insurance premiums, for example,are exempt from the VAT in Morocco, Senegal, and Ivory Coast (wherea special levy is assessed), but the exemption does not extend to anyrelated activities, such as insurance brokerage, fees, and commissions.Certain banking transactions are similarly exempt, particularly thoserelating to the activities of official financial intermediaries.

13 See Guerard, op. cit., pp. 135-36.14 The recently revised tax in Uruguay includes a reduced rate on financial

institutions that will replace an existing tax on financial transactions.



It is generally agreed that a VAT is not well adapted to financialservices, especially banking and insurance.15 The value added by banksand insurance companies is difficult to calculate under the indirect sub-stractive (tax-credit) method, although it would be feasible to employthe additive method and to apply tax to total payrolls and profits afterdepreciation allowances. Perhaps the most expedient treatment is thelevy of a separate tax on profits of financial institutions, as in Franceand Denmark and as has been proposed by the Republic of China.

Construction activity and real property transactions

Construction activity is subject to the VAT in Senegal, Ivory Coast,and the Malagasy Republic, but the tax paid on building purchases bybusiness firms is creditable for industrial buildings in Ivory Coast andfor industrial as well as agricultural, mining, and tourist installationsin the Malagasy Republic. In Latin America, only Uruguay taxes build-ing activity, but at a reduced rate. In Brazil, building contractors aresubject to the separate municipal service tax, on the value of servicesperformed, while construction materials are subject to the VAT; taxpaid on any building purchases is not creditable. Only the materials usedare taxed in Ecuador, and building contractors' margins appear to beexcluded from the scope of both the VAT and the separate grossreceipts tax on services.

Transactions in real property, in general, are left outside the scopeof the VAT in Brazil, Ecuador, and Uruguay, but are included, inprinciple, in the other countries. In fact, however, only the sales madein the other countries by registered taxpayers are taxable, while prop-erty sales by private individuals and exempt persons are not. Similarly,rentals are not covered by the tax in Latin America and are taxed inthe other countries only to the extent that they constitute a receipt fromcommercial or industrial activity.

EXEMPTIONS

In general, only exports are totally exempt from the VAT on theirfinal value, by allowing full credit for taxes paid earlier in the produc-tion process.16 For most other transactions, exemption is incomplete,

15 EEC, Report of the Fiscal and Financial Committee (The Neumark Report),Brussels, 1958, par. 185.

16 This is equivalent to applying a zero rate to exports, thereby providing, asfor other rates, for full credit against taxes payable—in this instance, zero.



as no provision is made for recovering tax borne on the inputs used inthe manufacture of exempt products. In the developing countries, how-ever, these inputs are themselves exempt for a number of products, sothat the amount of prior-stage tax incorporated in the price of theexempt final product is reduced, even resulting in complete exemptionfor some products. This has been seen to be true for off-farm sales inmost of the countries covered (see the section, Sales by farmers).

Exports

If the VAT is intended as a levy on personal consumption, on theassumption that the tax is shifted forward in higher prices, it is properto provide for the exemption of exports. This practice follows theso-called destination principle, according to which sales taxes are leviedonly by the country of final consumption, a principle that is sanctionedby the General Agreement on Tariffs and Trade. By effectively remov-ing all sales taxes that may have accumulated in the production anddistribution process, a country can better compete in the world marketfor its industrial goods. Virtually all countries, in fact, provide for theexemption of industrial exports from their different types of sales tax.One of the advantages claimed for a VAT in this respect is that theamount of tax applicable to the goods can be determined with greaterprecision, and no residual indirect taxes (laxe occulle) remain, as fre-quently happens with other types of sales tax.

On the other hand, many primary producing countries that enjoy acomparative advantage in the production of certain commodities doimpose export taxes, and the retention of a VAT on semiprocessed orprocessed agricultural products may sometimes be justified.

When exempt, exports are, in principle, zero rated, that is, they areexempt from further tax and full credit is granted for taxes paid atearlier stages or on deductible inputs. Generally, however, creditableinputs include only the cost of goods purchased and other current inputs,and specified types of capital input (see section, INVESTMENT GOODS).Moreover, the tax credits that exporters accumulate thereby are nor-mally supposed to be applied against VAT liabilities arising from theexporters' taxable domestic sales. If the VAT liabilities are lacking orare insufficient to absorb the credits, the latter may be made transferableto suppliers or to other taxpayers.

Only as a last resort do most of the developing countries go so faras to provide exporters with cash refunds of the excess tax credits, and



then often after the credits have been carried by them for an extendedperiod without possibility of being used up. In Senegal, for instance,the adjustment for exporters' excess credits can take place only afterthe close of the year, for either transfer to other taxpayers or aseventual cash refunds. Similarly, in Ecuador, excess tax credits arisingfrom exports may be transferred to suppliers only after a six-month lag.No refunds are contemplated in either Ecuador or the MalagasyRepublic. Uruguay appears to favor either offsetting the excess exportcredits against domestic tax liabilities or transfers to suppliers. InMorocco, there are no refunds, but export production can be exemptedfrom taxes paid at earlier stages if producers are registered with theCustoms Department for this purpose or if exports constitute at least85 per cent of total turnover. Ivory Coast is the only one of the sevencountries that clearly places no limitations on cash refunds.

In Brazil, the treatment of exports differs somewhat from that in theother six countries.17 Exports of primary products generally are notexempt but are taxed at reduced rates in some states and are taxedfully in others. Exports of manufactured goods are exempt, but, untilrecently, state policies on credit for taxes already paid and on refundsvaried widely. State practices are now being standardized, and by 1974it is expected that tax on manufactured exports paid at earlier stageswill be fully creditable throughout the country. The extent to whichactual cash refunds will be allowed, however, is still uncertain. More-over, the export of a whole range of semimanufactured goods stillgenerates prior-stage tax credit only in the states in the Center-South,while in the northeastern states such goods benefit only from a regularexemption at the export stage.

Food and other basic necessities

All seven countries grant some tax relief on food. This is generallyprovided in two ways: (1) by not taxing direct sales by farmers ofunprocessed agricultural products in general; (2) by exempting specificfoodstuffs, processed or unprocessed, regardless of the seller.18

The exemption of off-farm sales is provided in the VAT laws of theseven countries covered, except those of several Brazilian states. Theattendant tax relief on basic food items probably goes much further in

17 See Guerard, op. cit., pp. 139, 144-45, and 149-50.18 Also, some French-speaking countries provide for a reduced rate on food-

stuffs not otherwise exempt.



developing countries than in developed countries toward providing ageneral exemption of expenditures on food even if foodstuffs are notspecifically exempt.

Of the seven countries surveyed, only Ecuador appears to rely solelyon the farmers' exemption to provide tax relief on food consumption.All the others complement this with a specific foodstuff exemption,which varies from country to country. Brazil exempts only a limitednumber of foodstuffs, mostly in their natural state.19 Until 1973, Uruguayhad an extensive list of exemptions that included a number of processedfoods as well as basic necessities, such as medicines, soap, water, gas,electricity, coal, firewood, and kerosene, but many of these items arenow subject to a reduced rate. The two West African countries alsoexempt most foodstuffs, while the Malagasy Republic adds householdnecessities and some school supplies to the list and expressly exemptsa number of raw materials and intermediate products used for manu-facturing goods that are exempt as basic necessities. Similarly, in IvoryCoast, the exemption of bread, for instance, is supported by an exemp-tion for flour and cereals. Morocco exempts only basic foodstuffs.

Newspapers, periodicals, and other exemptions

Newspapers and periodicals are exempt everywhere, usually alongwith newsprint (as in Brazil, Uruguay, Senegal, and the MalagasyRepublic), and Uruguay also exempts printing equipment. Occasionallythe exemption is extended to books, other educational materials, andrecords.

Exemptions other than those covered elsewhere apply mostly to cer-tain services (in those countries where the VAT applies to services) andto real property sales and rentals (either totally or partially). InSenegal and Ivory Coast, exemption is also granted on the sales ofcertain public utility enterprises that operate under state concessions.

Goods subject to special excises

The tax treatment of goods subject to excises presents a specialproblem. Excises on tobacco products, alcoholic beverages, petroleumproducts, sugar, etc., are generally levied at high rates and account for

19 These include fresh fruits, vegetables, eggs, and poultry; in the northeasternstates milk, sugar, fish, and manioc flour are added to the list. However, staples,such as beans and rice, are conspicuously absent from the exempt list.



a substantial part of government revenues; in some instances these goodsare produced and sold through government monopolies. If these exciseswere replaced with a VAT, it would be necessary to introduce specialhigh rates so as not to sacrifice revenue; also, the advantages of excisetax administration and enforcement might be lost. On the other hand,producers would be subject to a VAT on their purchases, and unlessthese purchases were made taxable, or were zero rated, the producerswould not be able to recoup tax paid. European countries have gen-erally extended the VAT to cover sales of excisable goods; in somecountries, such as Denmark and Sweden, it has been superimposed onexisting excise tax rates, while in others, such as the Netherlands andGermany, excise rates were reduced so as to maintain approximatelythe same level of tax as before.

In developing countries, a limited number of goods and servicessubject to excises or sold by state monopolies are excluded from theVAT, particularly alcoholic beverages, tobacco, petroleum products,and public utilities. On the other hand, luxury excises are often super-imposed on the regular VAT, as an alternative to using the luxury ratesin the VAT itself (see the third paragraph of the section, TAX RATES).

INVESTMENT GOODS

The consumption variant of the VAT provides for a full credit ofthe tax included in purchases of capital goods. This is the policy fol-lowed uniformly by European countries. In developing countries, how-ever, there is a wide variation in practice, and investment is not entirelyremoved from the VAT in any of the seven countries covered in thispaper. Even when the law makes such tax creditable, because of thesizable credits frequently involved and the reluctance of the govern-ments to make refunds, considerable time may be taken to liquidatethe credit.

In the two West African countries and in the Malagasy Republic,tax is creditable on only specified categories of fixed asset. In general,the law is designed to give credit only to industrial equipment andsometimes building installations for industrial use, as in Ivory Coast.As a rule, tax on transport equipment is not creditable, except whendesigned exclusively for the internal handling of materials.

Both Ecuador and Uruguay provide full credit for the tax paid onfixed assets. Brazil originally allowed a credit for tax borne on industrialmachinery, although not on buildings. Industrial equipment is now



granted an outright exemption from the tax, and the tax-credit systemhas been repealed. The exemption is supposed to be complete (that is,a zero rate). To achieve this, manufacturers of equipment are to begranted full credit for taxes already paid on their inputs, in much thesame way as exporters.

Although industrial countries consistently avoid taxing investmentgoods (except in a transitional period), this policy need not necessarilyset a pattern for developing countries. In the latter, labor is generallyin surplus supply, and a cost advantage is frequently enjoyed by capitalthrough overvalued exchange rates, favorable credit terms, and incometax concessions. Taxes on capital goods, whether import duties or salestaxes, may serve partly to redress the imbalance between the cost oflabor and capital, and thereby encourage more labor-intensive produc-tion methods and industries.20

TAX RATES

For purposes of comparison, a distinction must be made betweennominal rates of tax and effective rates, depending on whether or notthe tax is applied to price exclusive of tax. In all European countriesexcept Sweden, and in Ecuador, the Malagasy Republic, and Uruguay,the tax is based on the price of goods and services exclusive of tax, andthe nominal rate is the same as the effective rate. On the other hand,Brazil, Ivory Coast, Morocco, and Senegal apply the tax rate to thetax-inclusive price; the effective rate therefore is higher than the nominalrate. For example, the 15 per cent rate in Ivory Coast and Morocco isequivalent to an effective rate of 17.65 per cent (0.15 ·*- 0.85 = 0.1765).

The VAT rates in the developing countries are somewhat lower, onaverage, than those prevailing in the VAT systems of the industrialcountries. Effective normal rates range from 10 per cent to 23 per centin Western European systems. In the developing countries, the effectivenormal rates on domestic sales range from 4 per cent in Ecuador to 20per cent in Brazil (Table 2 ).

As regards rate structure, Ivory Coast, the Malagasy Republic,Morocco, and Senegal have chosen the typical European multiple rateformat, with a normal rate, a reduced rate (usually half the normal

20 See, for example, Ian Little, Tibor Scitovsky, and Maurice Scott, Industryand Trade in Some Developing Countries: A Comparative Study (Oxford Uni-versity Press, 1970), pp. 145-48 and 330-33; George E. Lent, "Tax Policy forthe Utilization of Labor and Capital in Latin America" (unpublished, Interna-tional Monetary Fund, October 2, 1972).


EcuadorMalagasy RepublicUruguay

Brazil (states)Ivory CoastMoroccoSenegal

Reduced

6.01

5.0

7.5312.0 5

4.0 8

Normal Increased

Applied to sales excluding tax4.0

12.014.0

Applied to sales including tax16. 0-17. 0 2

15.0 30. 0 4

15.0 20. 0 6

9.0 25.0 9

Services

7.5 7

8.5 10

1 Food, basic necessities, drugs, textiles; construction materials and buildings;equipment; intermediary products; public utilities, banking, insurance, transport;services in general.

2 Rate of 14.0 per cent on interstate sales and exports.3 Ships, printed fabrics; certain equipment goods.4 Alcoholic beverages, cosmetics, jewelry, and bars and restaurants in the luxury

category.5 Foodstuffs, shoes, fuel alcohol, candles, bicycles, soap, coal, seeds, fertilizers. Also,

rates of 8.0 per cent on pharmaceutical products and of 11.25 per cent on radio andtelevision sets.

6 Luxury goods, automobiles.7 Reduced rates of 4.2 per cent on transport services and of 6.4 per cent on water,

gas, and electricity.8 Sugar, water, electricity.9 Luxury import rate (consumer durable goods, cosmetics). Normal rate of 11.9 per

cent on imported goods.10 Construction, electricity, and bars and restaurants.

rate), and a steeply higher luxury rate. In the three Latin Americancountries, the rate was uniform for all commodities until December1972, when Uruguay adopted a reduced rate for many goods that pre-viously were exempt from the VAT, being subject only to a grossreceipts tax.21 In Brazil and Ecuador, the differentiated treatment ofluxury goods is achieved not through the VAT but rather throughseparate luxury taxes, which in Ecuador take the form of excises. InBrazil the luxury taxes are incorporated in the Federal Government'smanufacturers' VAT system, which is characterized by a high degreeof rate differentiation on a product-by-product basis.

The reduced rates are used in the two West African countries and inthe Malagasy Republic for different purposes: (1) to grant a measure of

21 In the Brazilian states, the dual internal/inter state rate structure is designedto differentiate not on the basis of the type of product sold but on the geographicdestination of the sale. This rate structure is related to considerations of interstaterevenue allocation in the Federation, and is not concerned with the distributionof the tax burden among income classes.


TABLE 2. SELECTED DEVELOPING COUNTRIES : VALUE-ADDED TAX RATES

(In per cent}



relief to basic necessities that have not been exempted altogether (cer-tain foodstuffs, household products, school supplies, medicines; textilesin the Malagasy Republic; rough printed fabrics in Ivory Coast); (2)to assess public utilities more lightly in the countries where they are nottotally exempt (as in the Malagasy Republic and Senegal); (3) to taxconstruction and services (in the Malagasy Republic and Senegal, andin Morocco, where the rates on services are lower); (4) to tax equip-ment (in Senegal and the Malagasy Republic), thereby reducing theamount of tax credit that is subsequently allowed to business firms forpurchases of investment goods; and (5) to assess intermediate products(in the Malagasy Republic, where a long list of industrial raw materialsand semifinished goods is added to the list of equipment that is chargedat the reduced rate).

The higher rates apply essentially to luxury consumer goods, whichare mostly imported (cosmetics, jewelry, alcoholic beverages, automo-biles, and other consumer durable goods). The effective import rate onmost luxuries is 33.33 per cent in Senegal, 42.85 per cent in IvoryCoast, and 25 per cent in Morocco.

TAX CREDITS AND REFUNDS

All seven countries use the tax-credit method, which is the acceptedmethod in Europe. Credit is normally allowed for tax borne and shownon purchase invoices of all current inputs and fixed assets to the extentspecified in the statutes. No credit is allowed, as a rule, for tax paid oninputs used in the production of outputs that are exempt, with theimportant exception of exports and, in Brazil, of industrial machineryand equipment. Sometimes it is not possible to recover all the taxincorporated in an item that is taxed at a reduced rate when the inputshave borne the higher, normal rate of tax.22 This is so because of a pro-vision whereby the credit for taxes already paid on intermediate goodscannot exceed the tax due on the final product.

An excess of credits over tax liability is normally carried over to sub-sequent periods until it can be absorbed by a corresponding tax liabilityon a firm's sales. The transfer to other taxpayers and the eventual

22 This is the well-known butoir physique of the VAT based on the Frenchmodel, which has recently been repealed. An exception to this is the Ivory Coaststatute, which not only allows full deductibility but even grants cash refunds onprior-stage tax borne by products that are taxed at the reduced rate of 7.5 percent.



refund of unused credits are reserved almost exclusively to export taxcredits. In addition, as mentioned before, Brazil grants the same facilitiesto credits accumulated by manufacturers of equipment, which is taxexempt. In Senegal, cash refunds may also be granted for tax creditsarising from purchases of investment goods.

SPECIAL PROVISIONS FOR SMALL BUSINESSES

Generally, small businesses either are exempt or are assessed on aforfait basis. Sometimes, large numbers of small taxpayers have beenexcluded automatically from the tax by the exclusion of those sectorswhere they are numerous (for example, agriculture, in some instancesservices, retailing, and even small-scale wholesale activities in theWest African countries). In addition, within the scope of the tax,the very small business may be exempted, as in Ecuador and the Mala-gasy Republic. In other countries no statutory exemption exists evenfor the smallest businesses if they operate in a taxable sector; rather,they are covered by a forfait tax as in Brazil.23 In Sao Paulo, 174,000out of about 382,000 taxpayers are subject to the forfait system.

II. Revenue Importance of the VAT

SHARE OF TOTAL TAX REVENUE

As is usually true of broadly based general sales taxes, the VATmakes a substantial contribution to government revenue. In the countriesselected for the study, the share of the VAT revenue in total govern-ment tax revenue in 1968-70 ranged between about 10 per cent andabout 30 per cent (Table 3).24 In only two of the seven countries,Ecuador and Uruguay, was the revenue less than about 20 per cent oftotal tax revenue.

23 It is of interest that in France 1.4 million of the 2.0 million taxpayers aresubject to forfait, and they contribute only 7 per cent of the revenue. See GeorgesEgret, "La Taxe sur la Valeur Ajoutée en Belgique," in L'Entreprise Face a laT. V. A., Séminaire Organise a Liege, November 13, 14, and 15, 1969 (The Hague,1970), pp. 262-63.

24 Except for Brazil, this is a percentage of central government tax revenueexclusive of payroll taxes, which are usually assigned to a separate fund. Theratio for Brazil is based on total tax revenue of the federal, state, and local gov-ernments.



TABLE 3. SELECTED DEVELOPING COUNTRIES: VALUE-ADDED TAX (VAT) REVENUEAS A PERCENTAGE OF (1) TOTAL GOVERNMENT TAX REVENUE AND

(2) GROSS DOMESTIC PRODUCT, 1968-70 ι

Percentage of Percentage ofTotal Tax Revenue Gross Domestic Product

Brazil (states)EcuadorIvory CoastMalagasy RepublicMoroccoSenegal 3

Uruguay

1968

30.8

29.8

18.820.99.8

1969

28.9

29.120.923.917.713.2

1970

28.410. 3 2

27.419.024.822.316.0

1968

8.5

5.7

3.03.31.2

1969

8.4

5.43.24.23.21.7

1970

8.1l . l 2

5.42.74.54.02.1

Sources: Government reports; International Monetary Fund, International FinancialStatistics.

1 Government tax revenue is that of the central government, exclusive of socialsecurity payroll taxes, except for Brazil where it covers revenue of federal, state, andlocal governments. The VAT revenue includes that of supplementary tax on serviceslevied by the same level of government, where applicable.

21971.3 Fiscal years ending 1969, 1970, and 1971.

A comparison with 15 other developing countries that have salestaxes indicates that the VAT countries generally have a greater relativedependence on sales tax revenue. In only 5 of the 15 countries did thisrevenue in a recent year amount to 20 per cent or more of total centralgovernment tax collections, and in only one (India) did it approximatethat of Brazil.25

RATIO OF THE VAT то GDP

Perhaps of greater significance is the claim on GDP represented bythe VAT. Although the nature of the VAT suggests that the GDP (orGNP) represents the potential tax base, there is a wide gap betweenthe two. Besides the fact that exports, the value of capital goods pro-duced, and the value of government services are excluded, many otherexemptions and exclusions from tax may narrow the base (for example,farm sales, services, and retail sales). On the other hand, the value ofimported goods destined for consumption is included in the tax basealthough it is not part of GDP. The effective ratio of tax collectionsin relation to GNP, therefore, depends on three basic factors: (1) thevalue of expenditure excluded or exempted, (2) the level of the taxrate or rates, and (3) the level of enforcement.

25The percentage ranged between 8.0 (Ghana) and 32.9 (India). In India, asin Brazil, this represents a percentage of total government tax revenue.



Coverage of GDP

As we have noted in the section, THE TAXABLE BASE, in none of theseven countries covered is the VAT very complete in its sectoral scope.All countries exempt farm sales, exports of manufactured goods, andsubstantially all financial services; only three tax retail sales but theygrant exemptions for certain essential foods and other products; twoexempt all services, but the others exempt only specified services.

No estimate is available of the proportion of GDP covered by theVAT, except for Brazil, where it is approximately 60 per cent.26 Itshould not be inferred, however, that this represents value added onlyby the taxable sectors of agriculture, manufacturing, and trade; theoutput of the excluded sectors (for example, services and mining) istaxed indirectly by the purchases of such exempt goods and servicesbecause they carry no tax credit. The value of the intermediate produc-tion that is outside the direct scope of the VAT in Brazil and that iseffectively taxed in the form of noncreditable inputs is estimated toamount to from 15 per cent to 20 per cent of the value added byagriculture, manufacturing, and trade.27

Tax ratios

For the seven countries covered, the VAT tax collections in a recentyear ranged between 1.1 per cent of GDP for Ecuador and 8.1 percent for the Brazilian states (Table 4). While some difference in theseextremes could be expected because of the wide disparity in rates—ranging between 4 per cent for Equador and 20 per cent for Brazil—this accounts for only about 70 per cent of the difference.

In Ivory Coast, Morocco, and Senegal the VAT is also important inrelation to GDP. While their rates are fairly high—ranging betweeneffective normal rates of 10 per cent and 17.65 per cent—their tax ratiosare at least twice that of Uruguay, which has a rate of 10 per cent.Moreover, Uruguay taxes retail sales whereas the others do not.

It seems clear that in developing countries, in general, sales taxrevenue depends heavily on the value of imported goods.28 Informationis not available for all the countries covered that have a VAT, but datafor Ivory Coast, the Malagasy Republic, and Senegal show that the VATrevenue collected by the customs administration amounts almost uni-

26 Guerard, op. cit., p. 156.27 Ibid., pp. 154-55.28 See Ojha and Lent, op. cit., p. 558.



TABLE 4. SELECTED DEVELOPING COUNTRIES: GENERAL SALES TAX REVENUE AS APERCENTAGE OF GROSS DOMESTIC PRODUCT (GDP), RECENT YEARS

Brazil (states)ChileTunisiaIvory CoastMoroccoSenegalChina, Republic ofPeruMaliMalagasy RepublicKoreaThailandCosta RicaPhilippinesUgandaChadUruguayTanzaniaMauritaniaPakistan, WestIndia (states)GhanaIndonesiaEcuadorColombiaArgentinaNicaraguaMexicoHondurasBolivia

Type ofTax1

41444

4l andS

1 2

24

I and32522

24222

land 22242

25151 3

FiscalYear

19701970197019701970

19701969197019701970

19691969197019711970

19691970197019701971

1970196919711971197119701971197019701970

Percentageof GDP

8.17.26.35.44.5

4.03.93.32.92.72.72.62.42.42.3

2.22.12.12.01.6

.6

.4

.3

.1

.11.11.11.00.90.8

Sources: Government reports; International Monetary Fund, International FinancialStatistics.1 Type of sales tax: (1) multistage turnover tax; (2) tax on sales by manufacturers andimporters, and usually on selected services; (3) tax on sales of a broad range of selectedcommodities; (4) VAT; and (5) hybrid tax, on sales by licensed manufacturers andmerchants.2 With effect from January 1,1973, replaced with a tax on sales by manufacturers andimporters, with a partial tax credit, and separate lower rate taxes on wholesale sales andcertain services.3 With effect from June 1, 1971, revised to a single-stage manufacturers' tax (2).

formly to about 60 per cent of total revenue.29 In Morocco, the pro-portion is about one half.30 Imports probably play a less important rolein Latin America, especially in Brazil, but rough estimates indicate thatEcuador derives at least 40 per cent of its VAT revenue from imports.

29 For the fiscal year 1970, the percentages were 60 for Ivory Coast, 58 forMalagasy Republic, and 61 for Senegal. The percentage for Tunisia is also about60.30 That is, 48.7 per cent in 1968 and 54.4 per cent in 1969.



It is rather striking that, of a representative list of 30 countries withsales taxes, 5 of the 6 countries with the highest ratios of sales tax toGDP are those with a VAT (see Table 4). On the other hand, bothUruguay and Ecuador are at the lower end of the range, and theMalagasy Republic falls in midrange.

It is sometimes argued that the VAT is best prescribed for condi-tions of high sales tax effort because it becomes increasingly difficult toenforce tax collections from turnover taxes as tax rates are increased.31

This theory finds support in practice by the decision of 5 of the 6countries with high ratios of sales tax to GDP to employ this form, andby the fact that others with high tax ratios—including Chile, the Repub-lic of China, Peru, and Korea—have been giving serious consideration toconverting to a VAT. On the other hand, countries with low sales taxratios, such as Argentina, Colombia, and Mexico, have also consideredthe feasibility of the VAT technique.

ELASTICITY OF REVENUE

It would be important to know whether or not VAT revenues indeveloping countries increase at a faster rate than the growth of theeconomy, but the available data do not provide any clear answer. Whilethe ratio of VAT revenue to GDP has increased over the past few yearsin three of six countries with more than a full year's experience(Morocco, Senegal, and Uruguay), this may be attributable partly tochanges in rates and tax base as well as to enforcement, rather thanentirely to built-in elasticity (Table 3). In Uruguay, it may reflectlargely a revenue lag associated with the introduction of a new tax. Onthe other hand, revenue elasticity of the VAT would appear to be lessthan unity in Brazil, the Malagasy Republic, and possibly Ivory Coast.Brazil's declining ratio to GNP can be explained mostly by the liberali-zation of credits for exports and investment and the extension of pay-ment deadlines. The Malagasy Republic's revenue from domestic salesdeclined for reasons that are not clear, but there was a slight increasein the tax on imports. A priori, the taxable sector can be expectedto increase generally at a faster rate than does GNP, and experiencewith sales taxes in other countries shows an income elasticity that isusually greater than I.32 There would appear to be no reason, other thanchanges in the tax base and tax rates, why this should not also betrue of the VAT.

31 See Due, "Alternative Forms of Sales Taxation for a Developing Country"(cited in footnote 2), p. 274.

32 See, for example, Ojha and Lent, op. cit., p. 557.



Because of the concern over the revenue effect of the transition to aVAT, the experience of the countries covered would be of interest. Inall countries for which information is available, introduction of the VATapparently resulted in higher revenue than did the yield of the precedingtax. In Brazil, the state VAT revenue in 1967 rose by 54 per cent overthe revenue in 1966 from the turnover tax, but because prices rose by30 per cent on average, the real increase was nearer to 17 per cent.33

Uruguay's VAT revenues in 1968 also were appreciably higher thanrevenue from the tax that it replaced. The VAT in both Ecuador andthe Malagasy Republic significantly increased sales tax revenue in theearly years because the base was expanded to include imports, whichhad been excluded under the previous tax system.34

III. Problems of Administration

The feasibility of a VAT in developing countries depends largely onthe ability of the countries to administer it. This is a function not onlyof the scope of the tax but also of the degree of its complexity withregard to rate structure, exemptions, VAT techniques employed, treat-ment of small businesses and farmers, and other provisions that havebeen reviewed.

As was shown earlier, the VAT offers a wide variety of possibilitiesas to its coverage, ranging from a broad-based tax designed to reach asubstantial part of domestic consumption expenditure—touching allstages of the production and distribution of goods and services—to morelimited forms that exclude retailing, services, and farming. Another facetof the VAT that has direct influence on its administration is its ratestructure. While a single-rate VAT is much simpler to administer thana multiple-rate one, a number of countries have adopted multiple rates,for equity or revenue purposes. Exemptions also complicate the adminis-tration of sales taxes, since they require special records, invoices,credits, and, possibly, refunds. Exemptions provided on grounds of

33 Guerard, op. cit., pp. 125-26.34 Between 1968 and 1969, the year of introduction, the Malagasy Republic's

revenue more than doubled, increasing from FMG 3.1 million to FMG 7.2million, of which the tax on imports accounted for FMG 3.8 million; the internaltax revenue, however, declined slightly. Between 1969 and 1970, the first full yearof the VAT, Ecuador's sales tax revenue rose from S/ 162 million to S/ 439million, of which an estimated 40 per cent is attributable to imports.



equity have such a strong political appeal that their complete elimina-tion in developing countries is highly unlikely.

We must also consider the fact that the ability to administer a VATor, indeed, any other sales tax varies according to the stage of develop-ment in each country. Developing countries present a wide spectrum asto their degree of literacy, size of monetary economy, nature and size ofindustrial and trade establishments, adequacy of record keeping, atti-tudes toward taxation and tax administrators, and efficiency of taxadministration services. The existence of a great variety of situationswith respect to these factors precludes generalizing on the feasibility ofvalue-added taxation in developing countries. The proper approach isto try to identify certain crucial administrative problems that must beresolved in each country before such a tax can be implemented success-fully.

These problems should be viewed from the angle of not only govern-ment administration but also the taxpayers' problems of compliance.The costs of doing business tend to increase with the introduction of aVAT, especially during the initial period, because of the need to adaptto new accounting procedures.

The principal difference in enforcement and compliance betweendeveloped and developing countries arises from the relatively largernumber of small businesses in the latter and the inadequacy of book-keeping records. The same problem exists on a smaller scale in devel-oped countries, as may be seen, for example, in Denmark.35

While the problem of small taxpayers is important in developingcountries, this fact should not obscure the overall vision of their taxstructure, as industry and commerce are becoming more concentratedin large enterprises in many of these countries. Therefore, strictly fromthe point of view of revenue, the problem of enforcing tax on smalltaxpayers should not be overemphasized.36

35 According to Danish tax officials, even though the new tax is believed to befar easier to administer than was the wholesale tax, "it is not yet clear howreadily the mass of small and medium-sized firms will understand and followthe tax law and regulations." An observer outside the Government has suggestedthat the enforcement effort needed will be great indeed, relative to the numberof qualified officials available. See Carl S. Shoup, "Experience with the value-added tax in Denmark, and prospects in Sweden," Finanzarchiv, Neue Folge,Band 28, Heft 2, March 1969, p. 247.

36 For example, for the Chilean general turnover tax, 4 per cent of the tax-payers account for 74 per cent of the total sales reported, while 58 per cent ofthem report only 2.1 per cent of total sales. These data were obtained for July1965; estimates for the succeeding years show that the situation has not changedsignificantly. In the municipality of Säo Paulo, Brazil, 8 per cent of the taxpayersaccount for 90 per cent of the VAT collections.



NUMBER OF TAXPAYERS AND THEIR REGISTRATIONA VAT that reaches all stages of production and distribution is

bound to increase the number of taxpayers substantially, unless itreplaces a multistage sales tax.37 In developing countries, the problem ofincreasing the number of taxpayers should be viewed with caution,especially if only a small percentage of the new taxpayers will affect therevenue significantly. Even though the control and audit of small tax-payers may be kept at a minimum, their number alone may pose prob-lems of registration, filing returns, and tax collection that could impedethe efficient administration of the entire tax system. The cost of adminis-tering large numbers of relatively unproductive small taxpayers must beweighed against the considerations of efficiency and equity that may leadto their inclusion.

The problem of numbers, of course, can be minimized by exemptions.In both Denmark and Sweden the inclusion of farmers in the VATsystem accounted for most of the increase in taxpayers. As we haveseen, virtually all developing countries exempt fanners and therebyavoid this problem without necessarily prejudicing tax revenue becauseof the "catching up" at the processing stage. Moreover, substantialagricultural output may be exported and therefore may not be subject tosales tax. Also, the VAT may be limited to a select list of services, as inSweden, or services may be exempted from the VAT, as in Brazil andEcuador, thereby eliminating many small personal service firms.

Another practical approach is to limit the VAT to firms with annualsales in excess of a specified minimum, a policy that is generally prac-ticed in Europe. For example, Denmark exempts persons with sales ofless than DKr 5,000, and Sweden of less than SKr 10,000. In the Repub-lic of Ireland, retail units with annual sales of less than <£ 12,000 andpersons providing services of less than £1,800 are not obliged to regis-ter. These limits may be too high for developing countries; Brazil,Ivory Coast, and Senegal, for example, provide no exemption based on

37 In the United Kingdom, it has been estimated that the number of taxpayerscovered will expand from 65,000 under the rather selective purchase tax to some2 million under the VAT, Tait, op. cit., p. 124. In Denmark, the VAT coversan estimated 365,000 taxpayers, against 60,000 covered by its wholesale salestax, Shoup, "Experience with the value-added tax in Denmark" (cited in foot-note 35), pp. 246-47. On the other hand, Sweden's change from a retail sales taxto a VAT involved an increase in licensed taxpayers from about 170,000 to350,000, Martin Norr and Nils G. Hornhammar, "The Value-Added Tax inSweden," Columbia Law Review, Vol. 70 (1970), p. 412. The VAT in theRepublic of Ireland is not expected to expand the number of taxpayerssubstantially because the two-tier sales tax system already embraces most whole-sale/retail firms—about 30,000. Where a multistage turnover tax has been ineffect, as in Chile and Peru, the number of taxpayers is not likely to be increased.This was Germany's experience.



size but rather rely on a simplified forfait system for small businesses(see footnote 6).

In order to efficiently administer a VAT, as well as any type of salestax or income tax, one must have a proper system of taxpayer registra-tion. Such systems already exist in many developed and developingcountries, where they have been implemented with varying degrees ofsuccess.

In some countries, taxpayers have been registered and given a num-ber that has generally been valid only for a particular tax, and differentnumbers have been given to the same taxpayer for each tax that requiresa numbering system for filing, collection, etc. In general, these differentnumbering systems have led to lack of coordination of the informationabout each taxpayer.

In recent years, there has been a trend toward a registration and num-bering system, called the "master file system," in which each taxpayeris given a number that identifies him for several or all taxes to whichhe is liable. To operate successfully, this system should be computerized.The use of a master file system is ideal for administering a VAT, as itmakes possible an efficient control of tax collection; moreover, computerprograms could be designed to analyze returns of both the VAT andthe income tax, with respect to profit margins, relation of purchases tosales, etc., and for preselecting cases for audit. The use of a master filesystem with classification of taxpayers is also valuable in obtainingstatistics on input and output of businesses.

For many developing countries, however, it is not feasible to comput-erize their tax administration and to introduce a master file system.This is a handicap but not necessarily a barrier to the introduction ofa VAT.

If the taxpayers who are subject to the VAT have not already beenregistered for tax purposes, a special registration system must be devisedfor them. Even though a registration system may exist, the introductionof a VAT provides a good opportunity for purging these registers byrequiring taxpayers to register again for purposes of the new tax. Whenfeasible, the registration system should be designed for use within acomputerized operation, and a numbering mechanism should be devisedthat will be adequate for the overall requirements of the system.

INVOICES AND ACCOUNTING RECORDS

One of the essential elements for applying and controlling the VATis the invoice. As the invoice states not only the value of the goods soldbut also the amount of tax paid in relation to such goods, it is the



buyer's main evidence of the taxes that he has paid on his inputs, forwhich he will be able to claim credit against his tax on sales.

One problem that arises is whether invoices should be given onofficial forms, printed and numbered by government offices, or on pri-vately printed forms that, although containing a uniform set of facts,are not standardized in format. Sometimes the latter must be registeredwith the government, which affixes an indelible seal.

There is general agreement that the following information should beincluded: name and address of both the supplier and the customer;quantity and description of goods; unit price of the goods; separatestatement of taxable and nontaxable goods; separate statement of thetax applicable, together with the rate that applies in each case; and dateof the invoice. The invoice should also include the registration numbersof both the buyer and the seller. Experience has shown that smallretailers and artisans greatly resist issuing invoices, not only for theadministrative complexity that they imply but also to avoid registeringtotal sales. This problem is considered in the section, AUDIT OF A VAT.

With respect to accounting records, it is necessary to distinguishbetween taxpayers whose internal organization allows them to absorb taxchanges without undue administrative effort, and those of smaller sizeand less efficient operations for whom new requirements of accountingand recordkeeping imply high costs compared with their total profits.The principal difference between the accounting requirements of ageneral turnover sales tax and those of a VAT is that for audit andcontrol purposes of the VAT the taxpayer's records must show clearlynot only total sales and the sales taxes payable but also his purchasesand the taxes paid.

Multiple rates and exemptions compound the problems of record-keeping. With respect to multiple rates, purchases and sales taxed atthe different rates must be recorded separately.38 Similarly, exempt pur-chases and sales should be recorded separately from taxable sales. It isalso necessary to separate those exemptions that lead to a refund of thetaxes previously paid on the goods and services used in the productionof the exempt items (that is, zero rated) from those exemptions that donot result in a refund of taxes previously paid.

38 The simplicity of a single-rate system is best exemplified by Sweden's useof an ordinary punched card for a tax return form. The taxpayer reports onlytotal sales and export sales for the period, together with tax on sales and taxpaid on purchases during the period. Further simplification of payment andcollection of the tax is achieved by the use of the postal check, or "giro," system,Norr and Hornhammar, op. cit., p. 410.



A further complication arises when an enterprise deals in both exemptgoods on which tax is not refundable and taxable goods. If the law doesnot allow for a system of proration, it will be necessary to recordseparately the inputs that will go into the production of exempt goodsand taxable goods. In order not to overburden the taxpayer, a practicalsolution would be a system that allows the taxpayer a pro rata creditof his total taxes paid on purchases, based on the same proportion thathis taxable sales have in relation to his total sales.

FILING OF RETURNS, PAYMENT OF THE TAX, CREDITS, AND REFUNDS

The form of the returns that must be filed by taxpayers who are sub-ject to the VAT will vary according to whether the tax has a single rateor a system of multiple rates, and also according to the mechanism fordealing with exempt sales. The returns filed must contain all the infor-mation needed for mathematical verification of the tax due, as describedearlier.

Ideally, the returns that a taxpayer is required to file should be mailedto him with his registration number, name, and address preprinted bythe computer. Since many developing countries have neither sufficientcomputer capacity to do this work nor reliable postal services, the tax-payer must obtain the forms in the tax offices and file them personally.

Normal payment periods vary from one month (as in the French-speaking West African countries) to three months (in the Netherlandsand the United Kingdom). A monthly period for filing and payment canbecome a burden to the taxpayer as well as to the tax administration indeveloping countries, and perhaps a two-month period might be con-sidered acceptable; longer periods are employed in some countries forsmall taxpayers.39 On the other hand, it may be argued that this arrange-ment benefits the taxpayer unduly, in having the use of governmentfunds for a relatively long period, and makes eventual collection morerisky; against this argument is the fact that in most VAT schemes thetaxpayer who sells on credit has a liquidity problem if he is liable tothe tax when the sale is made.

As has been stated, exemptions from the VAT, if zero rated, mayresult in refunds of taxes previously paid on goods and services used in

39 Sweden provides a tax payment period of two months, but with the per-mission of the tax authorities a firm may file in a period of four, six, or eventwelve months, depending on the size of its annual turnover. Under these rules,most farmers can be expected to report their taxes only once a year, Norr andHornhammar, op. cit., p. 410.



the production of the exempt items. Refunds may also occur in othersituations, such as claiming excess credits, or absorbing credits duringthe transitional period between the old turnover tax and the VAT. Insome countries the law provides for a gradual liquidation of theseexcess credits until they are absorbed by taxes payable, but in othersit provides for refunds, especially on exports.

The administration of refunds is inefficient in many developing coun-tries; whenever possible, refunds should be avoided and a credit mecha-nism against future taxes should be used. The refund procedure entailsnot only a burden for the tax administration but also sometimes a longand unpleasant struggle for the taxpayer in obtaining his money.

AUDIT OF A VAT

Auditing a VAT concerns both sales and purchases as well as thetaxes paid on them. Auditors therefore must check a variety of matters,such as exemptions, multiple rates, connection between purchases andsales, and credits and refunds claimed by the taxpayers.

Existing literature emphasizes the "cross-checking" procedure of con-trolling evasion; this consists of comparing the invoices issued with thereturns filed by taxpayers, to uncover possible tax evasion at any stage.40

The following observations should be made about cross-checking VATpayments:

(1) Cross-checking purchases against sales is not a new idea; it is astandard procedure for both sales and income tax audit in many coun-tries. In general, invoices are required for administering both of thesetaxes, and different systems of cross-checking—manual and comput-erized—have been applied.

(2) In general, manual cross-checking has proved to be cumbersome,time-consuming, and relatively unproductive, owing to the complexityand size of the operations involved. Computerized cross-checking hasrun into difficulties because of lack of uniform invocies, insufficientcapacity of the computers, and other administrative problems. Develop-ing countries should be cautioned against relying on their computersystems for cross-checking; often the computers have proved to bebarely capable of performing relatively simple operations, such as print-ing bills and tax rolls.

40 As Shoup states, "At all earlier stages, down to the retail stage, the businessfirm buyer insists that the seller show his (the seller's) tentative tax on theinvoice. If, then, the seller does not in fact pay this amount of tax (minus thecredit for taxes shown on invoices for the things he has bought), his evasion canin principle be discovered by matching his tax return with the invoices in thefiles of his customers," Shoup, "Experience with the value-added tax in Denmark"(cited in footnote 35), p. 246.



(3) Once a discrepancy between invoices and returns has been dis-covered, the tax auditors must investigate the case. In practice, thisoperation is also troublesome, as a discrepancy in one or two invoicesmay not allow the whole of the taxpayer's records to be disregarded,unless fraud can be proved.

(4) Cross-checking retail sales is impracticable, since the retailer isunder no pressure from consumers to pay the tax.

A more fundamental question should be raised, especially within thecontext of developing countries: Is it correct to assume that each buyerwill "insist" on obtaining an invoice from the seller, so as to be able tocredit the tax stated in that document? The whole theory of the built-inchecking system of the VAT rests on this assumption (except forretailers).

In this context, the difference between the VAT and an ordinary turn-over sales tax lies in the fact that the buyer should have a greaterinterest in obtaining an invoice when he is subject to the VAT, as it isthe only proof of his right to a credit against his own tax liability. Inreality, each taxpayer is subject not only to VAT but also to a varietyof other taxes, among which the income tax is one of the most relevant.Therefore, the problem of evasion and control of a VAT cannot beanalyzed in isolation, but it must be studied within the context of thetotal situation of the taxpayer.

Experience has shown that the evasion of sales taxes generally has atwofold objective: to evade the payment of both these taxes and theincome tax through the understatement of sales. Evasion is easier toaccomplish through the understatement of sales than through illicitdeductions, which when stated on accounting records may be subject toscrutiny by tax auditors. The understatement of sales for this dualpurpose requires an accompanying reduction of purchases so as to givean appearance of consistency and thereby to disarm the tax auditors.Therefore, faced with the combination of the VAT and the income tax,taxpayers may be tempted to forgo "insisting" on obtaining invoicesand may prefer to obtain a price reduction on their purchases so thatthey also can sell a part of their output without invoices.41 In such situa-tions, it is obvious that cross-checking invoices against returns will give

41 In many developing countries a so-called black market chain is formed, withrespect to goods sold and bought without invoices. Producers sell a part of theiroutput through regular channels, giving invoices and other required documents,but they also dispose of an important part of their production to wholesalers orretailers with whom they have close business connections—perhaps even familyties—without invoices or other documentary evidence. In turn, these wholesalersor retailers also sell an appropriate fraction of their goods with invoices andanother part without, in such a way that what was originally sold at the firststage without invoices reaches the final stages of distribution in the same manner.



limited results, as taxpayers using this method of evasion will be carefulto have enough invoices to justify the purchases that they record in theirbooks, as well as to produce sufficient invoices to cover the amount ofsales that they wish to report.

Therefore, even though the VAT provides an important incentive foraccurate reporting of sales and purchases, through the self-interest thatthe purchaser will have in obtaining an invoice, one should not placeundue faith in the virtues of the so-called built-in control system or inthe cross-checking of documentary evidence provided by the taxpayers.

Audit of a VAT will have to rely on additional mechanisms such asthose used in traditional sales taxes; one of the most important is thephysical checking of inventories of goods on hand, which is practicallythe only method of piercing the taxpayer's web of documentary evi-dence. The principal problem in following this procedure in developingcountries is the relative scarcity of trained personnel, as staff time isusually devoted mostly to the daily problems of collection, appeals, andother administrative matters, and only a small percentage of trainedpersonnel is free for audit functions. Obviously, this physical checkingof inventory can best be accomplished by personnel with experience inincome tax audit, and it should be coordinated with the administrationof the income tax.

TREATMENT OF SMALL ENTERPRISES AND FARMERS

Small enterprises

As has been pointed out, large or medium-sized enterprises can absorbthe accounting and procedural requirements of a VAT with relativeease. Because there are relatively few such enterprises in developingcountries, and an important part of total economic activity is concen-trated in their hands, they tend to become a target for audit andcontrol by the tax administration services.

The problem arises with the large numbers of small artisans, traders,and peddlers that exist in developing countries, who may comprise aninsignificant proportion of total business activity. Various solutions toproblems of administering the tax on these firms have been advanced,mainly the following:

(1) Apply the VAT to all stages of production and distribution,including retailing, but limit it to those firms that have a yearly turnoverabove a specified level. Since most of the exempt firms would pay tax



on their purchases, tax would be sacrificed only on their retail margins.These small firms could choose coverage by the VAT and might do soif the tax paid on their purchases exceeded the tax paid on their sales(or if their buyers insisted on a tax credit). As we have seen, manyEuropean countries and some developing countries exempt small busi-nesses.

(2) Establish a limit, generally based on yearly turnover, belowwhich taxpayers may elect either to be incorporated within the VATsystem or to pay a low rate of turnover tax on their total sales with nodeduction for taxes paid on their purchases.

This system relies heavily on the accuracy of sales reported by smalltaxpayers. It is precisely this point that causes most difficulties inadministering any type of sales tax, as it is practically impossible to deter-mine total sales of a large number of small taxpayers. In such a systemmost customers of these small taxpayers have no interest in paying thetax or in receiving an invoice, while the taxpayer wishes to minimize histotal sales for purposes of both sales tax and income tax.

(3) Use the forfail type of assessment. This system is widely usedfor small businesses both in the countries that provide no exemption forsmall businesses and in those with firms that are larger than those inthe exempt category.42 In Uruguay, a variant of this system is to assessall exempt small firms with a special turnover levy (applied to eitheractual or estimated gross receipts) that substitutes for both the VATand several other taxes, including the schedular income taxes on busi-ness enterprises. The VAT that is assessed on a forfait basis is in somerespects a separate levy, especially to the extent that it does not providecredit for taxes already paid, and since normally it cannot be stated oninvoices even if sales are made to taxable taxpayers. One exception tothis rule is the Senegal statute specified in footnotes 11 and 12, whichallows firms assessed by forfait, and even unregistered traders, to passon to business purchasers the tax credit on their sales invoices.

42 The forfait system may be illustrated by the procedure employed in theFrench-speaking West African countries. There, small taxpayers are required tosubmit an annual declaration of gross turnover, purchases, number of employees,wages and salaries paid, and the value of inventory. On the basis of these datathe internal tax department estimates taxable sales and assesses the taxpayer, whohas 20 days to accept or reject it. If the assessment is rejected, the tax departmentnegotiates a mutually acceptable assessment. If no agreement is reached, the caseis referred to an ad hoc commission composed of the director of the internal taxdepartment (chairman), representatives of the ministry of finance, and business-men. Unless the taxpayer chooses to appeal to the courts, this assessment is finaland is generally valid for two years.



The forfait mechanism is a crude way of taxing small enterprises andis subject to arbitrary decisions on the part of the administration and tocollusion between taxpayers and tax inspectors. In those developingcountries in which political influence or other disruptive factors charac-terize tax administration, the forfait system might tend to perpetuatesuch abuses. Moreover, use of this technique does not encourage theuse of invoices and improvements in accounting.

(4) Use a variation of the forfait technique in which the taxpayerwould be allowed to deduct from his fixed tax the amounts of the VATthat are shown on his purchase invoices. Here, the forfait paymentwould be fixed at a higher amount than in a normal forfait system toallow for the deduction of taxes paid on purchases. One advantage ofthis modified forfait is that the taxpayer has a greater interest in obtain-ing an invoice for his purchases. Moreover, it has been suggested thatthe relative amount of tax credit taken by the forfait taxpayer wouldprovide a guide to the administration in making periodic changes in theforfait estimates.

(5) Give small enterprises, especially in the retail field, the option ofcoming within the scope of the VAT or of being subjected to an "equali-zation" levy that is chargeable at various rates on goods delivered tothem, depending on their selling margins. This technique has beenadopted in Belgium and has been studied for possible application in theCentral American countries that have adopted a hybrid system of salestaxes. Under this system, it is the responsibility of sellers to collect theequalization tax, showing on their invoices both that tax and the VAT.The Belgian system, which is of a transitory nature, has the advantageof incorporating small businesses within the scope of the VAT withoutthe need to audit or control them directly; however, it has been criti-cized for the multiplicity of the rates required, the burden on the seller,and the reluctance of small businesses to come under the system.43

With respect to the problem of small businesses, the fundamentaldifficulty, common to all the systems described, is to determine whichtaxpayers should be considered "small." Faced with this problem, mostcountries have fixed a limit on total yearly turnover as an appropriatedividing line.44 This criterion is open to several objections. One of the

43 Egret, op. cit., p. 262.44 Ivory Coast, the Malagasy Republic, and Senegal, in common with the practice

among French-speaking countries, have divided small firms into two categoriesdepending on whether they are engaged mainly in (1) selling merchandise or



main difficulties of administering any type of sales tax is to obtain anaccurate report of total sales from small enterprises. Small taxpayers willtry to adjust their total sales to fall within or outside the scope of theVAT, according to their interests, and the authorities are generally un-able to control such a situation. The amount of the limit is also arbitrary,and it is difficult to justify why two taxpayers should be in differentsituations only because one has a turnover that slightly exceeds the fixedlimit and the other is barely below this limit. It may therefore be desir-able to incorporate in the definition other objective elements, such asvalue of total assets, value of inventory, or number of employees.

Farmers

The inclusion of farmers presents one of the most serious problemsof administering a VAT. As we have seen in the section, Sales by farm-ers, some European countries have dealt with them by means of a"global credit offset" device, according to which farmers do not haveto pay the VAT but simply issue a receipt for goods that enables pur-chasers to claim a tax credit. The main reason for using such a proce-dure is to avoid imposing on these taxpayers the obligation of keepingthe records that are essential for administering the VAT. If this is thesituation in developed countries, it cannot be expected that the VATcan be applied to farmers in developing countries with any degree ofsuccess, unless a similar technique were to be devised for them.

In developing countries in which a VAT is in force, one solution hasbeen to exempt direct sales of unprocessed agricultural goods by farmersand to exempt agricultural producer goods that comprise the main costof their inputs. While this method may not be precise in avoiding cumu-lation of tax, neither does it sacrifice tax revenue, because the value ofthe farmer's output is recouped at the next taxable stage, that of thetrader, cooperative, or processor.

On the other hand, in many developing countries there is a greatcultural and economic difference between different categories of farmer;

providing restaurant and hotel services (Category A) and (2) other activities,mainly services (Category B). The limits of gross receipts on firms subject tofor fait are as follows:

(In millions of CFA francs)Category A Category В

Ivory Coast 30 15Malagasy Republic 5 3Senegal 20 7



frequently, large holdings are concentrated in the hands of a small per-centage of landowners, who make an important contribution to totalagricultural production and many of whom maintain accounting recordsrequired for a VAT. Therefore, although administrative reasons are ofconsiderable weight in favoring the exemption of most farmers in devel-oping countries from the VAT, they do not justify exempting largecommercial producers.

ORGANIZATIONAL ASPECTS

When a country decides to adopt a VAT, one of the first administra-tive questions that must be answered is which government service will beresponsible for administering it. The main possibilities include (1) theorganization that administers customs and, sometimes, excise duties;(2) the organization that administers internal indirect taxes, where suchadministration is separate from that of the income tax; and (3) theincome tax administration.

It is difficult to make a general statement as to which of these organi-zations is best equipped to administer a VAT. Nevertheless, some guide-lines for a decision in a particular situation may be inferred from theexperience of different countries with this matter.

It is true that up to a point the administration of the VAT is relatedto that of customs duties; usually the VAT will be applied to importsand remitted on exports. Nevertheless, apart from these two main pointsof contact, the whole expertise of a customs organization is directedprincipally to establishing the value of goods that cross the border of acountry. Generally, its personnel are not experienced in such matters asauditing taxpayers' records, cross-checking invoices, checking inven-tories, or other functions that are necessary to administer a VATeffectively.

As to the second alternative, in many countries a clear organizationalseparation exists between the administration of income taxes and ofindirect taxes. Generally, a high-ranking official or board of officials hasthe responsibility of supervising the two separate organizations and ofcoordinating their operations. Effective coordination between the twoorganizations depends on many factors, including the degree of authorityof their common supervisor, the personality and political influence ofeach of the heads of the separate organizations, the revenue importanceof the taxes administered by each organization, and the position of theemployees of the different organizations as to salary and other benefits.



It has become general practice to leave the administration of the VATto the organization in charge of indirect taxation.45 There are good rea-sons for such a decision, for usually the VAT replaces another kind ofsales tax that has been administered by this organization, which has acertain degree of skill in the matter, maintains taxpayer registers, etc.

Nevertheless, the efficient operation of a VAT requires a level ofexpertise in auditing that is more akin to that for the control of incometaxes than of other forms of sales tax. At the same time, the informationobtainable through the VAT should be helpful in enforcing the incometax. These considerations seem to argue more in favor of a unitedadministration, under a single organization, of both income taxes andthe VAT.

Long administrative history and political reasons, however, militateagainst this solution in many countries. In situations where sales taxesand income taxes are administered by separate departments, effortsshould be directed toward establishing a high degree of coordinationbetween the two organizations. This coordination not only should beenforced at the level of heads of organizations but also should beinstitutionalized at different technical levels, such as automatic process-ing of data obtained through tax returns or audits, exchange of thisinformation, consultation as to special audit programs, and design offorms.46

PROBLEMS OF CHANGING OVER то A VAT

While the problems connected with filing returns, collecting the tax,and auditing accounts are of a continuing nature, a series of otherproblems of administering a VAT are mainly of a transitional nature,and they tend to disappear once the tax has been in force for a periodof time. These include (1) training the technical personnel who willadminister the VAT, with respect to the new procedures and require-ments necessary for controlling it; (2) educating the taxpayers and the

45 Recently, the Republic of Ireland and the United Kingdom have followedthis policy; the Inland Revenue Department and the Board of Customs andExcise, respectively, were selected to administer the new VAT. Similarly, the Cus-toms and Excise Department in Malaysia was charged with the administration ofMalaysia's new manufacturers' sales tax.

46 A special problem exists when the VAT and the income tax are administeredat different levels of government. In this situation, coordination becomes thekey to a better administration of both taxes. In Brazil, the Federal Governmentsponsored centralized procedures for state and federal tax administration andprovides federal technical assistance to the less developed states.



general public about the characteristics of the new tax, as well as aboutthe new requirements with which taxpayers will have to comply; and(3) administering special transitional provisions that are generallyincluded in a new VAT law, covering mainly the treatment of invest-ment goods and inventory on hand when the new tax goes into effect.

The lack of adequate personnel training is one of the weaknesses ofthe tax administration services in developing countries that adverselyaffects the efficient administration of their whole tax structure, especiallythe implementation of any new tax scheme. The intensity of trainingwill depend on the previous experience of the personnel in administeringmore or less complex forms of taxation. In this respect, obviously person-nel who have been in charge of auditing income taxes will require muchless training than, for example, customs officials.

Educating the taxpayers and the general public about the features ofthe VAT is also of great importance to its adequate implementation. Ifit is a change from a general turnover tax, then it is not only a matter ofteaching the new technique but also of explaining the merits of a VATin contributing to the general equity and fairness of the sales tax, evenif it sometimes entails initial hardship for some taxpayers.

Adequate information about a new tax is conducive to better admin-istration. In many instances there is a lack of necessary contactbetween the administration and organizations of taxpayers or of pro-fessionals who devote themselves to tax problems. Information directedto the general public is useful, but direct contacts with business ortrade unions, associations of lawyers, accountants, etc., may be of morepractical use for a better administration of a new tax such as the VAT.

Another important administrative problem is that of applying thespecial transitional provisions included in most VAT laws. These pro-visions, which deal mainly with investment goods and inventories, maybe necessary when these items have borne some form of sales tax beforethe introduction of a VAT. If investment goods have borne no tax (asin Ireland and the United Kingdom), no problem arises; but when theywere taxable, as under a multistage turnover tax, it is necessary to avoidundue discrimination by reason of the exemption of investment goodsunder a VAT. The solution of Belgium, Germany, and the Netherlandswas to give a partial credit and to reduce the amount of credit for taxon investment goods gradually over a transitional period of several years.This problem would arise mainly in developing countries with a multi-stage turnover tax, for example, in Chile and Peru, where investmentgoods are taxed.



The problem of relief from double taxation of inventories in the tran-sition to a VAT arises in virtually every country where the sales taxreplaced is not of the retail variety. One method of relieving doubletaxation is to allow taxpayers to take credit for sales tax that had alreadybeen paid on inventories on the date of the change-over; this is thesystem that was implemented by Ireland and is planned by theUnited Kingdom. When the sales tax replaced is of the multistageturnover variety, however, a difficult problem arises in determining theeffective tax rate cumulated on the many types of goods in inventory.No attempt was made by most European countries to mitigate thisdouble taxation; rather, it was left to be worked out in the marketprocess.

IV. Comparison of the VAT with Other Formsof Sales Tax

The choice of sales tax technique, as with other taxes, rests on avariety of considerations that must be weighed by each country in thelight of its own social and economic conditions. And in appraising thefeasibility of a VAT for a developing country, it is necessary to specifythe realistic alternatives at its stage of development. The relative meritsand limitations of the alternative forms of sales tax that were listed inSection I are discussed in this section.

In this analysis no consideration is given to the stage of developmentat which a country may be justified in introducing a general sales taxin any form. According to one view, such a move depends on the com-parative importance of domestic production in a hypothetical sales taxbased on imported and domestic consumer goods and services: a generalsales tax may be warranted at a stage of development when domesticproduction becomes sufficiently important and accessible to leave asignificant gap in the hypothetical base.47 According to another view, anondiscriminatory sales tax on imports and domestic production may bejustified as a revenue measure that reduces the protective effects ofcustoms duties that might otherwise be enacted, even in early stages ofdevelopment.48

47 See Jonathan Levin, "The Effects of Economic Development on the Baseof a Sales Tax: A Case Study of Colombia," Staff Papers, Vol. XV (1968),pp. 75-93.

48 See John F. Due, Indirect Taxation in Developing Economies: The Role andStructure of Customs Duties, Excises, and Sales Taxes (Baltimore, 1970), p. 56.



In evaluating the choice of a VAT by a developing country, threepractical alternatives that have proved successful in operation are givenprimary consideration: (1) a single-stage manufacturers'/importers' taxof the suspensive type, on the model of Malaysia and Tanzania; (2) ahybrid retail/wholesale tax modeled on that of Honduras; and (3) atandem manufacturers' (or wholesalers')/retail tax similar to that of Ire-land's former system. Neither the multistage turnover tax nor a single-stage retail sales tax is considered suitable, the former because of itsdiscriminatory cascade effects and the latter because of difficulties inenforcement. These alternatives will be appraised on the basis of severalcriteria, including (1) neutrality as to organization and form of business;(2) neutrality as to effects on relative prices and consumer choice; and(3) problems of administration and compliance. While compatibilitywith an economic union, such as a common market, and effects onexports are also important, there seem to be no significant differences inthese respects among the alternatives considered.

MULTISTAGE TURNOVER TAXES

Probably the most elementary form of sales tax is a tax on each trans-fer of title to goods, known as a multistage turnover tax. Such a tax isusually supplemented by a levy on selected services. This type of turn-over tax was in effect in most EEC countries until it was replaced by aVAT; it is still in operation in the Republic of China, Korea, andMexico.

Fiscal economists have faulted this type of turnover tax on groundsof its discriminatory effects on domestic and external trade.49 This arisesfrom the "cascading" of the tax that is added to sales on each transac-tion and cumulated in the price of the final product. Since the amountof tax cumulated depends on the tax rate and the number of taxabletransactions incurred in the production and distribution process, it tendsto squeeze out the independent trader and producer and encouragesvertical integration; because transactions within an integrated enterpriseare not chargeable, such a business enjoys a substantial tax advantage incompeting with independent, small-scale enterprises.50

49 See, for example, the conclusion of John F. Due that "these defects are soserious and lead to so many complaints that the tax is completely unacceptableas a revenue source for any country," Indirect Taxation in Developing Economies(cited in footnote 48), p. 123. See also Carl S. Shoup and others, The FiscalSystem of Venezuela: A Report (Baltimore, 1959), pp. 305-306.

60 For an excellent account of the effect of Chile's turnover tax in encouragingintegration in that country, see Stephen Malcolm Gillis, Sales Taxation in aDeveloping Economy—The Chilean Case (University Microfilms, Ann Arbor,Michigan, 1969), pp. 117-65.



The unequal cumulation of the tax on different industries, dependingon the structure of the manufacturing and distribution process, alsocreates discriminatory effects in international trade and makes itespecially difficult to apply to trade among members of a commonmarket. If the turnover tax on imports is higher or lower than thatcumulated on domestic goods, or if the tax remitted on exports is higheror lower than tax actually cumulated, distortions may arise. This situa-tion led to its replacement by a VAT in the EEC as the best means ofharmonizing sales taxes among its members.

SINGLE-STAGE MANUFACTURERS' SALES TAX

Single-stage taxes may be imposed at one of several stages in themanufacturing and distribution process. The states of the United Statesand the provinces of Canada impose general retail sales taxes; byexempting sales for resale, they leave taxes on the final consumption ofgoods and selected services. In order to restrict further the incidence toconsumption goods, exemptions may be provided for machinery, equip-ment, feed, seed, fertilizers, fuel, and other intermediate goods. Single-stage taxes at the wholesale level—such as the United Kingdom's pur-chase tax and sales taxes in Australia, New Zealand, and Israel—arelevied on sales by manufacturers or wholesalers to retailers (or directmanufacturers' sales to consumers at a presumptive wholesale price). Asingle-stage tax at the manufacturers' level is designed to limit tax tosales by manufacturers to wholesalers or to retailers; this is usuallyaccomplished by a suspensive system according to which licensedmanufacturers are exempt from tax on their purchases. In addition, acomplementary tax is generally assessed on imports of finished manu-factured goods so as to equalize the burden with that on domesticproduction. Single-stage manufacturers' sales taxes of this type areimposed by Canada and, among developing countries, by Ghana, Malay-sia, Tanzania, and Uganda.

Developing countries, in general, have limited their sales tax to themanufacturing stage, with a compensating tax on imports. The principalexceptions are to be found in Latin America and in some states inIndia, where the tax has been extended to the retail stage.51 The retailbase has been avoided principally because of administrative problems ofenforcing tax on a large number of small-scale retail units that dominate

51 The Commission to Study the Fiscal System of Venezuela recommendedadoption of a tax at the wholesale level, Shoup and others, The Fiscal Systemof Venezuela (cited in footnote 49), p. 305.



distribution in developing countries, although, as is shown later, theseproblems can be partly met by using a hybrid wholesale/retail tax.

Elimination of cascading

Cascading is inherent in the taxation of most manufacturing indus-tries if purchases of raw materials, semifinished goods, and supplies aremade taxable. Two different well-established techniques are employedto eliminate the cumulation of tax on manufacturing: (1) the suspensivesystem, according to which licensed manufacturers are entitled to pur-chase goods and services tax free,52 and (2) the value-added principle,according to which an allowance is made for the tax paid on purchases.

The suspensive principle is illustrated by the law recently adoptedin Malaysia, whereby licensed manufacturers, with the authorization ofthe Customs Department, are entitled to import or purchase materialsand components from other manufacturers free of tax; when these goodsare purchased from a tax-paid source, such as an importing firm, theseller may apply to the sales tax office for a refund of the tax previouslypaid. If, as is usually true, sales tax is collected by the Customs Depart-ment at the time of import, this system may be cumbersome because ofthe seller's need to apply for tax rebates on tax-paid goods. The scopefor this treatment is greatly reduced by a long list of goods, includingmaterials and supplies, that are exempt under the law. Although thissystem, in principle, should substantially avoid the accumulation of taxeson manufacturers' sales, it may leave a residue of tax that is impractic-able to recoup on purchases from taxable sellers; while this is likelyto be of little overall significance, it may be important for particularindustries.

The value-added principle is applied at the manufacturing level by alarge number of developing countries. The French-speaking West Afri-can countries 5Я as well as Argentina, Colombia, and the Philippinesemploy the direct deduction technique. With minor differences, the taxesin the West African countries replicate the French production tax asrevised in 1948 to provide for fractional payments on the value addedby each producer; the French tax follows the physical deduction prin-ciple in allowing a deduction from manufacturers' sales only for taxablepurchases of raw materials and components that either are physically

52 Sometimes referred to as the "ring" system.53 East Cameroon, Dahomey, Guinea, Mali, Mauritania, Niger, Togo, and

Upper Volta.



included in the product or lose their identity, such as abrasives, lubri-cants, and chemicals. Unless exempted outright, purchases of capitalequipment are also taxable. These countries differ in the extent of thedeductions allowed.

The sales taxes in Algeria, Ivory Coast, the Malagasy Republic,Morocco, Senegal, and Tunisia, although differing among themselves insome respects, best approximate the concept of a VAT at the manufac-turing/wholesale level. They follow in general the 1954 French model,which came to be known officially as the value-added tax. It differs intwo major respects from the reformed production tax of 1948 that wasadopted by other French-speaking countries in (1) providing for theelimination of tax on purchases of machinery, equipment, and industrialbuildings (the financial deduction) and (2) replacing the direct deduc-tion method with a tax credit. This improved version represents a moredesirable model at the manufacturing level than the production taxes ofother French-speaking West African countries.

Full application of the VAT principle, whether based on the directdeduction or the tax-credit method, provides a clear-cut elimination ofany cascade effect and avoids discrimination among competing manu-facturers with different structures of production (that is, integratedversus nonintegrated). When imports of equipment, components, andsupplies serve a variety of uses, there may be some advantage in assess-ing tax uniformly on all goods at customs and allowing manufacturersto claim a deduction or credit for tax on their sales; the risk of evasionis greater if tax is not imposed at this point.54 On the other hand,when imports are used in producing for export, it may be more expedi-tious under a VAT to provide for the exemption of imports of materialsby licensed exporters, as in Morocco, so as to avoid the need to financeinventories of goods that include an element of sales tax.55 Moreover,such a system minimizes the problem of refunding tax on exportedgoods. In this respect, there is no essential difference from a single-stagemanufacturers' sales tax, except for the accumulation of tax on goodsthat are not imported directly by the licensed manufacturer who usesthem, but the VAT has an advantage because it completely eliminatesdouble taxation.

54 See Organization for Economic Cooperation and Development, Fiscal Com-mittee, Some Problems Concerning Value-Added Taxation (Paris, February 1970),p. 15.

55 Ireland exempts all licensed taxpayers from tax on imports.



Colombia's experience with the two methods illustrates possiblelimitations of the suspensive system. With the introduction of the tax in1965, provision was made for manufacturers to buy materials free of taxby notifying the seller that the purchases were to undergo furtherprocessing; in addition, manufacturers were allowed to reduce their taxbase by the cost of other materials that were subject to tax (that is,using the direct deduction method). Because of the abuses of this systemby manufacturers who overstated their purchases of taxable materials,and the difficulties of checking and controlling such evasion, Colombiaamended the law to limit the suspensive principle to those manufac-turers who produce goods for export, or other specifically exempt goods,and replaced the direct deduction method used for other purchases witha credit for taxes paid.56 Pakistan also recently replaced its suspensivemethod with the tax-credit device.

Neither Indonesia nor Thailand completely resolves the cascadingproblem. Rather, they tax raw materials, other intermediate products,and services in general at a reduced rate—in Indonesia at one half thenormal rate and in Thailand at a nominal rate of 1.5 per cent. Thus,cascading is mitigated somewhat but not eliminated at the manufacturinglevel. Its elimination could be accomplished either by sacrificing revenueor by higher tax rates. From an administrative point of view, it is neces-sary to specify the materials and supplies that are subject to thereduced rate and to enforce payment of the correct tax. It is more diffi-cult, of course, to provide for precise rebate of tax imbedded in thecost of manufactured goods that are exported.

Administration and compliance

From the point of view of administration and compliance, there wouldappear to be no significant difference between the suspensive and tax-credit approaches at the manufacturing level. Substantially the samenumber of taxpayers would be covered under both systems, and neitherwould entirely avoid the need for refunds. However, as noted earlier,uniform application of the tax to purchases, including imports of taxablegoods, would limit the possibilities of evasion that are implicit in thesuspensive method. Auditing of accounts would, of course, be necessaryto check the validity of invoices for which tax credit is claimed and toensure that all taxable sales are reported.

56 Colombian Commission on Tax Reform, Fiscal Reform for Colombia, ed. byMalcolm Gillis (Harvard University Law School, 1971), pp. 594-95.



Exemption of exports would present no problem under either system.No tax refund would be needed under the suspensive method, whereno tax is assessed; however, it may not be feasible to eliminate the taxcompletely when taxable purchases of supplies, etc., are unavoidable.Tax refunds may be necessary under the VAT method unless purchasesof licensed exporters are completely exempt. Payment of tax on pur-chases of materials, of course, would increase the cost of financinginventories under the VAT method.

HYBRID RETAIL/WHOLESALE TAX SYSTEMS

A manufacturers' sales tax is not well suited to a country wheremanufacturing is of little importance; moreover, a tax at this level issubject to various discriminatory effects as to channels of distributionand consumer prices. On the other hand, taxes at the retail level inmany developing countries encounter serious objections because of thedominance of small retail units that multiply compliance and enforce-ment problems. These conflicting objections have been partly reconciledby a hybrid tax at the manufacturing/wholesale/retail level that wasfirst instituted by Honduras, on January 1, 1964, and later adopted byCosta Rica, Nicaragua, and Paraguay. Similar taxes have also been ineffect in Finland, certain states in India, and Nepal.57 According to thissystem, tax is collected only on sales made by registered firms tounregistered buyers; firms with annual sales above a specific amount(US$30,000 in Honduras) are registered. By this technique, sales aretaxed either at the retail level by the registered seller or at the wholesaleor manufacturing level on sales to the small, unregistered retailer. Themargins of small retailers and artisans therefore remain outside the taxbase.

The Honduran tax applies to sales of all nonexempt commodities byregistered firms to unregistered buyers; in addition, certain services,such as hotels, amusements, and restaurants, are made taxable.58 Regis-tration is required only of larger firms, including manufacturers, whole-

57Ojha and Lent, op. cit.; Alan Tait and John F. Due, "Sales Taxationin Eire, Denmark and Finland," National Tax Journal, Vol. XVIII (1965),pp. 286-96.

58 See John F. Due, "The Retail Sales Tax in Honduras," Inter-American Eco-nomic Affairs, Vol. XX (Winter 1966), reprinted in Readings on Taxation inDeveloping Countries, ed. by Richard M. Bird and Oliver Oldman (Baltimore,Revised Edition, 1967), pp. 326-36; Donald E. Baer, "The Retail Sales Taxin a Developing Country: Costa Rica and Honduras," National Tax Journal,Vol. XXIV (1971),-pp. 465-73.



salers, retailers, hotels, and restaurants, with annual sales in excess of astipulated amount. Imports by registered firms are taxed at the time ofsale by the importer; tax on imports by nonregistered firms is collectedby customs.

Exclusions from tax in Honduras are defined as far as possible toconfine the tax to sales for final personal consumption. Registered firmsare exempt on their purchases of not only raw materials, intermediategoods, and machinery but also basic foodstuffs, drugs, certain clothing,and goods subject to excise tax. Export sales are also exempt.

Unless special permission is granted to absorb the tax, registered firmsare required to state the tax separately and to collect it from customers.It can be seen that, in the absence of further provisions, liability for thetype of sales tax instituted by Honduras falls on only a limited numberof larger firms (about 1,100 in Honduras and 1,900 in Costa Rica);most of the smaller firms pay tax only on their purchases.

Allocative effects

The Honduran prototype is well adapted to countries where manu-facturing is undeveloped and it is desirable to have a broadly based taxthat is distributed roughly according to consumer expenditures. As asingle-stage tax, it avoids cascading and does not encourage integration.Rather, it favors small-scale entrepreneurs who are taxable only on theirpurchases and who escape tax on their value added. This very discrimi-nation, however, may provide an undue advantage to small firms thatare not required to add the tax to their sales, thereby attracting businessbecause of their actual, or apparent, tax-free status. This has been theexperience in Costa Rica where marked competition developed betweenregistered and nonregistered restaurants, bars, nightclubs, and otherservice firms that were small enough to escape the tax entirely.59 Butthe same type of discrimination could arise with a VAT that providedsimilar exemptions.

The degree of disparity between registered and nonregistered firmsis suggested by data for Honduras that show that only 27.4 per cent oftax was collected from retailers and 3.1 per cent from restaurants, bars,hotels, etc.60 This means that possibly as much as two thirds of theHonduran-type tax is based on wholesale or manufacturing sales to

59 Baer, op. cit., p. 472.60 Ibid., p. 471.



retailers and other sellers who are not taxable on their own value added.While the discrimination inherent in this situation may not be seriousat present rate levels (5 per cent in Costa Rica and Nicaragua and 3per cent in Honduras), it may be necessary at higher rates to close thegap in the effective tax burden between registered and nonregisteredfirms.

Beginning in 1968 Honduras took measures to assess the sales taxat the end of the year on the difference between taxable purchases andsales by nonregistered firms with annual turnover above a certain mini-mum, covering about 2,000 firms.61 Since this is tantamount to applyingthe VAT principle, it would seem to be a short step to replace thishybrid form of tax with a VAT.62 Alternatively, it might be feasible tolower the limits of registration to the level adopted for the annual assess-ment, and to collect the tax regularly throughout the year. If this weredone, the differences between the two techniques would substantiallydisappear, except for the use of the suspensive principle by the hybridmethod in exempting intermediate goods and machinery from tax.

Administration

As has been noted, the difficulty of enforcing a single-stage sales taxat the retail level in developing countries militates against its use andhas led to the adoption either of taxes at the manufacturing/wholesalelevel or of retail sales tax structures based on the Honduran model orthe VAT principle. Both types of tax extending to the retail level havebeen administered successfully in developing countries, although neitherhas been without problems. Since the main touchstone of their appli-cability to developing countries is their ease of administration—especiallyat high rates—it is important to compare the principal characteristicsof each from this point of view.

Sales taxes generally run into trouble because of the large numbersof returns that must be processed and taxpayers who must be controlledand audited. The hybrid method has been advanced as a practical meansof confining the tax to larger firms without producing undue interfirmdiscrimination. But, as we have seen, inequities arise even at low taxrates, and these would be intensified with a rise in rates. Attempts to

61 Ibid., p. 466.62 A similar step was taken by Finland when on January 1, 1964, the manu-

facturers' tax was moved to the wholesale level and retailers were made subjectto tax on their value added, Tait and Due, op. cit., p. 294.



mitigate such discrimination by compensating taxes on the value that isadded by nonregistered retailers and other firms increase the adminis-trative burden. At this point of development, the number of taxpayerscovered by a retail VAT would not appear to be greater than thosecovered by a modified hybrid system, especially since it may be mostpracticable to exempt the very small firm under each system.

The suspensive system employed under the hybrid model facilitatesdiversion of taxable to nontaxable sales, similar to that already discussedin connection with a manufacturers' sales tax and which led Colombiaand Pakistan to replace it with a tax credit. From the point of view ofcompliance, it is necessary for sellers to make a distinction betweentaxable and nontaxable sales of intermediate goods, based on the state-ment of the purchaser. No such distinction need be made under a VAT;all sales are uniformly subject to tax, and the purchaser simply sets offthe tax paid on purchases against tax added on his sales.63 On the otherhand, all firms covered have to maintain accurate records of purchasesas well as sales.

As discussed in the section, AUDIT OF A VAT, one of the advantagesclaimed for a VAT is the self-reinforcing nature of the assessment andcollection process. Because the tax paid on purchases is set off againsttax, every taxable firm should have an interest in seeing that tax isincluded in the seller's invoice. This process, however, is subject toabuse through collusion and by the use of fraudulent invoices; more-over, no such discipline is imposed at the final sale to consumers.Experience nevertheless appears to attest the efficiency of the systemin minimizing evasion. Danish tax officials, for example, believe thatevasion is more easily deterred if it is based on a false statement to taxofficials to gain a credit or refund than if it is only necessary to givefalse information to a seller as to the intended use of the goods inorder to obtain an exemption under a single-stage tax.64

Some advantage also is claimed in the splitting up of the tax liabilityin the manufacturing/distribution chain, so that a single firm is notsubject to more than a fraction of the cumulative tax at the retail level—

63 According to Shoup, "the highest-level tax officials of the Danish Ministryof Finance are emphatic in their conclusion that the present value-added tax isfar easier to administer than was the wholesale tax, and representatives of bothfarm and non-farm business say that compliance is much easier under the value-added tax," Shoup, "Experience with the value-added tax in Denmark" (cited infootnote 35), p. 247.

64 Ibid., p. 239.



the part that is applicable to its value added. The significance of thisfactor, of course, is related directly to the rate of tax. Under the hybridsystem, the tax is paid only at a single stage, and if this is evaded theentire amount of tax is sacrificed; the risk of loss is minimized whenmore than one seller is involved in the payment of the VAT on aparticular good or service. Nevertheless, a problem may remain undereither system for personal service businesses with a high labor content.Where taxable purchases of materials are a relatively small part of thetotal business revenue, the burden of the sales tax may represent a largeshare of net profits.

TANDEM SYSTEMS

Ireland has successfully applied a dual system of sales taxes consistingof separate taxes at the wholesale and retail levels. Such a system ineffect would permit a developing country with an already establishedmanufacturing tax to supplement it with a retail sales tax rather thanby raising existing rates to meet increasing revenue requirements.

The reverse order of introduction took place in Ireland, which in1963 introduced a 2.5 per cent tax on retail sales of a wide range ofgoods and services. This was followed in 1966 by a 5.0 per cent levy onsales at the wholesale level of a select list of goods; broadly speaking,it covered all goods within the scope of the retail tax except food,beverages, medicine, clothing, fuel, tobacco, and gasoline. The tax waschargeable on sales by manufacturers and wholesalers to retailers, as wellas on direct sales to consumers. No tax was chargeable at either levelon plant, machinery, and equipment, and on certain materials and equip-ment used in agriculture. Subsequently, the retail tax rate was raised to5.0 per cent, and the normal wholesale tax rate was increased to 10.0per cent, with a rate of 20.0 per cent on less essential goods, such asmotor vehicles, television sets, radios, and recording equipment. (Bothtaxes were replaced on November 1, 1972 by a VAT at rates corre-sponding to combined rates previously in effect at the retail and whole-sale levels.)

Effects on channels of distribution

A tandem system, whether based at the manufacturing or wholesalelevel, is inherently discriminatory as to distribution channels; markupsvary among different types of commodity and also, even for competinggoods, the sales tax base varies with the division of the marketing



functions between the manufacturer or wholesaler and the retailer.With a tax at either level, large retailers are encouraged to buy directlyfrom manufacturers at preferential prices and assume much of thewholesaling function themselves. They are thereby favored with lowereffective tax rates in relationship to the retail value of their sales thanthose chargeable to small unit retailers who buy from a wholesaler orjobber. This type of discrimination with respect to distribution channelshas posed serious problems under both the Canadian manufacturers'sales tax and the British wholesale (purchase) tax, especially at thehigher rates, and has led to the adoption of "uplifts" in the UnitedKingdom for equalization purposes.65 As we have seen, a VAT throughthe retail level is neutral in its effects on channels of distribution andavoids integrative effects.

Conversion from a multistage turnover tax to a VAT presents specialproblems for integrated industries that have succeeded in minimizingtheir turnover tax, as in Chile and Peru. Because a substantially higherVAT rate might be necessary to replace turnover tax revenues, taxeschargeable against integrated manufacturers, for example, would beincreased greatly. When the turnover tax rate is already high, as inChile, much higher rates might be resisted and administrative problemswould be intensified. When turnover rates are low, however, as in thebusiness activities taxes in Korea and the Republic of China, and inte-gration has not reached large proportions, similar problems may notexist. Replacement of turnover taxes by separate sales taxes on manu-facturing and retailing would somewhat mitigate the sharpness of theincrease, especially when integration has not been carried to the retaillevel.

Flexibility

One reason advanced in favor of a tandem system is that a sales taxat the manufacturing or wholesale level is more adaptable to ratedifferentiation.66 A VAT is also amenable to multiple rates, but it ismost easily administered with one or two rates, as in Latin America,Denmark, the Netherlands, Germany, Norway, and Sweden. Whilehigher rates on luxuries are frequently defended on distributional

65 See George E. Lent, "Manufacturers' v. Wholesalers' Sales Tax Base,"Taxes—The Tax Magazine, Vol. 36 (1958), pp. 573-601.

66 Principally because of the relative amenability of a manufacturers' tax torate differentiation, Gillis has recommended this structure for reform of Chile'sturnover tax, Sales Taxation in a Developing Economy (cited in footnote 50),p. 396.



grounds, and may be necessary for political reasons, it is questionable ifa sales tax is the best tax instrument for achieving vertical equity. Onthe other hand, it is usually thought desirable to mitigate the regressivityof a sales tax by exempting such necessities as food, medicines, andrent, and this probably can be done as readily through a zero rate orexemption under the VAT as under a tandem system.

Enforcement considerations also tend to limit the level of rates thatmay be necessary to expand sales tax revenues, both at the manufac-turing or wholesale stage and the retail stage. This is known to be animportant factor in the sales tax planning of Ireland, although itsentrance into the EEC was the decisive consideration in adopting aVAT. Fractional payment of tax under a VAT and its built-in self-checking features tend to reduce the risk of evasion, and thereby permithigher tax rates than might be tolerable on manufacturers' or retailers'sales under a dual regime.

Administration

Administrative considerations do not appear to give any clear netadvantage to either sales tax structure. While a tandem system is likelyto entail fewer taxpayers, the difference is not likely to be so great as togive it much weight in the choice. On the other hand, as we have alreadyseen, the VAT principle is less conducive to tax evasion: the samearguments made with respect to the comparative advantages of thesuspensive method of eliminating cumulation of tax are equally appli-cable to the VAT system (see the section, Elimination of cascading).

It is also argued that a tandem system permits a low tax rate at theretail level and thereby reduces incentives for evasion in a sector thatis especially vulnerable. A greater share of the revenue can then becollected at high rates from a more limited number of manufacturersand importers. There is some force to this argument for personal servicebusinesses with a high labor content, but it should not be overlookedthat retailers are subject to the VAT only on their gross profit margins,usually a moderate fraction of their sales.

Because of the administrative problems that are encountered underany sales tax on small retailers and artisans in developing countries, theneed for a special regime to cover them is generally recognized. Provi-sion can be made, as in a hybrid tax, to exempt small firms from aVAT, leaving them taxable only on their purchases. Or a forfait systemcan be adopted, based on presumptive sales (see (3) and (4) in thesection, Small enterprises). One alternative that has been proposed in



the Republic of China and other developing countries is to tax smallbusinesses at a reduced rate (say, one fourth of the standard rate) ontheir reported sales, but to give them the option of being taxed underthe VAT system and claiming credit at the standard rate. This systemwould obviate the need for maintaining proper records of purchases,etc., but would reach the value added by retailers and other small firms.

V. Conclusions

Since the introduction of the VAT in Western Europe, a number ofAfrican and Latin American countries have adopted sales taxes basedon the value-added principle. The VAT systems in Brazil, Ecuador,Ivory Coast, the Malagasy Republic, Morocco, Senegal, and Uruguayare representative of the various forms that this type of tax has taken.All the systems differ, in some respects, from the European model of acomprehensive, uniform, and neutral tax on the consumption of goodsand services, thereby showing the adaptability of tax structure todifferent economic and social conditions; however, all use the tax-creditdevice in applying the value-added principle.

SUMMARY OF ANALYSIS

Differences in structure

On the basis of the laws enacted in these seven countries, it is notpossible to construct a model of the type of VAT that is likely to emergein developing countries. These examples, however, suggest some linesalong which these countries may be expected to go in their efforts toadapt the tax to their particular circumstances.

The scope of the VAT is narrowest in Ivory Coast, Morocco, andSenegal and is somewhat broader in the Malagasy Republic. Only theLatin American countries and the Malagasy Republic (in part) attemptto follow the distribution circuit all the way to the retail stage. Servicesare taxed, however, in all these countries but Brazil and Ecuador, wherethey are covered by other taxes.

Developing countries are apt to limit the range of the VAT byexcluding the most troublesome sectors (farmers, retailers, etc.) becausethey pose difficult enforcement problems. Virtually all developingcountries exempt farmers as a simple way of providing tax relief to thelowest-income group. Even if no measures are taken to exemptprocessed foodstuffs and other basic necessities or to tax them at a



reduced rate, equity purposes are served. Luxury goods, on the otherhand, are mostly imported and may be assessed at a higher rate of taxdirectly at the customs. Selective excises on luxury goods also increasethe tax burden on the higher-income groups without necessarily resortingto multiple rates for the VAT.

The tax is also simpler in structure,in the Latin American countriesbecause of the use of a uniform tax rate and relatively few exemptions(as in Brazil and Ecuador). In the Malagasy Republic the value-addedtechnique apparently is not used to the full extent even in the manufac-turing sector: the extensive list of intermediate products exempted ortaxed at a reduced rate suggests that a substantial proportion of the totaltax that is due on industrial goods is collected at the last stage ofmanufacture rather than being spread over earlier stages.

Developing countries are likely to be less concerned than industrialcountries with removing investment expenditures from the tax base. Thetax treatment of investment may vary with the objectives of the country'seconomic policies, including the relative incentives for using labor andcapital.

Another characteristic of the VAT in developing countries is theirreliance, in part, on exempting producer goods from the tax, rather thanon the tax-credit method, when the former is easier to apply. This resultsnot only in the widespread exemption of agricultural producer goods butalso in the exemption of industrial machinery equipment in Brazil andof construction materials in Uruguay. The tax exemption of industrialproducer goods in the Malagasy Republic also represents in effect apartial use of the suspensive principle to postpone collection of tax onintermediate products.

One of the major problems that confronts the developing countriesunder a VAT is the treatment of small businesses. While in industrialcountries small firms are concentrated in the agricultural and retailsectors, in the developing countries a significant share of manufacturingand trade may still be carried out on a small scale. Techniques designedto deal with this type of situation include use of the forfait techniqueand the tax-credit pass-through facility offered by Senegal to its forfaittaxpayers and unregistered traders on sales to registered purchasers.

Revenue importance

Revenue data for the countries covered show that the VAT is one ofthe most productive forms of sales tax, accounting for between 10 percent and 30 per cent of government tax revenue. VAT revenue in a



recent year exceeded 2 per cent of GDP for all countries exceptEcuador and ranged as high as 8 per cent in Brazil. As with sales taxrevenue generally, VAT revenues in developing countries can beexpected to increase at a faster rate than the rate of growth of theeconomy.

With few exceptions (Brazil, for instance), a substantial part of therevenue is derived from imports (almost uniformly 60 per cent in theAfrican countries). No information is available on the proportion ofGDP covered by the VAT in the developing countries except for Brazil,where it is estimated at 60 per cent. Despite substantial exemptions, theVAT effectively taxes a substantial portion of GDP outside its directscope; this is so because of the nontaxable purchases by businesses forwhich no tax credit is given on their chargeable sales—amounting to anestimated 15 per cent to 20 per cent of value added by agriculture,manufacture, and trade in Brazil.

Administrative considerations

The possibility of efficiently administering a VAT in developingcountries depends on many factors, including characteristics of the VATto be introduced, the economic structure and social environment inwhich it is to be applied, the revenue that it is expected to produce, andexperience with the sales tax that it is intended to replace.

The fundamental difficulty in administering this type of tax indeveloping countries is the problem of coping with small taxpayers,which include a large percentage of retailers, service enterprises, andfarmers. If an adequate solution can be found to exclude these taxpayersfrom the general requirements of the VAT, the problems of administer-ing such a tax will be reduced greatly. Various methods for dealing withthis problem have been devised in industrial as well as developingcountries; most provide for the exemption of very small businesses, andothers, such as Brazil and the African countries, provide for theirtaxation on a forfait basis.

A VAT with multiple rates and many exemptions undoubtedlypresents greater difficulties of administration and compliance than does asingle-rate tax with few exemptions. The VAT systems in the LatinAmerican countries except Uruguay have uniform rates, while in Africathey are differentiated with the class of consumption expenditure.

The administrative requirements for efficient control and audit of aVAT are closer to those of an income tax than to those of other types



of sales tax; therefore, those countries that have a high degree ofefficiency in administering income taxes are in a better position toadminister a value-added type of sales tax. Even though a VAT containsa built-in system of cross-checking, undue reliance should not be placedeither in the ability of administration in developing countries toeffectively apply a computerized or manual system of cross-checking ofinformation, or on the incentive that a VAT gives to purchasers torequire invoices from sellers. Other audit techniques must complementsuch cross-checking and self-enforcing features of the tax in order toadequately enforce compliance.

Finally, the transitional aspects of introducing a VAT must be studiedin each case, depending on the taxes for which it is intended to sub-stitute. Simple, although perhaps less equitable, transitional provisionsseem to be preferable, so as not to overburden tax administrators andtaxpayers in the initial stages of its application.

The choice of a sales tax

The choice of a sales tax technique rests on a variety of considera-tions that must be weighed by each country in the light of its owneconomic and social conditions. Three alternative techniques haveproved successful in this respect: (1) a single-stage manufacturers'/importers' tax of the suspensive type; (2) a hybrid retail/wholesale taxmodeled on that of Honduras; and (3) a tandem system, including atax on sales by manufacturers or wholesalers and one on retail sales.

Neither a single-stage retail sales tax, because of enforcement prob-lems, nor a multistage turnover tax, because of the discriminatory effectsarising from its cascading, appears to be a viable alternative.

Most developing countries have limited their general sales taxes tothe manufacturing stage, with a compensatory tax on imports. Twotechniques may be employed to eliminate double taxation: (1) theexemption of purchases by licensed manufacturers and importers (thesuspensive method); and (2) the value-added technique, which provideseither for a deduction from taxable sales of taxable purchases, or acredit against tax chargeable on sales for sales tax paid on purchases.

Both systems have merit and have been applied successfully. Thesuspensive technique avoids tying up funds in tax that is added to thecost of inventories, with resulting pyramiding of the tax in price. Onthe other hand, it offers greater opportunity for evasion and may requiregreater administrative effort in its enforcement. The value-added tech-



ñique permits greater precision in the elimination of cascading, includingthe remission of taxes on exports, and is less subject to tax evasion. Forthese reasons, both Colombia and Pakistan recently converted to thisform.

A hybrid retail/wholesale tax system has been applied successfullyin several developing countries in Latin America. Under this system,tax is collected only on sales made by registered firms to unregisteredbuyers. Since only firms with annual sales above a specified amount areregistered, small retailers, artisans, and suppliers of services are taxedonly on their purchases; the larger firms are taxed on sales other thanthose to registered firms. The suspensive, rather than the VAT, principleis applied. Greater possibilities therefore exist for evasion, as under amanufacturers' sales tax. On the other hand, the number of taxpayersis considerably smaller than would be covered by a VAT. Small retail-ers, etc., are not taxed on their value added, and they enjoy some taxadvantage as against larger retail firms. It is possible, however, to assessthese margins by an annual tax, as in Honduras.

Separate taxes at the manufacturing or wholesale level and at theretail level offer another realistic alternative to developing countries.Once a manufacturers' sales tax has been established, it can be supple-mented by a lower tax rate on retail sales of goods and services. Such atandem system has operated successfully in Ireland and has been sug-gested for replacement of multistage turnover taxes, as in Chile. Oneadvantage claimed is the greater flexibility of taxation at the manufactur-ing or wholesale stage, so as to permit variation of rates with classes ofconsumer goods. A tax at the manufacturing or wholesale level, how-ever, encourages the absorption of wholesaling functions by retailers forthe purpose of minimizing tax, and discriminates against the small-scaleretailer. Such discrimination is avoided by a VAT at the retail level.

CONDITIONS FAVORING ADOPTION OF A RETAIL VAT IN DEVELOPINGCOUNTRIES

It seems to be evident that the choice of a VAT over other formsof sales tax in a developing country rests on a number of conditions.While it cannot be held that all these conditions need to be fulfilled, theirdegree of fulfillment will determine the comparative success with whicha VAT can be implemented as against other forms of sales tax. Both thegreater complexity and greater number of taxpayers comprehended bya VAT through the retail level are the main distinguishing features thatset it apart from other sales taxes at this stage.



Size of retail units

As we have noted, only sales taxes carried to the retail level can betruly neutral in their effects on the organization of production anddistribution and on consumer prices. The European precedent for aVAT at the retail level has, in fact, identified the VAT as a comprehen-sive tax on household expenditures that is implemented by means offractional payments on producers and traders through the retail level. Anecessary condition of any retail sales tax is the development of retailunits of a sufficient size to facilitate its administration at this point. Thefact that retail distribution in many countries at an early stage ofdevelopment is characterized by small traders militates against effectiveenforcement of a retail tax, and a VAT in itself offers no solution tothis problem. Indeed, very small businesses are typically excluded fromsuch a tax. Optional assessment methods, such as forfait, are available,but there are limits to their toleration in a VAT system.

Records and bookkeeping

Another indispensable condition is the adequacy of records main-tained by firms. Since a true record of purchases and sales is a minimumrequirement for applying a VAT, the system could break down whenproper invoices are not used, Artisans, farmers, shopkeepers, and smallservice firms are notoriously lax in keeping accounts and frequentlymake no distinction between household and business transactions; thissituation makes it virtually impossible to enforce accounting for tax.Even when accounts are kept, their reliability is often open to question.

On the other hand, the introduction of a VAT is bound to enforcebetter accounting discipline because of the need for invoices to supportclaims for tax credit. Standard forms issued or approved by thegovernment could be used for this purpose.

Administration and compliance

Closely identified with the adequacy of records is the level ofadministrative competence in collecting and enforcing a sales tax.Although a VAT imposes a somewhat greater burden on both taxpayersand the administrative service than other forms of sales tax, it neverthe-less is less complex than an income tax. Unless the administrativeservice is strong or can be strengthened, it would not be advisable totake on the additional burden. Computerization of tax returns is animportant consideration.



Previous experience with sales tax

It would appear inadvisable for any developing country to adopt aVAT at the retail level without previous experience with a sales tax.All VAT systems now in effect evolved from different forms of pre-existing sales taxes, and it was a short step to the introduction of aVAT. The nature and extent of the transitional problems vary with theform of the preceding tax and the stage to which it was carried. Therewould be some advantage if retail sales were taxed previously.

Level of tax rate

Another important consideration is the level of the tax rate thatwould justify introduction of a VAT rather than an alternative formof sales tax. If rates are low, the discriminatory effects inherent in aturnover tax or hybrid form may not be sufficiently great to warrant amore complex and comprehensive tax, and the incentives for evasionmay be minimal. As tax rates are increased, however, they may reach acritical point at which a VAT technique of fractional payment isrequired to minimize loss on evasion and avoidance. A VAT not onlyimposes greater discipline by reason of its so-called self-checkingfeatures but also is self-correcting in "catching up" with tax that mayhave been escaped at a previous stage. In this respect, it has someadvantage in reducing the risk of revenue leakage.


Documents

The Value-Added Tax in Developing Countries