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VAT and Excises. Ian Crawford (Surrey / IFS) Michael Keen (IMF) Stephen Smith (UCL/ IFS). Introduction. 30 years since the Meade report 35 years since the introduction of VAT in the UK How does economic theory now view the optimal structure of indirect taxes?
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VAT and Excises Ian Crawford (Surrey / IFS) Michael Keen (IMF) Stephen Smith (UCL/ IFS)
Introduction • 30 years since the Meade report • 35 years since the introduction of VAT in the UK • How does economic theory now view the optimal structure of indirect taxes? • What can we learn from new empirical evidence? • How has the economic environment changed? • eg The elimination of internal frontiers in the EU has brought new issues of administration, enforcement and tax competition. Do these radically alter the case for VAT?
Outline and key issues • Theory, and empirical results • The rationale for indirect taxes. • Uniform vs differentiated commodity taxes • Indirect tax systems • VAT versus Retail Sales Tax, etc • Exposure to fraud and evasion • International aspects of indirect taxes • VAT treatment of international trade in goods and services • Excises • What justification for the UK’s high taxes on alcohol and tobacco?
The rationale for indirect taxes. • What do VAT and excises achieve that other taxes cannot? • Possible benefits in terms of compliance if multiple taxes are used • Possible gains in efficiency and/or equity from taxing different goods at different rates?
The rate structure • Diamond / Mirrlees: efficient revenue-raising taxes should not distort production decisions • Equity: taxes on goods and services are a blunt instrument for achieving distributional objectives • Efficiency: differential commodity taxation can be used to mitigate the adverse incentive impact of taxing wages • Tax most heavily those goods that are most complementary with leisure • Administrative efficiency: Complex rate structures can be costly for the revenue authorities and taxpayers
The empirical work in the paper • We estimate demand elasticities while allowing for the possibility that preferences over different combinations of commodities might not be independent of how much leisure time a household enjoys (separability). • a conditional demand system which places hours and a participation dummy (to capture the fixed costs associated with going to work) on the rhs (suitably instrumented). • Quadratic Almost Ideal Demand System using 22 years of pooled FES data (approximately 7,000 households per year). • 20 commodity groups, reflecting current tax treatment
We find that… • The labour supply variables are individually and jointly strongly statistically significant across the equations in the demand system; evidence that leisure is nonseparable. • However the magnitudes of the effects are small (see Table 1); generally much less than half of 1 percent on the budget shares. • Also the effects on the estimated elasticities of ignoring the dependence on hours/participation is small (compare Tables 2 and 3). • The estimated behavioural responses to price changes are themselves pretty low generally (Tables 2 and 3).
Using these results to simulate a tax reform with uniform 17.5% VAT • uniform 17.5% VAT on all goods would be strongly regressive (in the absence of any off-setting benefit reforms). • Given the low estimated price elasticities this is largely driven by the pattern of expenditures on zero rated goods with respect to household income • low income households spend a higher proportion of their budgets on commodities which are zero rated than do richer households. • The same experiment was conducted ignoring the effects of labour supply variables and there was no effect on the overall pattern of regressivity.
Indirect tax systems • VAT versus Retail Sales Tax • VAT registration threshold • Treatment of financial services • Enforcement and compliance aspects
VAT evasion and fraud • The case for VAT is primarily that it is an effective way of raising revenue • But it is also vulnerable to distinctive risks of fraud, due to extensive refunds • "A VAT invoice is a check written on the government" (Richard Bird) • Recent alarm over “carousel” frauds, which exploit • export zero-rating • "deferred payment" mechanism for collecting VAT on imported goods • HMRC estimates VAT "gap" of 14.5% of potential VAT revenues • roughly a quarter of this reflects organised fraud
Policy options for carousel fraud • Administrative responses • Reverse charging • Liability for VAT placed on buyer rather than seller in a B2B transaction • could be targeted or general • Ending export zero-rating
Origin and destination principles Substantial economics literature compares relative merits of • OP: goods bear tax at rate of country of production • DP: goods bear rate of country of consumption • Establishes conditions under which the two are equivalent • and, where not equivalent, discusses which is to be preferred • (broadly, DP achieves production efficiency, but complex) • Note some EU policy discussion uses DP and OP in a different sense • To refer to two different ways of achieving DP outcomes with a VAT • Much confusion and misunderstanding • Practical significance of OP is surely limited. • Even if it’s equivalent to DP, it would seem grossly distortionary
Alternatives to export zero-rating on intra-Community trade • Options include: • Exporter-rating, as proposed by Commission prior to 1992 • exports taxed in exporting country as if domestic sales, credit given to importer for VAT paid on imports • EU-wide export VAT rate • Eg 15%, as in recent Commission suggestion • VIVAT (Keen/Smith) • harmonized Community-wide VAT rate for intermediate goods • Criteria • Efficiency: (neutrality in business purchasing w.r.t. VAT rate) • Compliance cost neutrality: similar tax bureaucracy on exports and domestic sales • Avoid revenue redistribution • Enforcement feasibility and incentives
VIVAT (Keen/Smith) • Establishes a harmonized Community-wide VAT rate for intermediate goods (eg of 15%) • All B2B transactions between VAT registered firms (including exports) subject to this intermediate goods rate • Member states retain full discretion over VAT rates on sales to final consumers • Exports taxed according to identical arrangements as domestic sales • System introduces an end-user distinction (which VAT otherwise avoids), but of minor significance
Excises on alcohol and tobacco - 1 • UK has very much higher excises on alcohol and tobacco than the EU average • Significant externalities from individual use of alcohol and tobacco may justify higher-than-average taxation • Defining external costs in this area is difficult • But if net public expenditure effects are included, overall smoking externality may be negative, because of savings on pension and old-age care costs for smokers who die young (Viscusi) • “Behavioural” issues of rationality and addiction should be considered, and may justify higher taxes than if decisions were being made by rational, well-informed consumers
Excises on alcohol and tobacco - 2 • Taxes and other measures • Alcohol taxes target incentives very imprecisely • Most external costs generated by small number of abusive consumers • Non-tax measures may be much more effective at influencing abusive consumption • Cross-border shopping • Substantial (legal and illegal) cross-border shopping in alcohol and tobacco • UK policy needs to take this into account • But there’s also a case for co-ordinated action within EU to reduce differentials, by raising minimum excise rates.