Value-Added Tax, Excises, and Import Tariffs
While VAT has been adopted in most developing countries, it frequently suffers from being incomplete in one aspect or another. Many important sectors, most notably services and the wholesale and retail sector, have been left out of the VAT net, or the credit mechanism is excessively restrictive (that is, there are denials or delays in providing proper credits for VAT on inputs), especially when it comes to capital goods. As these features allow a substantial degree of cascading (increasing the tax burden for the final user), they reduce the benefits from introducing the VAT in the first place. Rectifying such limitations in the VAT design and administration should be given priority in developing countries.
Many developing countries (like many OECD countries) have adopted two or more VAT rates. Multiple rates are politically attractive because they ostensibly—though not necessarily effectively—serve an equity objective, but the administrative price for addressing equity concerns through multiple VAT rates may be higher in developing than in industrial countries. The cost of a multiple-rate system should be carefully scrutinized.
The most notable shortcoming of the excise systems found in many developing countries is their inappropriately broad coverage of
products—often for revenue reasons. As is well known, the economic rationale for imposing excises is very different from that for imposing a general consumption tax. While the latter should be broadly based to maximize revenue with minimum distortion, the former should be highly selective, narrowly targeting a few goods mainly on the grounds that their consumption entails negative externalities on society (in other words, society at large pays a price for their use by individuals). The goods typically deemed to be excisable (tobacco, alcohol, petroleum products, and motor vehicles, for example) are few and usually inelastic in demand. A good excise system is invariably one that generates revenue (as a by-product) from a narrow base and with relatively low administrative costs.
While VAT has been adopted in most developing countries, it frequently suffers from being incomplete in one aspect or another. Many important sectors, most notably services and the wholesale and retail sector, have been left out of the VAT net, or the credit mechanism is excessively restrictive (that is, there are denials or delays in providing proper credits for VAT on inputs), especially when it comes to capital goods. As these features allow a substantial degree of cascading (increasing the tax burden for the final user), they reduce the benefits from introducing the VAT in the first place. Rectifying such limitations in the VAT design and administration should be given priority in developing countries.
Many developing countries (like many OECD countries) have adopted two or more VAT rates. Multiple rates are politically attractive because they ostensibly—though not necessarily effectively—serve an equity objective, but the administrative price for addressing equity concerns through multiple VAT rates may be higher in developing than in industrial countries. The cost of a multiple-rate system should be carefully scrutinized.
The most notable shortcoming of the excise systems found in many developing countries is their inappropriately broad coverage of
products—often for revenue reasons. As is well known, the economic rationale for imposing excises is very different from that for imposing a general consumption tax. While the latter should be broadly based to maximize revenue with minimum distortion, the former should be highly selective, narrowly targeting a few goods mainly on the grounds that their consumption entails negative externalities on society (in other words, society at large pays a price for their use by individuals). The goods typically deemed to be excisable (tobacco, alcohol, petroleum products, and motor vehicles, for example) are few and usually inelastic in demand. A good excise system is invariably one that generates revenue (as a by-product) from a narrow base and with relatively low administrative costs.
