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International Lessons in Goods and Services Tax

Goods and Services Tax Amaresh Bagchi lessons for all engaged or interested in introducing VAT in a country or putting it in a better shape where it is already in operation in some form. While not attempting to summarise all that it contains, the paragraphs that follow seek to provide a flavour of the ideas thrown up by the au The two outstanding developments in the tax field in the 20th century have been the emergence of income tax in the first half and the value added tax (VAT) in the second half as the preferred instrument of taxation across the world. Income tax was in the making for over a 100 years. The ascent of VAT in just 50 years beginning with France replacing its turnover tax with a tax on value added in the mid-1950s has been truly remarkable. With the European Commission (now European Union, the EU) in the lead, the tax spread rapidly

november 17, 2007 Economic & Political Weekly28book reviewGST in Retrospect and Prospectby Richard Krever and David White (eds);Thomson, Brookers, Wellington, New Zealand, 2007, pp 658.The two outstanding developments in the tax field in the 20th century have been the emergence of income tax in the first half and the value added tax (VAT) in the second half as the pre-ferred instrument of taxation across the world. Income tax was in the making for over a 100 years. The ascent of VAT in just 50 years beginning with France replacing its turnover tax with a tax on value added in the mid-1950s has been truly remarkable. With the European Commission (now European Union, the EU) in the lead, the taxspread rapidly – like “bushfire” as one observer put it – and is now operating in over 130 countries of the world. Initially, while its superiority over the other forms of domestic trade taxes like the retail sales tax was recognised, what would be the best design of a VAT was not established. Until the mid- 1980s the only example of VAT in operation was what was working in Europe. The introduction of the the goods and services tax (GST) in New Zealand (NZ) in 1986 with its most comprehensive base and a single rate, turned out to be a landmark in the evolution of VAT by bringing up what could be regarded as an ideal to em-ulate and a benchmark to use for evaluat-ing the VAT systems in operation. In order to take stock of how it has fared after20 years of operation, its impact in other countries and the issues that have emerged in the operation of VAT inNZ and elsewhere, the Centre for Accounting, Governance and Taxation Research at VictoriaUniversity of Wellington and the Taxation Law and Policy Research Institute at Monash Uni-versity of Australia had organisedasym-posium in late 2006. Participantsinclud-ed, apart from the top taxpolicymakers and administrators who designedand ushered inGST inNZ, expertsassociated with the designing and implementation of VAT from a cross-section of countries where it has been in operation for some time as also economists engaged in monitoring and analysing trends in thinkingontaxation in theoretical litera-ture. The volume under review is the product of that symposium. Political Economy Divided into eight parts, the volume opens with a narration of the political economy of GST inNZ including an empirical study of its economic and equity effects (Part 1), followed by a review of issues arising in the interpretation of GST law inNZ and Australia (Part 2). Essays in Parts 3,4 and 5 go into issues and problems involved in applying GST to financial services, real property and cross-border services respec-tively. Part 6 highlights the revenue risks inGST/VAT and responses in Australia,NZ and alsoEU. “Economic Integration and GST/VAT” forms the theme of Part 7 with a focus on countries in the Pacific, the expe-rience of Tongo and also 15 years ofVAT in South Africa. The volume concludes with a survey of the role of VAT, the main strands of the debate on the much touted “Fundamental Tax Reform” and a rea-soned defence of the income tax in a mix of countries seeking to perfect their tax systems (Part 8). As the editors indicate in the preface, the “volume synthesises many of the les-sons learned to date but at the same time highlights many emerging issues to which responses are still evolving”. Written by experts with hands-on experience of de-signing and drawing upVAT laws and/or implementing them, the papers in the volume contain invaluable insights and lessons for all engaged or interested in introducingVAT in a country or putting it in a better shape where it is already in op-eration in some form. While not attempt-ing to summarise all that it contains, the paragraphs that follow seek to provide a flavour of the ideas thrown up by the au-thors of the papers in the volume on mat-ters pertaining to the implementation of VAT in all important dimensions. These may be of interest in India in the context of the ongoing efforts to usher in an “integrated national tax on goods and services” envisioned by the union finance minister to be put in place by 2010. First, the political economy of GST. Lessons in Reform Everywhere an attempt to introduce a new tax or reform an existing system radically has to contend with the “political econo-my” of the country. Even when wedded to democracy, countries tend to differ in the environment in which their political sys-tem operates especially when it comes to the question of tax reform. InNZ, the im-peccable way in which the GST was ush-ered in holds lessons in political economy of reform for all countries founded on democratic principles. The two unique features for which the GST of NZ stands out, making it an ideal to emulate, are its comprehensive base and a single rate that makes no variation for “essentials”, some-thing unthinkable in India. How could they bring this about and so successfully – a “success” testified by the fact that the structure that was erected at that time has remained in place fundamentally un-changed for 20 years now? The essays in Part 1 of the volume seek to provide an answer in a charming way. The first essay of the volume, a contri-bution by Roger Douglas, the finance minister ofNZ, who adopted and pushed the idea of a comprehensive tax on goods andservices in the country and piloted thelegislation to implement it, attributes the successofGST inNZ to five “process elements”: “political will, the right people (to design and frame the law) (emphasis added), the way in which the proposal was packaged, an effective consultative process, and an effective communication process”. International Lessons in Goods and Services Tax Amaresh Bagchi
BOOK REVIEWEconomic & Political Weekly november 17, 200729Only “quality people” irrespective of their ideological leanings drawn from experts and not just civil servants were put in charge of preparing the white paper on which the new tax was to be based and putting it across to the people. Packaging provided the flexibility to show that the losses that the new tax might entail would be made up by lower personal taxes (in-come tax) and a lower tax rate on future increase in incomes. A notable feature of the endeavour was the faith in the “princi-ple of quantum leaps and big packages”, contrasting with what believers in “incre-mentalism” propagate. This is cited by Douglas as one of the reasons why NZ was able to carry through many far-reaching reforms in the 1980s. The bold initiatives would probably not be possible without an effective consultative process. How the public was consulted in developing a GST and the role of “information, education and coordination” form the subject matter of the next two chapters. These chapters delineate how the reactions to and comments on the idea of a GST put forward in the white paper were consid-ered by the advisory panel that was set up following the publication of the paper. Key Features in New Zealand What enabled the proponents of GST inNZ to go forward were its key features, viz: (i) simplicity with a single rate of 10 per cent and no exemption, (ii) revenue neutrality (no additional revenue was budgeted in the year of its introduction), (iii) a wider reform programme comprising income tax cuts, (iv) abolition of the antiquated wholesale sales tax and increase in wel-fare payments to offset the impact of GST on pensioners and low income groups, and (v) wide consultation. Of these, the most striking and most difficult to sell was simplicity with one rate and no exemption. The way the idea of no exemption was sold to the people is instructive. Examples fromVAT in the United Kingdom were used to show what kind of complications law enforcers face ifasked to draw a line between exempt and non-exempt items. In zero rating an ordinary item like children’s clothing, an entry like this was required: “Young chil-dren’s clothing including footwear and hats (but excluding humorous and party hats)”. Understandably “fun clothing” was not to be tax free but what about fur coats? So the law had to say: “Items made of fair skin are taxable unless the ‘fair skin’ con-stitutes less than one-fifth of the garment outside area”. But what is ‘fair skin’? So there follows a lengthy definition to help decide when a fur skin comes within the “fair” category. Such conundrums should sound familiar to those conversant with how sales tax systems in India operated with multiple exemptions and any number of rates giving rise to questions like wheth-er coconut is a fruit or a nut going up to theSupreme Court for resolution. The state VATs now in operation have no doubt achieved considerable simplicity by bring-ing down the number of rates to three or four but the problems in drawing lines between commodities and services to decideinwhich rate category they belong still persist. Convincing the people that exempting items like food benefit the rich more than the poor was more difficult. However, this was accomplished by citing how much more a rich taxpayer pays for food in dol-lar terms even though it may be relatively small as a percentage of his/her income as compared with that of one in the low in-come category. In addition there was an accompanying proposal to enhance family welfare support. Perhaps our policymakers might draw a lesson and consider demon-strating how a simple system of GST can be used to get revenues that could help universalise a truly helpful social security system. The NZ government of the time deserves credit for resisting pressures for granting exemptions from GST. Few items were kept out of the purview of the tax and those that were like financial services and domestic rental accommodation were so treated on practical and not political considerations. Unique Feature A unique feature of the GST inNZ is it treatment of the government sector. So far as public sector enterprises were con-cerned it was clearly understood that they would be treated on the same footing as private producers/suppliers of goods and services. As regards core government ac-tivities, each government department was to be treated as a producer of services that were consumed by the “Crown”. They would be treated like any other undertaking. This approach came under maximum opposition from local governments. The issue was finally settled with payment to local bodies of a part of the revenue raised from taxing local rates. A lucid exposition of how the problems faced in “selling” the idea of a truly comprehensive base for GST inNZ on this and other scores were overcome is contained in one of the papers in this part of the volume (‘The NZ GSTPolicy Choice: An Historical Per-spective’ by Ian Dickson, a former official of the NZ treausary). How tricky issues like taxation of residential dwellings, second-hand goods, medical services and tourism were handled is described in a way that may be instructive for GST designers everywhere. EquityThe concluding chapter in this part of the volume analyses the “Economic and Equi-ty Effects ofGST inNZ” combining the ef-fects of the changes in both income tax and GST. On the economic effects, the sectoral effects and efficiency gains from reduction of tax induced distortion, the paper does not have much to offer as not much research has been done on these issues. However, on the distributional ef-fects, the paper provides the results of some painstaking studies. Broadening of the consumption tax base was feasible, the paper notes, when combined with a change in the tax-mix. The change signified a reduction in the dependence on income tax with cuts in the rates the top rates going down from 66 per cent to 33 per cent. To alleviate the possible regressivity ofGST a family support tax credit (FSTC) was introduced replacing the tax rebate that prevailed earlier. The paper provides four illuminating tables, the last one showing “effective average tax rates” for different levels of average earnings. Effective average tax rates are computed separately for personal tax (single person and for couples with two dependants) and also after incorporating the burden ofGST (net) for eight selected years beginning 1982 and ending 2006. Clearly there was a decline in progressivity after GST was introduced but this was partially made up with the increase in
BOOK REVIEWnovember 17, 2007 Economic & Political Weekly30the top income tax rates after 1998. FSTC didgo some way to offset the decline in the progressivity of the tax system but fellshort of what was required for full compensation to the poor. Nevertheless the paper concludes: “ Sharp instruments like family support are a better method of compensating families with dependent children than selective omission of food or children’s clothing”. An exercise of this kind remains to be done in India The paper concludes by observing that while the GST has proved to be a robust revenue source for NZ – compelling better compliance with income tax as well – “the increased use of electronic commerce, especially for delivery of services across international borders, digital products and virtual property may put the GST base under increasing strain”. The mes-sage has relevance for tax policymakers everywhere. Interpretation of Tax Law Part 2 of the volume contains papers deal-ing with the interpretation of the GST law inNZ. The first paper in this part, a contribution by a sitting judge of the NZ supreme court deals with two of the four core elements of what creates a liability for GST under the law, viz (i) where there isa“supply” (sale in our vocabulary) and (ii)the supply takes place in the course of furtherance of a taxable activity by a re-gistered person. Some landmark judgments bearing on the issues are discussed in con-siderable detail supplemented by a com-mentary on the paper. The commentator argues for some comity of approach in the interpretation of GST andVAT laws among countries. The paper that comes next gives an ac-count of how the law framed for imple-menting the GST introduced in Australia in 2000 is interpreted. It appears there has been the “usual trend of increasing litiga-tion and issue complexity that occurs as a tax develops”, even in the short period that GST has been in operation in Australia. After providing a brief history of GST law interpretation the paper goes on to discuss critically some of the leading cases. Part 3 of the volume contains three papersdealing with the problems in taxing financial services under aGST. In the case of financial services the standard practice so far has been to exempt their supply and deny credit for tax on associated inputs. Though considered undesirable this prac-tice continues primarily because of the difficulty in identifying and measuring the value of the service that could be brought under a GST. The difficulty stems from the specific problem associated with the need to impute the amount of the implicit price to consumers of financial services. To sidestep the problem, the re-sponse of tax systems has been to exempt financial services treating the financial service provider as the final consumer of its inputs. The opening chapter of this part authored by Tim Edgar , a professor of law in Western Ontario University, brings out the source of the problem and the distor-tions that exemption of financial services inGST gives rise to. Compromise Solution A workable solution to the problem – a compromise – is put forward by Satya Poddar, the only Indian participant in the
BOOK REVIEWnovember 17, 2007 Economic & Political Weekly32related operational matters”, a feature that needs to be noted by those who advo-cate levy of GST only at the nationallevel in India. Though focused primarily on a review of the experience of GST implementation and operation inNZ the volume contains papers that go into issues of interest to countries seeking to adopt VAT in a federal set-up. These are contained in Part 7 under the heading “Economic Integration and GST/VAT”. Special mention may be made of the article by John Wallace of Ernst and Young, Sydney, and visiting fellow at tax research institutes in twoNZ uni-versities. While going into the implica-tions of increasing economic integration in the Asia-Pacific region, the paper pro-vides a lucid and comprehensive survey of the literature that has grown around the question: how to design a domestic trade tax regime anchored on a destination-based VAT in an economic union or federa-tion that would foster economic inte-gration and the functioning of a common market, while respecting the fiscal auto-nomy of the constituents. The issue has figured extensively in the literature and has been a matter of concern to policy-makers in theEU and all countries with a federal set-up. Currently the matter is en-gaging the attention of a working group set-up in India to design a suitable scheme of GST for implementation in the next two years. The paper by Wallace goes overthe pros and cons of the contending modelsfor tackling the issue of taxation of cross-border sales in a most balanced and objectivemanner. Of particular relevance in the present Indian context is the discussion of the fol-lowing models: (i) nationalVAT/GST regimes plus revenue sharing with sub-national governments; (ii) harmonised sub-national GST/VAT regimes; (iii) dualGST/VAT re-gimes; (iv) compensatingVAT, and (v) viable VAT regimes. Trade-offs The discussion sharply brings out the trade-off involved in choosing among the available models between the imperatives of fostering a common market and the need to preserve the fiscal autonomy of the sub-national governments. In a refreshing contrast with arguments favouringtotal uniformity inVAT/GST regimes in afed-eral system as essential for the function-ing of a “single market”, the paper stresses the need to preserve the fiscal autonomy of sub-national governments on efficiency and not just political grounds. While considering the merits and drawbacks of a “National” GST/VAT regime with revenue sharing after noting its advan-tages the author enumerates a number of “economic costs” entailed by such a sys-tem. Most notable among these is the weakening of the incentive for sub-national governments “to increase the efficiency with which they provide goods and services to their citizens.” “Overall”, the paper concludes, “the economic costs…tend to reduce and poten-tially even more than offset the efficincy gains from implementing a nationalGST/VAT regime.” The theme of economic costs involved in reducing the accountability of sub-national governments for the amount of revenue they raise runs through the evaluation of the merits and drawbacks of alternative models like “harmonised system ofVAT/GST”, the European Com-mission proposal for a common system of VATfor the EU and its variant the VIVAT. The paper ends with a deliberation on “the best path forward” recommending GST/VAT regimes at both national and sub-national levels based on the destination rule and relying on “reverse charges” and “deferred payment” arrangements draw-ing on the international experience with income taxation. Illuminating Survey The concluding section of the volume (Part 8) contains an illuminating survey of the evolution of thinking and practices in the arena of taxation in recent years and the thrust of intellectual opinion as to the directions in which tax policy shouldturn if the objectives of equity and efficiency are to be adequately served. Authored by Neil Brookes, an academic from Toronto and fellow at taxation re-search institutes in Monash and Victoria universities, the paper opens with an ac-count of the “rise andfallofincometax” and the ascent of VAT as a broad-based consumption tax in the last century. Taking note of the calls for “fundamental tax reform” to cure the basic infirmities of income tax – particularly its inability to find a satisfactory way of taxing income from capital – the paper argues that none of the alternatives suggested are better than theVAT and none, not evenVAT, can replace the income tax completely. The paper discusses in this context the strengths and weaknesses of the various alternatives to the income tax as it operates now that have been put forward from time to time, such as the flat tax (Hall and Rabushka), “X’ tax (David Brad-ford), and the US treasury’s Blueprint for tax reform. The discussion is more than barely descriptive and takes the reader through some of the intricate theoretical reasoning that motivates the talk of fundamental tax reform.1 The debate re-mains inconclusive. However, many wouldbe inclined to share the author’s perception that while value added taxes arerequired to raise the vast amounts of revenue needed by modern welfare states, the income tax will have an important role “in achieving a more socially acceptable distribution of economic resources than that which results solely from the market forces”. In a way the paper provides a pointer to the direction in which tax systems ought to and are likely to move in the 21st century. All in all the volume provides a rich fare for tax reformers and should be a compul-sory reading for all who are involved or associated with framing and implementa-tion of GST in India. Email: amaresh_23@yahoo.comNote1 For a flavour of the proposals and the surrounding debate seeToward Fundamental Tax Reform by Alan Auerbach and Kevin Hassett (eds), American Enter-prise Institute, Washington DC, 2005. Call for PapersDepartment of Political SciencePanjab University, ChandigarhInvites papersfor a multidisciplinary national seminar onINDIAN IDEAS OF FREEDOM21-23 February 2008Last date for abstracts: 15 December 2007Last date for papers: 15 January 2008Contact:Bhupinder Brar/Pampa Mukherjeeideasoffreedom@rediffmail.com

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