Finding the Right VAT Rate

Mr. Hakim is taking up his Bachelor of Art degree in Politics and Economics at the School of Oriental and African Studies (SOAS), University of London. He was an intern in Action for Economic Reforms in 2008.

Value-added tax (VAT) for many is considered to be the best form of general indirect consumption tax. VAT is an indirect tax, in that the tax is collected from a person or entity that does not bear the entire cost of the tax. It is levied on the added value that results from each exchange in the process of delivering a final product to the consumer. To avoid double taxation on final consumption, exports (which by definition, are consumed abroad) are usually not subject to VAT and VAT charged under such circumstances is usually refundable. It differs from a sales tax because a sales tax is levied on the total value of the exchange. For this reason, a VAT is neutral with respect to the number of passages that there are between the producer and the final consumer.

Whether the VAT is the best way to respond to a shortage of revenue is widely debated. In the Philippines, serious questions about sufficient collection, administration, applicability, and impacts, especially on the poor, have all fueled a myriad of views on the subject. To add to this, serious reservations of tax policies in general arise through criticisms about the lack of integrity within the government. Recent tax reforms in the past few years, including exigency measures of expanding the VAT base to include petroleum and other energy products as well as selected services (EVAT) and increasing the VAT rate from 10 percent to 12 percent (RVAT) have been especially controversial given recent increases in the prices of certain commodities.

It is important to note however, that focusing on the impact of VAT in isolation may be particularly misleading. What affects poverty may not be merely the impact of a particular tax, or even the tax side alone, but depend on spending policies as well. A reduction in the tax rate may possibly be the best option to finance pro-poor expenditures, with the net effect being to alleviate poverty. This paper therefore argues in favor of reducing the VAT tax rate from the current 12 percent back to 10 percent, while at the same time focusing on alternative measures of raising public revenue.

Read full paper here .

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