Value Added Taxation

Value Added Taxation:   Mechanism, Design, and Policy Issues
Tuan Minh Le

Paper prepared for the World Bank course on Practical Issues of Tax Policy in Developing Countries
(Washington D.C., April 28-May 1, 2003)


      The idea of the value added taxation (VAT) traces back to the writing by von Siemens, a German businessman, in the 1920s.   Not until 1948, however, was the tax first applied in France.   At the beginning, France applied the GNP-based VAT covering up to the manufacturing level and subsequently replaced it with a consumption VAT in 1954.   Theory and practice indicate that to be efficient, the VAT must be consumption-typed, broad-based, and applied through to the retail stage.
      Empirical studies have shown the interlinks between the VAT performance of a country and its level of development.   The revenue gains from VAT are likely to be higher in an economy with higher level of per capita income, lower share of agriculture, and higher level of literacy (Ebrill et al. 2001).[1]   VAT proves to be an efficient tool for revenue collection;   its performance, therefore, has direct impact on fiscal mobilization, macroeconomic stability, and development.
      Compared with alternatives in indirect taxation, the VAT has more revenue potential:   it is generally more broad-based and entails a trail of invoices that helps improve tax compliance and enforcement.   Note also that the VAT may eliminate the cascading problem, which is typical for the turnover tax.   Heady (2002) observes a clear, consistent trend for greater use of the VAT to collect sales tax revenues among OECD countries:   “[The VAT becomes] the sales tax of choice in OECD countries” (p.4).   While these countries continue to rely heavily on income tax collection, the VAT revenues have risen steadily in both absolute and relative terms:   the general consumption taxes (mainly VAT—in recent years) increased sharply from 12 percent of the total tax revenues in 1965 to...