Is VAT always a good tax?
Rapid spread of VAT (value-added tax) across the globe signifies that it may be a good tax. However, VAT can be problematic when the economy has a large informal sector. The basic concept behind the levy of this consumption tax was that the legal incidence of VAT would be on sellers, including importers, manufacturers and distributors and, eventually, retailers. And the effective incidence would be upon consumers according to their capacity to consume. However, a considerable number of manufacturers in an informal economy failed to shift the tax burden to consumers, as several intermediate distributors and retailers between manufacturers and consumers are not registered for VAT. Therefore, the major burden of VAT (legal and actual incidence) has been borne by the manufacturers. This aspect adversely affected manufacturing activity and economic productivity.
Moreover, in informal economies, the registered taxable persons find it difficult to compete in the market due to higher prices, inclusive of VAT, as non-registered suppliers commonly offer inputs of similar quality for lower tax-exclusive prices. Therefore, informal economies discourage taxable persons to operate under VAT by encouraging them to keep turnover below VAT registration threshold. Taxable persons intentionally keep turnover below VAT registration threshold by under-reporting turnover in economies where prescribed turnover is the basis for VAT registration; or by splitting the utility bills among different taxable persons (largely manufacturers) where certain value of utility bills is prescribed as yardstick for VAT registration.
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