VAT empirically fails – exemptions and evasion demolish enforcement

Policy Recommendations All of the major tax systems implemented by governments must be seen as fair if they are to remain stable and sustainable in the long run. If a tax is viewed as unfair, then there will be constant demand to make adjustments to the system to address the demands of special interest groups. The problems associated with the administration of and compliance with a VAT system grow exponentially with the number of goods and services that receive tax preferences. In a single-stage sales tax system, a good is exempted from taxation, and only that good and its sales are affected in terms of special record keeping and additional compliance costs. However, with VAT, all sellers of such an item and the buyers who use it as an input in production must keep a special record of these sales and purchases separately. This is especially burdensome for small businesses that do not have sophisticated computer systems to track these special transactions. Even in the European Union today, small and medium enterprises account for more than 90% of the entire compliance costs associated with the VAT operation []. While in many countries, VAT has been the major tax instrument for raising revenue for their governments, it has in some cases collapsed. The experiences of Malaysia and previously of Ghana and Belize are examples. Usually, the collapse comes as a result of political concerns of tax fairness and compliance issues. In other countries, particularly in Latin America, it has occasionally been severely weakened by the proliferation of tax preferences and only salvaged by implementing major tax reforms []. Belize is a good case study of a situation where the collapse of the GST system seems imminent unless a major reform is undertaken. Over 40% of the entire workforce in GST tax administration are assigned to auditing and processing claims for refunds. Furthermore, the backlog of unprocessed claims in 2016 was equal in value to 50% of the annual revenues of the GST system. This is an institutionally unsustainable situation. This empirical study shows that the objective of raising a substantial amount of revenue with a single-rate, broad-based GST system in Belize is not in conflict with the government’s income distribution objectives. Our analysis shows that currently, the GST is highly progressive in Belize, with the effective tax rate paid by households in the top quintile 1.5 times the effective tax rate paid by those in the bottom quintile. However, the current tax system has required an extensive array of tax exemptions and zero rating of items, causing it to become impossible to efficiently administer. Even after eliminating the zero rating of all goods sold domestically and a drastic reduction in the number of GST-exempt goods, the tax system remains progressive. The average tax rate of households in the top quintile is approximately 1.2 times that of those in the bottom quintile.