Post-COVID VAT and GST reform – righting the wrongs

Value Added Tax, Goods and Services Tax and U.S. sales tax are having a ‘good’ coronavirus crisis. But let’s seize the momentum to improve and simplify the world’s most popular tax.

VAT to the rescue

VAT, GST and U.S. sales tax reliefs have taken centre stage in the actions governments have taken to support businesses and boost consumer spending as economies emerge from lockdown. The immediacy of impact of VAT rate cuts has further boosted the indirect tax’s pole position as the most favoured fiscal instrument.

But what of the future for the tax which spread to almost 170 countries in just over fifty years? What reforms are required to strengthen and simplify it?  And do governments now have the impetus to address one of the most stubborn prejudices against it: its regressive propensity to extract a larger percentage of income from low-income earners than from high-income earners.

Broadening the tax base – simplicity and fairness

The great, self-inflicted weakness of most countries’ VAT regimes is the multitude of exemptions and reduced rates on various goods and services. These are meant with the best of intentions: aimed at reducing the tax burden for the less well-off and blunting its regressive nature. However, this brings many problems:

1. Complexity – tracking and enforcing these multitude of rates and rules for businesses and tax authorities has created a huge compliance bill. Huge amounts of time and costs are consumed on tax audits and court cases looking to determine when a cake is VAT free or private tutor should enjoy the same VAT shield as a state school. It also encourages businesses to game the system, and bend their product promotions in an attempt to gain a VAT cut.
2. Unstable taxes – by taking so many supplies out of the tax net, the base narrows and becomes vulnerable to more economic swings. This results in unpredictable government revenues and difficulty in spend and investment planning.
3. Subsidies for the rich – the VAT reductions on necessities also provide a completely unnecessary tax cut for the middle and top earners. This makes reduced VAT rates an expensive way to tackle the regressive nature of VAT. Countries such as Canada and Singapore have found ways around this by instead issuing VAT reduction vouchers to less well-off shoppers. As technologies improve, and seek to avoid embarrassment at the checkout, this is increasingly being delivered automatically through credit card payments and income tax systems as better targeted welfare payments instead of VAT cuts.

Fairer VAT deductions 

VAT is a tax on the final consumer, collected by the business (unpaid!). One of the core pillars of VAT is that it is neutral for businesses – they are able to recover, through their return, any VAT charged to them. However, there are many barriers to this, creating a major administrative and cashflow cost for businesses. These tax leakages need addressing to free business from a masked tax on them. These could include:

1. Faster credits. Businesses with a surplus in VAT owed back to them by government, a VAT credit, should receive this immediately with no, or very limited, prolonged auditing. Many countries do not make this refund automatic and may even just roll the repayment against future VAT liabilities. This represents an unfunded credit line from businesses to government.
2. Bad debt relief. The right for businesses to reclaim a VAT refund on their customer’s bad debts has always been problematic. But the COVID liquidity crisis has put this into the spotlight. The delays, often six months or longer, on VAT bad debt repayments is an unreasonable burden on legitimate and trading businesses of failures of others.
3. Import and export VAT deferment. Importers of goods often have to fund import VAT taxes with delays and audits to gain repayment. Many countries operate postponed accounting – a removal of the VAT cash payment at the point of import – but only for businesses with years of certified VAT compliance behind them. For major exporters, they are burdened by heavy input VAT bills which required applications for refunds. Countries should look to set up special schemes for both, since global trade is vital to help deliver the cheapest and best products for recovering economies.
4. Digitalising VAT. Whilst the digitalisation of VAT in Europe was already following the anti-VAT fraud trend of South America, the COVID pandemic has exposed the missed opportunities. If countries had had at their disposal live VAT invoice reporting into central tax office databases, they would have been much better positioned to understand the effects of the shutdown, and which businesses needed what support. So, whilst a number of real-time invoice projects have been postponed because of lockdown, from 2021 onwards the pace of the shift from the traditional VAT return to real-time invoice clearing will pick up.

2021 wholesale reforms

2020 has been all about adapting VAT and other government fiscal and spending levers to support the economy during the COVID-19 crisis. But, as the ‘new normal’ establishes, countries will be anxious to learn from the lockdown.

COVID has confirmed VAT as governments’ favourite tax. But is time to show some it some tender loving.