I LOVE VAT

Let me start by declaring that, as far as taxation can ever be adored and appreciated, I love VAT; an expression of a sentiment that will probably alienate a fair segment of the STAR’s readership. VAT is basically a tax on what we spend, not what we earn. Every time we buy something, we pay tax. This way, all of us contribute.
But before we get on to that, let’s consider one or two other factors: Nobody really enjoys paying taxes, and many do their best to avoid or evade them altogether. Despite this, however, we all expect and demand that Government provide services and facilities to make our lives safe and comfortable.
And even if we happen to agree that Government must have an income in order to pay for all the amenities and benefits a population requires, few will ever agree that Authorities manage a country’s finances fairly, honestly and effectively. There is a general acceptance that Government will squander and misuse, legally or otherwise, much of whatever income it derives from taxes, which leads to an ever-increasing reluctance to pay them.
Then again, an ever-increasing public service, which by definition has to be supported and paid for by taxation, is seen as wasteful and corrupt. Where does it state that public officials of a certain level should enjoy the benefits of tax-funded luxury vehicles, longer holidays (and the ability to “hoard” hundreds of days of these holidays for pre-pre-retirement leave) and other benefits and gratuities not available to the general population?
I am reminded that the Public Service pays taxes, but never am I told that these taxes come from government money in the first place; government employees simply return to government a portion of the money government has paid to them. In the first two years of Dr Anthony’s administration, from 1997 to 1999, the number of government employees skyrocketed from 5,490 to 7,431. It’s anyone’s guess how many government employees there were by the time he left office in 2006.
The private sector is not free from corruption either. Few would be surprised if it were revealed that many a business owner benefits from the free access to the products he or she deals in. It would be quite natural, even understandable, if a shopkeeper avoided paying for his own goods, a baker his own bread, a grocer his own groceries; understandable, but illegal and unfair.
But this is not what this article is about; it’s about the mechanisms and principles of Value Added Tax, or VAT.
First of all, VAT is nothing new. Most well run countries have it. And although France was the first nation to introduce VAT on April 10, 1954, the idea had been floating around for almost half a century after the German telecommunications industrialist, Dr Wilhelm von Siemens, put forward the concept in 1918. It is significant that a businessman proposed the idea; he did not see VAT as a threat to the health of the Siemens’ industrial empire but as a means of increasing state income in an equitable fashion.
Dr Siemens, incidentally, was a visionary in many ways: He is credited with championing the Berlin to Iraq railway system that was completed in 1915.
Initially directed only at large businesses in France, VAT was extended over time to include all business sectors. In many countries, VAT is now the most important source of state finance, accounting for nearly 50 percent of state revenues.
Although many business people complain that VAT will ruin their businesses, this is, at best, a misconception and at worst a downright fabrication—as the success of VAT worldwide has shown.
But then again, poor St Lucia, with its first world fantasies and third world attitudes to its economy, is the country ready for VAT, or anything else for that matter?
A Value Added Tax is like a Sales Tax in that, ultimately, the end consumer is taxed. The customer bears the burden of the total Value Added Tax payments that have been made before and up to the point of purchase. A 10 percent value added tax will immediately mean that the cost of all goods and services will increase by at least 10 percent.
Inevitably, increases in the cost of living will mean a demand for higher wages because everything will cost more. Higher wages will result in higher costs for every business. And so on, until, like a tornado, the spiraling monster runs out of steam and the calm after the storm reclaims the market place. This is inevitable.
VAT differs from the sales tax in that sales tax is collected and remitted to the government only once, at the point of purchase by the end consumer.
With VAT, collections and remittances to the government, and credits for taxes already paid occur each time a business in the supply chain purchases products or services; the supply of raw materials might be step 1; the initial production of parts might be step 2; the assembling of the parts step 3; the vending of the finished product step 4; each step of the way being the subject a value added tax. A VAT taxes the value added at each transaction.
From the perspective of the buyer, VAT is a tax on the purchase price.
From the perspective of the seller, VAT is a tax only on the “value added” to a product, material or service at his stage of manufacture or distribution.
The manufacturer remits to the government the difference between these two amounts, and retains the rest for themselves to offset the taxes they had previously paid on the inputs.
Let’s trace the history of your Volvo car. Greatly simplified, let’s assume Volvo buys all the parts from a supplier, who in turn buys the raw materials to make the parts.
Suppose the VAT rate is 10 percent. A parts’ supplier (PS Co) buys $5,000 worth of raw materials from the raw materials’ company (RM Co). PS Co will pay $5,500 (5,000 + 10% = 5,500) for the raw materials including VAT.
Upon receipt of $5,500, RM Co will retain $5,000 and send $500 to the government as VAT. So RM Co does not lose out; it gets its money but “collects” $500 for the government.
The parts’ supplier, PS Co, now has raw materials that it paid $5,500 for with which to make parts that it will sell to Volvo for $15,000 dollars + VAT.
Volvo will pay PS Co $16,500 (including $1,500 VAT) for the spare parts.
Now this is where it gets interesting. PS Co has received $16,500, which is the same as $15,000 for the spare parts plus $1,500 VAT for the government. However, PS Co had already paid $500 VAT when it bought the raw material for the spare parts from RM Co, so all PS Co owes the government is the difference between the two sums, $1,500 – $500 = $1,000.
PS Co sends the government $1000 plus proof of the $500 already paid. So PS Co does not lose out; it gets its money but “collects” an additional $1,000 for the government.
Volvo sells the car to a dealer for $20,000 plus $2000 VAT. But although Volvo receives $2,000 in VAT, it sends the government only $500 plus proof of the accumulated $1500 that has already been paid.
The dealer sells the car to a consumer for $25,000 plus $2500 VAT. It sends the government $500 plus proof of the $2,000 already paid.
The government has received $500 from RM Co, $1,000 from PS Co, $500 from Volvo, and $500 from the dealer, which equals the $2,500.
At each step of the way companies are able to “offset” the amount of total “VAT paid” against the amount of total “VAT due”. At every stage, companies receive the full price of goods or services delivered.
Shoppers on the other hand, and these include everyone who purchases anything, cannot recover VAT on purchases. Personal end-consumers of products and services bear the brunt of VAT, which means all of us
VAT works like a sales tax, but it is harder to avoid.  The owner of a clothing store could avoid sales tax on his own clothes by just taking his inventory home and wearing it. The same applies to every store, manufacturer, sales’ outlet or service centre. Company vehicles and other “perks” attract VAT. VAT makes “tax-free perks” a lot less easily hidden.
The philosophy behind VAT is that businesses are able to recover VAT on the products and services that they buy in order to produce further goods or services that will be sold to yet another business in the supply chain or directly to a final consumer.
The total tax levied at each stage in the economic chain of supply is a constant fraction of the value added by a business to its products. The cost of collecting the tax is borne by business, rather than by the state.
In some countries VAT reporting is done annually and businesses have to wait a long time for refunds. In Sweden, businesses are required to file monthly VAT reports, which greatly increases the speed at which refunds are paid out. If a country of 8 million can do this in a painless fashion, it should be possible for a country of under 200,000 to muddle along in the same way.
Value added taxes create stronger incentives for collection than sales taxes do. Sales taxes offer the buyer a mechanism to avoid or evade the tax by persuading the seller that the buyer is not really an “end consumer”, and therefore the seller is not legally required to collect a sales tax.
The burden of determining whether the buyer’s motivation is to consume or re-sell a product or service rests on the seller, but the seller has no direct economic incentive to collect the tax.
The VAT approach gives sellers a direct financial stake in collecting the tax, and eliminates the problematic decision by the seller about whether the buyer is or is not an end consumer.
The most significant impediment to a successful implementation of a VAT system is the allowance of individual exemptions for various businesses. Any system of VAT exemptions will be open to abuse as are the present mechanisms that allow businesses to import a wide range of goods that in no way further the efficacy of their operations.
The only exceptions to the VAT rule should be essential services, such as medical services and goods, basic foods, domestic transport, and utilities such as water and electricity. Telephones, which are a luxury for most, should not be exempt. Ask yourself: How many of the hundreds of phone calls you made in the past year solved a life or death emergency problem? And would you have hesitated to make the call had it cost you 2 cents more?
VAT is a broad-based, low rate tax to raise revenue for the government. It is collected piecemeal along the production chain.
Income tax does not work in St Lucia. Affluent and poor alike are equally adept at finding ways to avoid paying tax, and it would cost the taxman too much, fiscally and politically, to raise tax revenue by closing loopholes and blocking deductions.
Almost every industrialized country has an income tax, a payroll tax, and a consumption tax. VAT is the most, or perhaps the only, equitable tax available to governments. If you drink milk, you’ll pay a few cents VAT per packet. If you prefer and can afford champagne, you’ll pay $22 VAT on a bottle of a reasonable quality.
Let’s examine another example just to make sure we know how VAT works. You go to the store to buy bread. In the pre-point-of-sale production line you will have a farmer, a baker, and a supermarket. The VAT is 10 percent. Note that the VAT is ADDED to the price; it is not a cost to the producer.
The farmer grows the wheat and sells it to the baker for 20 cents. The VAT is 2 cents (10% of 20 cents). The baker pays the farmer 22 cents, and the farmer sends 2 cents in VAT to the government.
The baker makes a loaf and sells it to the supermarket for 60 cents. The VAT is 6 cents (10% of 60 cents). Now the supermarket pays the baker 66 cents, of which 6 cents is VAT.
Now although the baker has received 6 cents in VAT, he only sends 4 cents to the taxman. Why? Because he has already paid the farmer 2 cents VAT that he can now recover (6 – 2 = 4).
The cost of the loaf is $1, but the supermarket charges the customer $1.10. ($1 + 10%) The supermarket sends the taxman 4 cents VAT – the 10 cents it collected in VAT on its sale of the loaf of bread, minus the 6 cents VAT it paid to the baker in VAT (which it probably gets back in a credit).
In total, the government gets 2 cents from the farmer, 4 cents from baker, 4 cents from the store. That’s 10 cents on a final sale of a dollar, or a 10 percent VAT.
However, the astute reader will realize that all along the chain producers and vendors have been able to recover the VAT they have paid. The customer, however, is afforded no such luxury: The price of bread and everything else goes up by 10 percent.
The customer bears the total cost of the value added tax.
For once, I have to praise Dr Anthony and his government. VAT could break the back of any political party. But by opting to introduce the tax early in his reign, the prime minister is gambling on being able to implement the tax and iron out all the wrinkles within the next four-and-a-half years so that the next election will be fought on a platform of social reformation and revitalization that is funded by the millions upon millions of dollars that flow into the exchequer from the Value Added Tax.
To the doubter, the VAT system may sound complicated, replete as it is with various tax payments along the production line, and tax credits to offset taxes but, because it comprises various stages of “VAT reporting” there is an inbuilt mechanism to keep people honest. The baker in the above example may want to avoid paying VAT, but he knows the supermarket will report the purchase because it wants to offset the cost against the income it receives when it sells the bread. The supermarket is the counter-mechanism, the one that keeps the baker honest. The government can go to the baker and say, “you forgot to report your 60 cents of sales.”
Obviously, this tiny example serves merely to illustrate a much more serious problem of under-reporting. In a retail sales tax system, taxation is very easily avoided because there is no counterparty to the transaction, no counter-mechanism.
When times are tough and economies are struggling, it is all too easy to point a finger at events abroad and take the easy way out.
St Lucians, Dear Readers, “Abroad” is not going to help you. Any recovery has to come from within. Manna will not fall from the heavens, nor will prosperity come sailing in on a cruise ship or descend from the clouds on a mighty jet.
We, yes we, need to raise revenues; we need to stimulate the economy; we need to use those revenues wisely; we need to spend more now in order to spend less later; we need to save less now in order to save more later. VAT will not come without a price; there are costs associated with setting it up. As mentioned before, there will be wrinkles, but these will be ironed out before the next election.
Five years is a heartbeat in politics. Let’s hope that the nation will rally to its own defense and raise the wherewithal to develop its infrastructure and institutions without resorting to too many expensive, unserviceable foreign loans. Let us learn to live within our means, cut costs and, above all, be productive.