Indirect Taxes

Ian Crawford (Surrey / IFS)

Michael Keen (IMF)
Stephen Smith (UCL)
 Introduction
• Developments in theory since the Meade report have
considerably altered our understanding of the
contribution that can be made by indirect taxes to
revenue-raising efficiency.
• The VATs of EU member states have now run for some
35 years. Time for a review?
• The elimination of internal frontiers in the EU has
brought new issues of administration, enforcement and
tax competition.
• There have been suggestions that the existing VAT
struggles to handle some recent developments in
business activity and organisation, such as the growth of
services and e-commerce.
 Outline and key issues
• Theory, and empirical results
• The rationale for indirect taxes.
• Uniform vs differentiated commodity taxes

• Indirect tax systems

• VAT versus Retail Sales Tax, etc

• International aspects of indirect taxes

• VAT treatment of international trade in goods and services

• Conclusions: what future for indirect

taxes?
 Principles
• The rationale for indirect taxes.
• Why do we have them at all?
• Equivalences between indirect taxes and other taxes
• Uniform vs differentiated commodity
taxes
• Efficiency
• Equity
• Administrative considerations
• The incidence of indirect taxes: who
bears the burden?
 Empirical evidence / results
• The key parameters: What does the
empirical evidence show?
• Summary of the state of knowledge about elasticities of
demand, cross-elasticity with labour supply, etc.
• VAT, excises and income distribution
• Simulation of uniform VAT versus UK
zero-rating.
 Indirect tax systems
• VAT versus Retail Sales Tax
• (and, more briefly, different forms of VAT)
• Practical compromises
• VAT registration threshold
• Treatment of financial services
• other hard-to-tax goods and services
• VAT and capital goods
• Enforcement and compliance aspects
• Evidence on VAT compliance costs
• VAT evasion
• Specific versus ad valorem taxes
 International aspects 1
• Origin and destination principles
• Conditions for equivalence, etc

• Different VAT mechanisms for cross-

border trade
• export zero-rating
• VAT-inclusive exporting (as Commission 1987)
• VIVAT, etc

• VAT and international business

organisation
• The Commission's 1996 definitive regime proposals, based on a "single
place of taxation"
 International aspects 2
• Indirect taxes and cross-border shopping
• implications for revenue-maximising tax rates
• case for rate harmonisation?
• VAT and internationally-traded services
• Reasons for complexity, and growing
significance of the problem
• Basic principles
• E-commerce
 Conclusions: what future for
indirect taxes?
• VAT will remain central component of tax
system
• Substantially greater revenue potential than RST
• The UK’s VAT zero rates
• Hard to justify. Main focus of our empirical simulation.
• VAT treatment of international trade
• Strong case for moving to a system that does not break
VAT chain at borders (eg “exporter rating”, or VIVAT)
 Applied Issues
• Knowledge of demand responses is important
• What do we know?
• Not a huge amount
– Elasticites are heterogeneous
– They are hard to measure
– Getting income effects right at different points matters
– There are few (zero?) published papers reporting
large scale, household-level UK demand systems
• So we have decided to estimate one
 Applied Issues
• We used the Quadratic Almost Ideal Demand
System (Banks, Blundell and Lewbel, 1999)
– It’s Rank 3 (so we can get the income effects right)
– It’s integrable (so we can do welfare analysis)
– It allows a degree of heterogeneity in elasticities.
• Data: 25 years of the UK Family Expenditure
Survey (176,068 households)
• 20 commodity groups (we don’t model leisure)
 Applied Issues

2
n
 m  λi   m  
h h
w = α i + ∑ λij ln p j + β i ln 
h
+ ln  
 a ( p )  b( p )   a ( p )  
i
j =1

−1
 ln m h − ln a( p )  −1

( )
ln V m h , p = 
b( p )
 + λ ( p) 
  
 Applied Issues
• Mean elasticities are for the most part moderate
• Classic inelastic commodities appear to be
inelastic
Tobacco: -0.839
Petrol & Diesel: -0.314

• But
Wine & Spirits: -2.995
 Applied Issues

• We simulated the effects of ending zero rating

and having uniform 17.5% VAT
• The tax revenues have been burned
• For each household we calculate the welfare
loss:
( ) (
V m h , p + ∆p − V m h , p )
Applied Issues
 Indirect Taxes

Ian Crawford (Surrey / IFS)

Michael Keen (IMF)
Stephen Smith (UCL)