27 March 2007 Centre for Tax Policy and Administration Organisation for Economic Co-operation and Development A MODEL VAT OECD PARIS 27 March 2007

Centre for Tax Policy and Administration Organisation for Economic Co-operation and Development 2 The spread of VAT 140 countries now have VATs VATs generate significant tax revenue: –OECD: 6.9% of GDP, 18.9% of all taxes –Mexico: 3.7% of GDP, 20.2% of all taxes Growing reliance on VAT revenue: –OECD: 16.4% (1985), 18.9% (2003) –Mexico: 15.9% (1985), 20.2% (2004)

27 March 2007 Centre for Tax Policy and Administration Organisation for Economic Co-operation and Development 3 VAT design: main policy issues Almost universal use of credit-invoice system and application of destination principle Much diversity in the structure of VATs & revenue Considerable variation in registration thresholds (zero to $90,000) VAT- a tax to refund (as well as collect)

27 March 2007 Centre for Tax Policy and Administration Organisation for Economic Co-operation and Development 4 VAT DESIGN: RATES Mexico: 15% = 3.7% of GDP Luxembourg: 15% but = 7.1% of GDP Germany was 16% = 6.2% of GDP

27 March 2007 Centre for Tax Policy and Administration Organisation for Economic Co-operation and Development 5 VAT DESIGN: RATES Exemption: No tax charged but no tax recoverable Exemptions: Most countries exempt financial services, education, health, charities. Financial Services: Difficult to ascertain value for adding tax. But New Zealand recently zero-rated business-to-business financial services. Education, Health, Charities – social reasons. Exemption can be big tax-raising mechanism (UK = 8% of VAT)

27 March 2007 Centre for Tax Policy and Administration Organisation for Economic Co-operation and Development VAT DESIGN: RATES Zero Rate: No tax charged but tax is recoverable by business Few countries apply widely (UK and Ireland exceptions) Food, Books and Newspapers most common Mexico much wider than most (jewellery, hotel conference services, caviar)

27 March 2007 Centre for Tax Policy and Administration Organisation for Economic Co-operation and Development VAT DESIGN: RATES Reduced rates: Tax charged at a rate less than Standard Rate. Recoverable by business Covers items zero-rated in some countries Others include construction, domestic electricity and gas, supplies to disabled people

27 March 2007 Centre for Tax Policy and Administration Organisation for Economic Co-operation and Development 8 VAT DESIGN: THRESHOLD France, UK and Slovak Republic have highest thresholds (c.$90,000) 6 OECD countries have no thresholds (inc Mexico) 4 OECD countries have collection thresholds Some have variable thresholds (e.g. France and Ireland with one for goods, one for services)

27 March 2007 Centre for Tax Policy and Administration Organisation for Economic Co-operation and Development VAT DESIGN: THRESHOLD High thresholds favoured Avoids expensive tax collection of small amounts Removes compliance burden on small business High cost of maintaining large number of registered businesses

27 March 2007 Centre for Tax Policy and Administration Organisation for Economic Co-operation and Development VAT DESIGN: THRESHOLD Can give some problems Artificial splitting of businesses to keep below threshold “Cliff-edge syndrome” But international consensus that high thresholds are more efficient

27 March 2007 Centre for Tax Policy and Administration Organisation for Economic Co-operation and Development 11 A VAT designed for sub-optimal performance? LOW THRESHOLDS NARROW BASE (AT STD RATE) + MULTIPLE RATE STRUCTURE LARGE NUMBERS OF SMALL VALUE PAYERS REQUIRE KEY FEATURES HIGH STANDARD RATES INCENTIVES TO EVADE COMPLEXITY POOR USE OF AGENCY RESOURCES LEADING TO RESULTING IN POOR COMPLIANCE HIGH COMPLIANCE COSTS HIGH ADMINISTRATION COSTS

27 March 2007 Centre for Tax Policy and Administration Organisation for Economic Co-operation and Development 12 VAT Efficiency FeaturesNZSwitz.EU15Mexico VAT standard rate (%) VAT reduced rate (no.)NoYesManyYes VAT revenue/GDP (%) VAT C efficiency VAT compliance burdenLow High

27 March 2007 Centre for Tax Policy and Administration Organisation for Economic Co-operation and Development 13 Improving Mexico’s VAT: Policy Minimise zero rates Exemption for some goods? Reduced Rate in border regions? Introduce registration threshold ($50,000?) MAJOR CHANGES AS PART OF WIDER TAX REFORM