What do we know about VALUE ADDED TAX??


In public finance literature, the conception of taxation employed due to government’s role in providing public services. To date, government must have the means to purchase the necessary resources or products (Musgrave: 1973 : p.187).

Value Added Tax (VAT) as one of the taxes on consumption is designed as the means to generate income from business activities. Thus, the tax is then charged between business throughout the production and distribution chain (Ogley : 1998). Since its characteristic is underlined within each stage of business activities, thus VAT can be classified as a multi-stage tax.

The positive characteristics of VAT taken from some literatures can be outlined as follows:
1. VAT has a potentially wider coverage. Thus, instead of only taxed on goods VAT also allows particular services to be charged. Nonetheless, financial services are exempted from VAT due to technical problems associated with taxing these services. With this regard, VAT would broaden the coverage of tax base.
2. VAT eliminates the price distortion caused by cascading. This characteristic is noteworthy since the principle of a good tax falls over its neutrality to avoid undesirable incentives or disincentives. VAT allows a recovery mechanism over incurred VAT paid. In other words, VAT-registered business has the right to recover VAT incurred at an early stage of production or distribution chain. Therefore, the problem of cascading could be sorted out thereby attempting undesirable disincentives.
3. VAT eliminates horizontal inequities as well as vertical inequities. In term of horizontal equity, the tax will encourage each level of business activities to maximize its outcome, since the tax is charged at the same rate. The neutrality of VAT ensures that the process of economic integration, across borders, is not discouraged by tax penalties (Ogley, 1998). In order to obtain horizontal equity, a single VAT rate thus should be applied.
At the same time, the tax can be addressed the problem of vertical inequities as well. Those who have less ability to pay would be levied less from their income. This can be achieved from a zero-based rating for certain goods (i.e. foods). On this ground, the poor would enjoy the benefit from paying less over their income.
4. A self-enforcement mechanism (the so-called ‘audit trail’) provides an automatic check which enables VAT-registered businesses to recover VAT paid in respect of their inputs. From this standpoint, VAT will not distort final prices so that it does not effect on consumers’ behavior.
The audit trail is also effective as a tracker to investigate tax evasion. Based on principle that “one man’s proof of purchase is evidence of another man’s sales” could be effective to attempt fraud on tax administration.

5. Since the tax base covered only the domestic consumption, exports would be encouraged as an upshot of VAT.

However, negative characteristics are respectively attached within the VAT’s system. To substantiate, the following are some negative characteristics identified in some literatures:
1. It is hard to determine the tax rate whether it is best to apply single or multiple rate.
The problem of single uniformity tax rate in VAT is linked to be regressive since the poor may spend a larger share of their income. In term of equity, this would create vertical inequities between the poor and the have.
Meanwhile, multiple tax rates are even arising more problems caused by the complexity of the tax base. It is understandable that VAT is collected between each stage of business activities. Therefore, it is sufficiently difficult to define which business stages or individual purchases should be taxed more. Also, the process of defining which tax bracket that a particular item is in might be accompanied by collusion between tax payers and revenue authorities. Hence, it then leads to another problem in conjunction with credibility and accountability.
2. AT leads to more compliance costs.
The negative characteristic arises from the audit trail attached in its system. In principle, the audit trail requires more efforts and resources to gain an optimum result. Some literatures often link this problem with the trade-off between effectiveness and efficiency. To gain effectiveness of VAT collection, it means that more compliance costs are needed which can be adjourned efficiency. For instance, more tax officials required in collecting and assessing the tax would lead to the increase in government expenditure. At the same time, more time is needed for VAT-registered business dealing with tax burden.
3. Its complexity in registration, collection, and assessment system makes it difficult to reach small businesses activity. This is because small businesses are usually poor in book keeping, thus, the mechanism of recovery VAT paid would be sufficiently difficult as well. Against this background, the negative characteristic of VAT is only reached large scale of business activities.

Regarding those circumstances, it is notably examining vigilantly what are the main issues to be considered in designing and implementing VAT in a country, especially in Indonesia. Indonesia has applied VAT as part of its tax reform in 1983 which is disabled taxes on retail sales.

In my view, the neutrality of VAT as a device to attempts problems of cascading should be considered to overcome the horizontal integration among business activities. It is undeniable that Indonesia is most vulnerable to domestic supply-shocks problems, i.e. administered price for domestic fuel consumption, which might be hampered the process of integration. Hence, the tax should not discourage the process of economic integration. VAT –which enables uniformity tax rate for each stage of business activities- would be encountered the horizontal integration and at the same time will attempt the horizontal inequities as well. This is based on reason that the earnings from same sector would be levied with the same rate of tax. In addition, the right to recover incurred VAT paid will encounter the problem of cascading. Henceforth the tax would not harm the administered price to consumers.

Moreover, the self-enforcement mechanism attached in VAT is best linked to avoid tax evasion. This issue is important since VAT allows an automatic check among VAT-registered business activities therefore an effort of evasion will be easily tracked down. In addition, by using the invoice-based method the possibilities of collusion between tax payers and revenue authority would be minimized. As above-mention that “one man’s proof of purchase is evidence of another man’s sales” it clarifies that this soundness should be considered in designing and implementing VAT in Indonesia.

Nevertheless, since the VAT entails a complexity in administration system, it is worth noting the practical difficulties that might occur in Indonesia. Firstly, it is undeniable that small business considers at a large number in Indonesian economic activity. According to law number 8/1983 of VAT and Tax on Luxury Goods, small businesses are exempted from VAT. However, it is difficult to define the borderline of business scale that should be classified as small business. It might lead on disputes and a wide-open of collusion between tax payers and tax officials. That is why the exemptions underlined within VAT might be caused technical difficulties, particularly in classifying the VAT-registered business.

Secondly, the difficulty outlays from the designing of recovery VAT paid system. This is essential since the main principle of VAT accounts on its characteristic to avoid undesirable disincentive as a result of price escalation. Therefore the mechanism of rebate incurred VAT paid should be regulated vigilantly. A recent violence against VAT which has just taken place in Indonesia reveals that a premature system of rebate creates a loop hole for criminals to reclaim fictive VAT paid from fictive invoice. The vague regulation from previous law opened the possibility of a new motive of crime.

And thirdly, lack of skills of tax officials takes into account as the practical difficulty. The term of skills here includes education, knowledge and technical ability. It is often claimed as a cliché argumentation, yet the human resources development still entitled within Indonesian tax administration. The above crime example might indicates how is the lack of technical ability endangered the potential income for the country. The initiative to further investigate (the so-called audit investigation) was in a poor condition which enable criminal to commit the fictive reclaimed VAT. To sum up, the positive characteristics of VAT could be overcome the imperfect- previously sales tax applied in Indonesia before tax reform in 1983. However, the loop hole which outlays within the VAT system, in particular the rebate system, should be encountered vigilantly to avoid tax crime.