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The Value Added Tax : Its Causes and Consequences

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  • Keen, Michael

    (IMF Institute, International Monetary Fund)

  • Lockwood, Ben

    (University of Warwick)

Abstract

Almost unknown in 1960, the value added tax (VAT) is now found in more than 130 countries, raises around 20 percent of the world’s tax revenue, and has been the centerpiece of tax reform in many developing countries. This paper explores the causes and consequences of the remarkable rise of the VAT. A key question is whether it has indeed proved, as its proponents claim, an especially effective form of taxation. To address this, it is first shown that a tax innovation—such as the introduction of a VAT—reduces the marginal cost of public funds if and only if it also leads an optimizing government to increase the tax ratio. This observation leads to the estimation, on a panel of 143 countries for 25 years, of a system of equations describing both the probability of VAT adoption and the revenue impact of the VAT. The results point to a rich set of determinants of VAT adoption, this being more likely, for example, if a country has a program with the IMF and the less open it is to international trade. In the revenue equation, the presence of a VAT does indeed have a significant impact, but also a complex one, with a negative intercept effect counteracted by positive effects that are greater the higher are per capita income and, more tentatively, openness. While the sign of the revenue impact of the VAT is thus in general ambiguous, most countries that have adopted a VAT seem to have gained a more effective tax instrument in doing so (though this is less apparent in sub-Saharan Africa), and most without it seem likely to gain from its adoption.

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Bibliographic Info

Paper provided by University of Warwick, Department of Economics in its series The Warwick Economics Research Paper Series (TWERPS) with number 801.

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Length: 35 pages
Date of creation: 2007
Date of revision:
Handle: RePEc:wrk:warwec:801

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Keywords: Value added tax ; tax reform;

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References

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  1. John Piggott & John Whalley, 1998. "VAT Base Broadening, Self Supply, and The Informal Sector," NBER Working Papers 6349, National Bureau of Economic Research, Inc.
  2. Edwards, Jeremy & Keen, Michael, 1996. "Tax competition and Leviathan," European Economic Review, Elsevier, Elsevier, vol. 40(1), pages 113-134, January.
  3. Joshua Aizenman & Yothin Jinjarak, 2008. "The collection efficiency of the Value Added Tax: Theory and international evidence," The Journal of International Trade & Economic Development, Taylor & Francis Journals, Taylor & Francis Journals, vol. 17(3), pages 391-410.
  4. A. Lans Bovenberg, 1987. "Indirect Taxation in Developing Countries: A General Equilibrium Approach," IMF Staff Papers, Palgrave Macmillan, vol. 34(2), pages 333-373, June.
  5. Dani Rodrik, 1998. "Why Do More Open Economies Have Bigger Governments?," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 106(5), pages 997-1032, October.
  6. M. Shahe Emran & Joseph E. Stiglitz, 2002. "On Selective Indirect Tax Reform in Developing Countries," International Trade, EconWPA 0210003, EconWPA.
  7. Agha, Ali & Haughton, Jonathan, 1996. "Designing VAT Systems: Some Efficiency Considerations," The Review of Economics and Statistics, MIT Press, vol. 78(2), pages 303-08, May.
  8. Besley, Timothy & Jewitt, Ian, 1995. "Uniform taxation and consumer preferences," Journal of Public Economics, Elsevier, Elsevier, vol. 58(1), pages 73-84, September.
  9. Kent Matthews & Jean Lloyd-Williams, 2000. "Have VAT rates reached their limit?: an empirical note," Applied Economics Letters, Taylor & Francis Journals, Taylor & Francis Journals, vol. 7(2), pages 111-115.
  10. Bird,Richard & Gendron,Pierre-Pascal, 2007. "The VAT in Developing and Transitional Countries," Cambridge Books, Cambridge University Press, Cambridge University Press, number 9780521877657.
  11. Alesina, Alberto & Wacziarg, Romain, 1998. "Openness, country size and government," Journal of Public Economics, Elsevier, Elsevier, vol. 69(3), pages 305-321, September.
  12. Atkinson, A. B. & Stiglitz, J. E., 1976. "The design of tax structure: Direct versus indirect taxation," Journal of Public Economics, Elsevier, Elsevier, vol. 6(1-2), pages 55-75.
  13. Timothy Besley & Michael Smart, 2005. "Fiscal restraints and voter welfare," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 3769, London School of Economics and Political Science, LSE Library.
  14. Glenn P. Jenkins & Hatice Jenkins & Chun-Yan Kuo, 2006. "Is the Value Added Tax Naturally Progressive?," Working Papers, Queen's University, Department of Economics 1059, Queen's University, Department of Economics.
  15. Keen, Michael & Lockwood, Ben, 2006. "Is the VAT a Money Machine?," National Tax Journal, National Tax Association, vol. 59(4), pages 905-28, December.
  16. Keen, Michael, 2008. "VAT, tariffs, and withholding: Border taxes and informality in developing countries," Journal of Public Economics, Elsevier, Elsevier, vol. 92(10-11), pages 1892-1906, October.
  17. Kent Matthews, 2003. "VAT Evasion and VAT Avoidance: Is there a European Laffer curve for VAT?," International Review of Applied Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 17(1), pages 105-114.
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