“Occupy the Wall Street” in the USA and similar protests in other countries in recent times show the people's perception about the economic set up that it is unjust and is skewed against the poorer class. These upheavals are no less against the the tax system also which is a key element in the economic set up . Indeed the whole world is burdened with GST, thanks to the motivation supplied by the IMF. Only exception is the USA.
About the regressivity of GST there is not doubt. When the ratio of consumption tax to income decreases it is called a regressive tax. A single rate of VAT with no zero-rate, except for exports, and few exemptions must mean that the VAT payments by low income households will be a higher proportion of incomes than payments by higher income households. That is, the VAT will be regressive1. Regressive tax is taken as unfair by people. The definition of fair is vague but it is well accepted that fairness must be interpreted relative to the extent a person derives benefits from the society.2 In England, Adam Smith laid down his concept of fairness in four canons, the first of which stated that taxes are fair when the tax burden is universal and applies equally to all in society.3 The concept of proportional tax is fundamentally same as Adam Smith,s idea of fairness.
There are economists who argue that burden of a VAT levied at uniform rate would also be largely proportional if the denominator where lifetime income, rather than annual income became relevant because many income recipients are only temporarily in the lower income brackets. They move into middle or upper income brackets as their earnings increase4. This argument is more of semantics and is not accepted by those who are poor now. They refuse to believe that one day they will be rich and so the effect will even out. VAT is regressive for who are poor now. And the postulate that all poor will be rich one day is an utter trash.
There have been attempts to make VAT less regressive but there is a high cost of attaining it. There is a great administrative cost for trying to get progressivity by rate differentiation. The advantage of progressivity gained by a whole host of exemptions, zero rating and multiple rates is almost not certainly sufficient to offset the disadvantages associated with departure from a uniform rate and comprehensive base. Exemptions and differential rates distort consumer and producer choices, make for administrative complexity (and hence increased administrative and compliance cost) and raise questions of interpretation that often must be resolved in courts5.
Any equity gains from differentiation of rates are likely to be more than outweighed by the additional administrative cost entailed. Exemption introduces cascading leading to major distortion and lack of neutrality, which is the virtue of VAT. In Turkey to achieve progressivity in 1991, the total VAT collection, as a percentage of total tax revenue itself was only 24% while half of it was given back as rebate to the lower income groups. This was done through a cumbersome mechanism that required monthly representation of receipts, their verifications, huge bureaucracy and a very high compliance cost6.
In this context we may judge the recent thesis by Michel J Graetz7that in the USA the threshold for income tax should be raised so that about 100 million tax returns become less. The loss of revenue could be made good by a comprehensive GST.
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While reducing the number if returns of tax is a good idea, (more in vogue in the UK), the introduction of GST in its place is not so particularly because it will replace income tax which is a more progressive tax with consumption tax (GST) which is regressive.
A better switching of tax regime would be to raise the threshold for income tax and also raise the general rate somewhat.
The conclusion is that GST must be understood to be regressive and it should be more and more replaced by direct tax with higher threshold because that it a more progressive set up.
1 Alan A. Tait- VAT Policy Issues, p 5 in VAT Administrative and Policy Issues edited by Alan A. Tait IMF, 1991
2 Robert F. Van Brederode – VAT’s Regressivity: Empirical Truth or Political Correctness- International VAT Monitor-March/April, 2007-p.87.
3 Adam Smith – Inquiry into the Nature and Causes of the Wealth of Nations (first published 1776; The Modern Library, New York:1937), p.777.
4 Sijbren Cnossen – Key Questions in Considering Value Added Tax for Central and Eastern European Countries-VAT Monitor, November 1992, p.7.
5 Sijbren Cnossen – Canadian Tax Journal 1987 Vol.35 May-June 1987, p.567
6 Alan A. Tait – VAT Policy Issues, Structure, Regressivity, Inflation and Exports, p.7 in Value Added Tax: Administrative and Policy Issues edited by Alan A. Tait, IMF 1991
7 Graetz, Michael J Hundred Million Unnecessary Returns 2008