VAT can include services in tax base if rates are same

EXPERT EYE

A commonly accepted proposition regarding value-added tax among economists is that the VAT is better equipped to include services in the tax base.

Combining goods and services by making their input credit and adjustments interchangeable, goods and services can be taxed together under the VAT. Most retail sales taxes (RST), on the other hand, exclude services. The RST is usually identified with the sale of goods, not services.

For example, transport, telecommunication, professional services and construction are not usually taxed under the RST (Allan A. Tait, VAT- Policy Issues: Structure Regressivity, Inflation and Exports p.3 in VAT Administration and Policy Issues, Occasional Paper 88- IMF 1991).

In some countries like the US, in attendance is sales tax on service and it is a combined RST. But it is not possible to combine the services, which have got inter-state implications such as Railways, etc. with the RST.

Inclusion of services in the RST base would be complicated, while their exclusion leads to complication of another kind. It is complicated to separate the service element from the sale of a good whenever the two occur in combination (Sijbren Cnossen "� Key Question in considering a VAT for Central and Eastern European Countries, VAT Monitor, Nov.1992, P.6).

An example of how the RST is difficult to extend to the services is the following: the airlines would be required to ask every person who buys a ticket: Do you travel as a private person or as an entrepreneur? Only the travel of private persons should be taxed.

In Norway and Denmark, when a retail sales tax was levied in these countries, the "beginning" services were not included in the sales tax. The result was that an activity was often artificially divided into a service (not taxed) and a delivery of goods (taxed).

Separate enterprises were set up to render the services that previously were rendered by the entrepreneur who delivered the goods (in which delivery the service was absorbed); all of this was done to avoid taxation.

The legislators responded by making a whole list of services taxable. The system became too complicated. For this reason, and others, Denmark switched to a value-added tax system (Ben J.M. Terra "�supra, note 2, p.6-7).

The above argument has its limitations. It is not necessary to separate service from goods. But they can be taxed together under an RST mechanism also, such as service of food in a hotel or restaurant.

If the service is such that it cannot be separated from goods then it can be charged to the RST as a whole, as in the case of VAT.

In general, it is wrong to say that services cannot be taxed effectively under the RST since it is small firms, which mostly cater to services purchased by consumers in the economy.

In the US, services are charged to the RST. So long as there is no constitutional bar to charging services to sales tax, it is possible to charge service tax on goods and services at the same time. If it were that small firms mostly provide services, then it would come below the threshold not only under the RST but also under the VAT.

So there is nothing to choose from this point of view. The argument against the RST on this count that the latter cannot tax service properly is not maintainable because it does not take into account the fact that it is not only in the US, but also in the provinces in Canada, the provincial RST (for example, QST in Quebec) imposes on service along with goods.

The example given above of airlines ticket is based on trying to tax goods but not services. But if both are taxed at the same rate and no exemption is given for service, the problem should not arise. That is to say if the rate is made the same for both, such problem will not arise.

(The author is a former member of the Central Board of Excise&Customs)

smukher2000@yahoo.com