Is the VAT being set-up to fail?

April 29, 2010

A wise economist friend of mine asked me the same question as is the title of this article. I must confess I had not thought of that. Some days ago I was berated for saying that the value added tax (VAT) if properly structured with some exemptions – to protect the low-income groups – and a threshold, below which there is no VAT, could be a good tax. I stand by my words.

I am not a fiscal economist so my sense of the VAT is more of a gut-feeling. True it is a demanding tax. It needs time to prepare and educate economic agents because not many understand what ‘value-added’ means. It needs documentation, something we are excellent in avoiding or shrug aside by saying we can never have because we are a poor, illiterate country which cannot read or write. However, to sell my government-allotted plot of land was a nightmare of documentation.

I made four visits to the cutchery where I was required to produce every manner of documentation imaginable and sign five registers. I was photographed by a computer video camera and finger-printed in the office of the housing society and my record of allotment was updated online. For my foreign exchange transaction I was given a proper receipt with the company’s name, exchange rate and time and value of transaction on it. The bank-to-bank remittance of foreign exchange to my account here in the US was done after providing the appropriate documentation and giving the bank manager in Pakistan my US tax payer identification number.

My point in recounting this is to say that I have never seen so much documentation in the economy before. The refrain that we are not a documented economy is self-serving. It is exactly the refrain the fat cats of business and industry, trade and services, the land mafia and the high-rollers on the stock market want us to believe. They keep not one but three sets of books. There is no VAT below a given threshold. Neither the big, bad wolf – the IMF – nor the government is interested in taxing every khoka down the street.

They are exempt from the VAT because they fall below the threshold. We want the big guys. Furthermore, the VAT is going to replace the present general sales tax (GST). Unfortunately the GST system has already been corrupted by the phenomenon of ‘fake and flying invoices.’ It is no surprise that the rich and powerful in Pakistan are connected in one way or the other to this immensely lucrative business of fake and flying invoices. Their fear is that the VAT may tighten up the present GST system into a seamless chain of value-addition.

Most importantly, if the VAT is implemented correctly, there should be no price-push inflation. Yet it would not surprise me if on the first day of the VAT every business pushes up its price by the amount of the basic VAT rate even if they are exempt or below the threshold. This is not an additional tax; the VAT will replace the GST. I hope I am wrong in thinking we are setting up the VAT to fail. That would be a setback considering we have been playing ducks and drakes with the IMF on the VAT for the past 15 years.

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