When the Minister of Finance announced in his Budget Speech in March 2003, that the government intends to introduce the Value Added Tax (VAT) by 2006, very few understood the concept while most concluded that this meant more taxation. However, very little has been done to explain to the public what this new concept means and how it will affect their economic well-being in the future. Limited understanding of policies, especially new policies, has led to policy failure in developing countries. This article simply tries to explain or simplify for the public this new concept called VAT and analyze the merits and demerits of the introduction of such a tax.

Most people will agree that our present tax system in Guyana is narrow, inequitable and subject to massive evasion. The tax base is narrow because services are not fully incorporated into the tax regime. More so, the present liberalisation of trade regimes under IMF and WTO conditionalities along with regional integration commitments that essentially reduce tariffs will lessen potential revenue. In this regard, a new tax structure has to be designed to ensure the economy’s revenue base remains strong. This new regime is the (VAT). So far, more than 120 countries around the world have already implemented the VAT and another 15 to 20 are contemplating its implementation.

Simply defined, VAT is a tax levied on all sales of commodities at every stage of production. A notable feature is that it credits taxes paid by firms on their input against taxes they levy on their sales. Because the VAT credit taxes paid on input, it does not distort production decisions by creating `cascading’, i.e. further tax on taxes, which occur when a tax is charged both on an input and output of the same production process. The VAT is based on the net value of the final sale of a product or simply a tax on final consumption.

A simple example of how the VAT is calculated follows. Let us assume that there is a uniform 10% VAT. Company A sells raw materials at a cost of $100 to Company B. Company B produces a product costing $400 using the raw material it purchased from Company A. With the 10% VAT, Company A will charge Company B $110 for its raw material, remitting $10 to the customs as taxes. When the final product is sold by Company B for $440 to the consumer, the residual $30 taxes will be paid, thereby remitting a total of $40 in taxes to the government. Under the VAT system there is no incentive for Company A not to remit the $10 taxes on its sale. Even if Company B tries to evade the taxes, with a good audit system in place tax evaders can be easily caught.

There are three main reasons why the VAT has risen in popularity since its introduction. Firstly, it broadens the tax base in an effort to increase revenue, secondly, it is less distortionary and thirdly, it is a more efficient system. Experiences have shown that most countries which have introduced the VAT, are able to create a more reliable revenue base. The VAT provides the best tools to tax services that have been a buoyant source of economic activity in many countries that go untaxed. Moreover, because the tax base could be broadened to include services the revenue base will be stronger. The authorities will therefore have more flexibility in reducing the high tax rates on goods that are at present bearing the brunt of the taxes. The VAT has in many cases replaced inefficient, distortionary and poorly administered taxes. It has also contributed to the reduction of the number of tax rates in the regime.

The present consumption tax regime that operates in Guyana is very distortionary. It discriminates against the consumption of goods in favour of services. It is also a factor that undermines economic growth. Notwithstanding the fact that there is need to beef up the capacity of the Revenue Authority the present consumption tax system is easily subject to abuse. The options available for a reform of the present tax system are:

1. a wholesale level sales tax

2. a retail sales tax

3. the VAT

Of these three, the latter option, the VAT, seems the most viable option in Guyana.

A properly administered VAT has great advantages for Guyana, being a small and open economy. A well-designed VAT will be more equitable; taxing goods and services, equally thereby broadening the tax base. This has the advantage of permitting a lower tax rate to raise revenue via a system of equitable burden sharing. The VAT will contribute to growth of the productive sector since inputs and capital overheads will not suffer from the present cascading tax system.

The main disadvantage in introducing a VAT in Guyana will be the extra administrative burden with the introduction of the invoicing mechanism, and the need to claim credit for taxes paid on inputs designed for exports can be subject to fraud. The only mitigating factor to offset such disadvantage is a strong, vibrant and effective Guyana Revenue Authority.

Finally, let me be blunt about one thing. Even though the VAT has had major success stories in a number of countries, it is not the panacea for the numerous ills facing tax collection and administration in developing countries, including Guyana. Experience has shown that starting up a VAT has had major hiccups and operational problems but the reality is very few things were born perfect. Only through a process of constant reform and learning by the use of best practices can implementation hurdles be overcome. Guyana with a VAT should be able to design to tax system that is effective, equitable and fair. History has shown that a state that can administer the collections and spending of taxes efficiently also produces quality social and public goods that every citizen yearns for.