Indirect taxes are probably the oldest way that governments have of raising revenue. At the earliest stages of their development, indirect taxes focused on the essentials of life (grain, salt, wool) and it was only with the rise of the money economy that they developed into their modern form.
By the beginning of the 20th century, the pattern had become pretty constant across the world. Customs duties were an important source of revenue, while excise duties focused on taxing home production of specific goods. These varied from country to country, although alcohol and tobacco were always likely to be taxed. In addition, there were some very specific taxes on services, such as hotels.
Over the course of the 20th century, this situation changed considerably, leading to the present-day situation in which indirect taxation is all embracing and all intrusive. Four factors have led to this change.
The first is the ever-increasing pressure for governments around the world to raise revenue. New and imaginative taxes have been developed, but the old favourites are still necessary. Whilst this process began in advanced capitalist economies, it has become a global phenomenon, with all governments exploiting their tax systems as hard as they can.
The second feature is the change in the nature of customs duties. Increasingly, they are seen as instruments of trade control and facilitation, rather than revenue raisers in their own right. Global and regional trade and preference agreements have successively reduced their rates and limited their scope. As a result, many businesses no longer see customs duties as applicable. This can be a mistake as, where they do still apply, they constitute a significant cost.
Then, there was the invention of value-added tax (VAT). Whatever it is called locally, this multi-stage credit/invoice system is the key to giving governments access to the maximum revenue from consumer expenditure. Because in theory VAT does not impact on businesses, governments can levy quite high rates of tax (up to 25%) without putting all the responsibility for payment on one intermediary in the distribution chain. A great idea for government, but not so good for business. For the first time, all businesses – whether they supply goods or services, other businesses or final consumers – find themselves in the tax net.
Finally, the advent and development of the computer has made possible what has never been available to governments before – an all-embracing tax on transactions that can be operated even in a high volume business without exceptional cost to the business. It is difficult to believe that, without computers, VAT could have spread globally in the way that it has. It is, without doubt, the late 20th century's most popular tax.
Inevitably, VAT has its defects. It claims to be an international tax, operated nationally. It does this, in theory, by removing tax from exports of both goods and services and imposing tax on imports. A variety of mechanisms are used to achieve these objectives and they are not perfect. As a result, tax is imposed when, in theory, it should not be.
However, the real problem with this approach is the lack of international collaboration. Because countries adopt different mechanisms, there are possibilities for double taxation, or none at all. Even within the EU, where the rules are the most harmonized, there is no absolute standard. When non-VAT countries look at this system, however, they see a very different picture. If their indirect taxes are not fully rebated on exports, but the goods they are importing from VAT countries are rebated, they see an inequality. This seems a particular problem for the US.
The second major perceived problem of VAT as it exists in practice, as opposed to theory, is the real cost to business. Not only do businesses bear the not inconsiderable costs of being unpaid tax collectors – that is in the nature of indirect taxation – they also suffer a real burden of VAT. This hidden tax varies from industry to industry, and is most prevalent in the financial sector. Hidden tax is much more widespread than that, however, and is totally contrary to the way in which VAT ought to work.
There have been many proposals to solve both these problems. As our chapter on the taxation of financial services shows, there can be ways forward, but they do not attract universal support. Too many countries take the view that hidden tax is an unfortunate fact of life and a nice source of additional revenue.
Strangely enough, the burden of running the tax may be eased by one other concern of the tax authorities – fraud. VAT, because it is collected in instalments, is supposed to be less open to fraud than single stage taxes. In theory. However in practice, certain opportunities have been developed. One way to limit the opportunities is to limit the number of people able to recover input tax. This has led to a number of proposals to short circuit the normal VAT structure by creating VAT-free "rings". These would be groups of taxpayers who would not charge VAT to each other, thus reducing the compliance burden and limiting the opportunities for fraud.
Whatever happens to these proposals, the short- to medium-term picture is that VAT will stay much as it is in western Europe. In the rest of the world, it will be progressively adopted in more and more countries, albeit with restrictions and variations. Some countries may follow the example of more adventurous states such as New Zealand, in departing from the EU norm whilst following the theoretical VAT pattern. If the tax is ever adopted by the US, this may be the line taken there.
In the meantime, businesses need to operate VAT around the world. The remaining chapters of this supplement are devoted to helping with this process, and to reminding global businesses of the need to cope with customs duties.
The format of the supplement is not a comprehensive survey. It is rather a series of in-depth looks at specific key subject areas.
All multinational businesses need to be aware of the impact of indirect tax on cross-border transactions, especially when they are expanding or reorganizing themselves. More than this, however, they need to be able to handle indirect taxation within each country, appreciate the special features that apply in each jurisdiction and be aware of the particular problems experienced by their industry.
The first few chapters deal with the impacts of cross-border transactions; the next with specific industries and the final group with issues that will concern any business operating in any country.
These are the issues of the future as well as – very much – the present.
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