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Business e-Bulletin

Vol. 1, Issue 1, 55-64

GOODS AND SERVICES TAX, PROBLEMS AND


EFFECTS OF IMPLEMENTATION
ABOOD MOHAMMAD SALMEEN ALEBEL

INTRODUCTION

In taxation, taxpayers are taxed in two forms: whether through direct taxes
such as income tax and road tax or through indirect taxes such as the sales
tax and the services tax. For direct taxes, taxpayers will definitely realize
that they are facing the tax burden since taxpayers are required to declare
their income and to pay tax accordingly to the government. However, for
indirect taxes, taxpayers usually don’t realize that they are being taxed since
the amount of tax is already accounted for with the selling price.
Goods and services tax (GST) is one type of indirect taxes. GST is also
known as value added tax (VAT) (Behan & Jenkins, 2005). Although GST and
VAT have different names, they represent the same system where the cost of
tax is actually borne by the end user. However, each step in the supply chain
will collect the tax and will be remitted to the government. The supply chain
can also claim back the GST included in the products they buy. According to
Singh (2007), it is well documented that a GST can be an effective form of
indirect tax. Currently, many countries such as the United Kingdom, New
Zealand, Australia and Singapore have already implemented the GST.
The VAT has been adopted as part of a package of trade liberalization,
compensating for the revenue loss from the reduction of tariffs whilst
preserving the gains in production efficiency from moving producer prices
closer to world prices. At a more general level—and especially in developing
countries—adoption of the VAT is often seen as the central element in a
program of modernizing tax administration, developing the use of methods of
self-assessment whose generalization is expected ultimately to ease
administration and compliance in relation to other taxes too (Keen &
Lockwood, 2007).
However, there are many issues and questions raised on indirect tax
reform in developing countries that favor a reduction in trade taxes with an
increase in VAT to raise revenue. Specifically the issue of whether the VAT
now in place in some developing countries is always the best way to respond
to the revenue problems arising from trade liberalization. Emran and Stiglitz
(2005) implied that substituting VAT for broader taxes is likely to reduce
rather than improve social welfare because developing countries have large
informal sectors. They argued also that the key problem with the literature
supporting the use of VAT in developing countries is that it neglects that
these countries have large informal sectors.
The purpose of this paper is to examine the factors or the problems
which delay the implementation of GST and the effects of implementing VAT
on the revenue, trade and equity. According to Singh (2007), various matters

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need to be considered carefully before a comprehensive GST system can be


introduced. The discussion is divided into problems related to taxpayers and
problems related to administrator/government. Next, this paper discusses
the effects of implementing GST on the revenue and trade and equity, and
the final part of the paper concludes the discussion.

PROBLEMS IN IMPLEMENTING GST

This section discusses several problems or factors that might retard the
development of the GST system which should be taken into account by the
government before GST become into the force as problems can occur on both
sides of taxpayers and administrators.

PROBLEMS RELATED TO ADMINISTRATORS

Computerization and trained personnel

Implementation and enforcement of GST will need administrators to have an


efficient computerization system which could carry out the task of checking
and auditing the revenues from GST. James and Zheshi (2004) proposed
three things to enhance the management and supervision of the VAT
invoices. Firstly, the printing of the VAT invoices must be further upgraded. It
must have the ability of anti-counterfeit. Secondly, the management of the
VAT invoices must be based on computers, and then a network, especially for
the administration of the VAT invoices and tax collection, must be formed all
over the country. Finally, tax collectors must more strictly verify the VAT
invoices with large amount. In all, the management and supervision of the
VAT invoices must have the instant information processing capability.
Apart from this, the administrators should also be ready with well
trained personnel to operate the computerization system. The personnel
should also be knowledgeable about the GST since in the initial period, the
public which does not very familiar with the new tax system will need extra
guidance from the administrators.
From the discussion above the implementation of GST needs advance
preparation, adequate investment in tax administration because the
management of the GST must have efficient computerization system. This
requires that the government spend money to buy computers and also train
the staff that will operate this computerization system in addition to provide
an extensive public education program .These considerations should be taken
into account before the GST become effective lest there will be a serious
delay in the implementation of this system .

Rate of tax and exemption

The government should carefully choose the most suitable tax rate so that
the tax will not burden the poor. Considerations should be made on whether
the GST to be levied at a single rate, or a higher rate to certain products
which is considered luxury products

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However the government will face some problems when it takes into
account these considerations. For example, if the government takes into
account the poorest in the country and offers lower tax rate on necessities
this will benefit the rich more because they will spend relatively less of their
income and receive more benefits from these concessions. But if the
government imposes high rate in luxury goods, taxpayers may seek to lower
their tax liability through both legal and illegal means. Edmiston and Bird
(2004) argue that imposition of high tax rates on sales of ‘luxury’ goods are
an ineffective means of increasing progressive fiscal system and any minute
‘benefit’ attained in this fashion is unlikely to suffice to offset the costs in
terms of reduced efficiency and effectiveness of the tax. Furthermore, the
government will also have to consider products that should be exempted
from GST. Usually necessity products such as food should be exempted from
tax. Kenny (2000) examined whether food should be exempted from GST.
They found that there is a strong support for GST food exemption.
However implementing the GST on a broader base will reduce the
administrative cost and increase the revenue. The broader the base the
better it is for two reasons. First, with a broader base, the rate required for
any revenue is obviously lower, which means that the efficiency cost of
raising revenue is correspondingly lower. Second, administration is simpler
with a broader base, in part simply because there are fewer avenues of
escape and in part because a larger proportion of all activities are
encompassed in the tax net to (Edmiston & Bird, 2004)
From this discussion it can be understood that the choice between a
single-rate and a multiple-rate VAT depends on balancing tax administration
considerations: If the government uses differentiated rates by lowering the
tax rate on necessities and imposing high rate in luxury goods this may
increase the administration cost and will lead to reduced revenue. However,
if the government uses a single rate on broader base this will reduce the
administration costs and will increase the revenue but a single rate will affect
the poorest in the country .So the government should choose the most
suitable tax rate so that the burden of tax will not be too aggressive to the
poor and should not lead to reduced revenue. Choose the most suitable tax
rate and determine the goods that should exempt are not easy for
government and may take long time.

Impact on general price level

In the early stage of GST implementation, the fact that the price level will be
increased cannot be denied. Since the public is still in the transitional
process, traders will go for option in pulling up the price. However, according
to Singh (2007), the introduction of GST may bring about a one-time
increase in the cost of living, the probability of it leading to inflation is not
high. GST may lead to increase in consumer price at the early stage of
implementation, but GST will not have a huge effect on inflation
James and Zheshi (2004) maintain that when the VAT was introduced
in China in 1994, it did not cause any inflation. Compared with the taxation
reform of 1994, the proposed transformation of the VAT is far less complex.

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Valadkhani (2005) conducted study to examine the size and duration of the
goods and services tax (GST) effect on the quarterly growth rate of the 11
groups of the consumer price index (CPI) in Australia using the Box and Tiao
intervention analysis. It was found that prices did not increase significantly
before or after the introduction of GST. Furthermore, the varying one-off
effect of GST on prices was significant in seven out of 11 CPI groups; the
effect was found insignificant for the other four CPI groups.
Based on the above discussion, it is clear that the imposition of GST by
itself cannot be considered inflationary or deflationary even if sellers able to
raise price to cover what they pay since this would constitute one time
increase in their prices but would not necessarily lead to inflation which is
continuous increase in the average of price over the time.

PROBLEMS RELATED TO TAXPAYERS

Accounting records

Most small businesses do not have a proper system to keep accounting


records. But the implementation of GST will need businesses to keep their
accounting records accordingly. This is because proper documentation and
accounting records will influence in determining the exemption threshold of
the businesses. Proper documentation and accounting records will also be
useful when the government wants to perform audit and investigation.
Patterson (1990) indicates that despite the simplification of the goods and
services tax announced by the government, there are no easy solutions for
small businesses. For example, under the Singapore GST law, every GST-
registered trader has to keep the following accounting records and source
documents for at least 5 years:

(a) Business and accounting records e.g. sales book, purchase book,
cashbook and GST account;
(b) Copies of tax invoices and receipts issued for sales;
(c) Suppliers’ tax invoices and import permits;
(d) Export documents e.g. bill of lading, air waybill, note of shipment or
subsidiary export certificate;
(e) Credit and debit notes; and
(f) Payment evidence e.g. bank statement and remittance advice.

These documents will lead to increase compliance costs of GST for (small
firms) which are likely to be much higher as they tend to be relatively less
educated or illiterate. The fact that it is difficult for small firms to keep
appropriate records also implies that they are at a disadvantage in the
bargaining process with tax inspectors.

Education

According to Singh (2007), it is essential that the general public, in particular


businesses and traders are adequately informed about the features of the

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GST and the procedural requirements before the GST legislation comes into
force. This is necessary to avoid unwarranted increases in price of goods and
services. Knowledge about GST should be spread to public especially to the
businesses parties. This is to avoid any discrepancies in implementing the
system and also to avoid the traders from pulling up the sales price which
will definitely become a burden to the end consumers .This requires a
comprehensive education campaign. The campaign should involve a wide
range of stakeholders and distribution of different types of informational
materials throughout country and also should be extended to low-volume
traders and consumers
From the discussion above there are two important things that
taxpayers should have for implementing the GST which are accounting
records and knowledge about the features of the GST and the procedural
requirements before the GST legislation comes into force. Without these,
there is bound to be a delay in the implementation of GST because it is
important that knowledge about the features of the GST be spread to the
public time before the tax becomes effective.

THE EFFECTS OF IMPLEMENTING VAT ON THE REVENUE


AND TRADE AND EQUITY

This section discusses some serious criticisms that have recently been
leveled against VAT in DTE with respect to its effects on trade, revenue, and
equity.

VAT AND REVENUE

The potential revenue which can be raised from the VAT depends on a
number of factors, such as how broad the tax base will be and the extent to
which businesses will comply with the tax. Jenkins and Kuo (2000) conducted
a study in which the main purpose is to provide an analytical framework that
can be used to estimate the potential tax base and associated revenues for a
VAT in a typical developing country which, at present, has an indirect tax
system containing sales, excise taxes, and tariffs. In their study, it is
assumed that the VAT will replace the sales taxes and allow for a
rationalization of the excise and tariff systems. These procedures are applied
to the economy of Nepal. It was found that because the share of the formal
economy is relatively small in a developing country; the potential tax base
for a VAT is rather narrow .Hence, if a government of a developing country
wants to rely more on the VAT over time, it must move aggressively to
broaden the base and enhance compliance.
Some other studies have also conducted on the implications for VAT of
the considerably larger underground or shadow economies found in DTE as
compared to developed countries. These studies suggest that in the presence
of a substantial ‘informal’ sector, a tax like VAT that falls on the formal sector
acts to deter the growth and development of the economy as a whole .From
these studies, Erman and Stiglitz (2005) argue that substituting VAT for
border taxes is likely to reduce rather than improve social welfare because

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developing countries have large informal sectors. They also argue that the
key problem with the literature supporting the use of VAT in developing
countries is that it neglects that these countries have large informal sectors.
From this statement, it is noticed that substituting VAT for border
taxes in developing countries will reduce the growth and development as a
result of large informal sectors in these countries that lead to very narrow
VAT tax base. This is because informal sectors are able to escape
commodity tax coverage (large number of goods or serves are exempt or
zero rate) that will lead to reduced rather than improved social welfare.
In addition, Munk (2004) asserts that the least developed countries
may not benefit from the introduction of domestic taxes as the administrative
costs may outweigh the allocation benefit and unlikely to be in the interest of
developing and transition countries to give up the use of border taxes
entirely. In short his analysis suggests that it will in general not be desirable
for developing countries with a large informal sector to adopt free trade.
From this it can be concluded that implementing VAT reduces the revenue
and effect the social welfare as result of high administrative costs which
outweigh benefit from implementing VAT in developing countries.
Furthermore, if a VAT can be administered adequately, the implementation of
it offers the best way for a country to make up revenue losses from trade
liberalization as result to reduce administration cost.
Emran and Stiglitz (2007) suggest that the emphasis on value-added
tax (VAT) as the main instrument for indirect taxation is likely to result in
inefficiency in resource allocation due to production and consumption
substitutions in favor of the informal/shadow economy. They also argue that
the imposition of VAT may also retard the development of markets, especially
in the rural areas. Also these tax reform policies implemented in a large
number of developing countries are also likely to be undesirable in terms of
equity. However Keen and Ligthart (2002) have provided academic support
for the IMF and World Bank recommendations for developing countries to use
VAT rather than border taxes to raise government revenue by showing that
for a small economy a cut in import duties (respectively, export taxes)
combined with a point-for-point increase in domestic consumption taxes
(production taxes) increases both welfare and public revenue.
To sum up the discussion above has argued that in order to make up
the losses from substituting VAT for border taxes and increase the welfare
governments should consider two things: Firstly, in order to increase the
revenue from implementing VAT the government must move aggressively to
broaden the base. But this is not easy especially for countries that have large
informal sectors like agriculture sector and goods that are exempt from this
system. Secondly, the government should reduce the collection costs. If the
collection cost is high the benefit offered from a VAT will be reduced.
Reversal in implementing VAT on the narrow base (the tax base for a VAT is
rather narrow) and weak tax administration leads to increased collection
costs will and this will reduce the revenue and affect the social welfare.

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VAT AND TRADE

The most important rationale for the original adoption of VAT in Europe was
to facilitate trade within the then-new European Community by turning sales
taxes into true destination-based consumption taxes both by ‘unsexing’
exports (and removing hidden subsidies) and by placing the taxation of
imports and domestic production on the famous level playing field (Bird,
2005). However, some studies conducted to examine effect of implementing
VAT on the international trade found the VAT discouraged international trade
and exports rather than facilitating trade between countries especially when
a number of elements of the VAT were actually imposed for example the
imposition of high effective rates on imports, delay rebates for exports or
difficulty in obtaining it. Edmiston and Fox (2004) argued that the VAT has
often been viewed as export friendly because of the border adjustments that
impose the tax on imports and rebate it on exports. This view is derived from
a theoretical perspective of tax. In fact, a number of elements of the VAT
actually imposed have a strong potential to discourage international trade
and exports, and effectively cause the VAT to operate as a tariff on both
imports and exports (though at different rates).
Desai and Hines (2002) examined the relationship between the
reliance on VAT (VAT revenue as a percent of total government revenue) and
the size of exports and imports. They conclude not only that countries relying
on VAT have fewer exports and imports (relative to GDP) than countries that
do not but that the negative correlation between VAT and trade (the sum of
exports and imports) is stronger for low income countries. In short they
conclude that the VAT may deter rather than facilitate trade.
From review of previous studies, imposing VAT on imports and
imposing zero rates on exports will facilitate trade since exporters will receive
rebates equal to the amount of VAT paid in the course of producing the
exported item. This of course will reduce the cost of exports and encourage
foreign importers to buy these goods and increase foreign currency in
country which can use it to import raw material or goods that it needs. In
other words it is clear that the implementation of VAT gives the country
competitive advantage but this will happen when exporters receive rebates
equal to the amount of VAT paid in the course of producing the exported item
quickly without delay because delayed refund will lead to increased
opportunity cost and may make tax rate on exports much greater than zero
since the tax on inputs used in the production of exports is included until
rebates. This will affect the trade and may deter the trade especially if
rebates for exports are difficult to obtain because this will lead to increased
price of exports.

VAT AND EQUITY

In general, equity issues may be approached at two different levels. First,


one may consider the details of exactly how different taxes impose burdens
on taxpayers who are in the same and different economic circumstances.

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Secondly, one may instead focus on the overall effects of taxation on the
income and level of well-being of different people (Bird, 2005).
An important aspect of tax policy reform introduced in developing
countries is its emphasis on broadening the VAT base which is based on the
general presumption that a broader base will be more efficient. However
according to Chan, Gosh, and Whalley (1999), who have conducted a study
to analyze tax reform options for Vietnam through using a general
equilibrium model of Vietnam, calibrated to 1995 data. The study focused on
aggregate welfare impacts as well as welfare of household groups ranked by
income. The main focus was on indirect tax reform (VAT. They found the VAT
base broadening is likely to be very regressive as previously untaxed goods
are brought into the tax net which are consumed more by the poorest
segment of the population. Their estimates for Vietnam show that such a
base broadening with a uniform VAT hurts the bottom two quintiles of
households (income loss 1 percent), while the top three quintiles gain half a
percent of their income.
Moreover, the point that deserves mention with respect to VAT and
equity in DTE is the importance of the shadow economy. Many DTE have a
large economic sector that is effectively not subject to direct taxation. This
reality clearly should affect how one assesses the effects of different fiscal
instruments on equity. Emran and Stiglitz (2007) argued the dramatic shift in
favor of VAT as the main instrument for revenue rising in developing
countries which have a large informal sector is misguided both on efficiency
and equity grounds.
It is clear from literatures above that the emphasis on broadening the
VAT base will reduce the administration cost which also disregards the
differences in expenditure pattern and differences between high level and
lower income in a country. This is because it will affect the poorest in the
country since untaxed goods are brought into the tax net which are
consumed more by the poorest segment of the population. However using
different rates a as result of informal sectors that escape commodity tax
coverage (large number of goods or serves are exempt or zero rate) and
imposing high rate on formal sector will be misleading on both efficiency and
equity grounds especially if the informal sector producers produce a close
substitute of the formal VAT-liable commodity, which will lead consumer
expenditure to be reallocated to the informal sector products, thereby
increasing the demand for it and getting a higher price for their product that
exceeds the formal sector producer price by exactly the amount of VAT. In
other words, so the producers that produce a close substitute of the formal
VAT-liable commodity will get high profit without bearing tax while formal
sector producer may get lower profit and bearing tax. So achieving equity is
difficult through the implementation of VAT in a country that has informal
sector.

CONCLUSION

GST or VAT is not a new tax system. Most countries in the world have
already adopted this taxing system. However, in implementing GST, the

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government should take into consideration several problems or factors that


might retard the development of the GST system. Problems can occur on
both sides of taxpayers and administrators. Therefore, a properly planned
GST system should be looked upon before the system is introduced. For
example, the public should be properly educated with general knowledge on
GST system, since the end consumers will bear the burden of the cost of tax.
The business entities should be briefed on the administrative side since
remittance of revenues to the government will be done by the supply chain.
The business entities should also be encouraged to update their accounting
records to facilitate audit and investigation process. On the government side,
well trained personnel should be provided in assisting the public. The
government should also need to determine the right GST rate so that the
welfare of the lower income citizen will not be so much affected. Decisions
should also be made on the products which are exempted from tax.
Overall, the GST system is considered to be effective since it can
increase the total revenue of the government. However, the implementation
will need a well planned system since without it; a comprehensive GST
system will not be achieved. But the potential revenue which can be raised
from the VAT depends on a number of factors, such as how broad the tax
base will be and the extent to which businesses will comply with the tax .So
to increase the revenue from implementing VAT the government must move
aggressively to broaden the base but this is not easy especially for countries
that have large informal sector like agriculture sector and some goods that
are exempt from this system. In essence, achieving equity is difficult from
implementing VAT in a country that has informal sector since it affects the
poorest portion of its population.
The effect of value-added taxes (VATs) on international trade depends
on two features of VAT implementation, that is whether there are high
effective rates on imports, and whether rebates for exports are delayed or
difficult to obtain.

BIBLIOGRAPHIES

Bird, R. M. (2005). Value-added taxes in developing and transitional


countries: Lessons and questions (ITP Paper No. 0505). International
Tax Program, Joseph L. Rodman School of Management, University of
Toronto. Retrieved from:
http://www.rotman.utoronto.ca/iib/ITP0505.pdf
Behan, A., & Jenkins, P. (2005). The high costs of controlling GST and VAT
evasion. Canadian Tax Journal, 53(3), 720-763.
Chan, G., & Whalley, J. (1999). Evaluating tax reform in Vietnam using
general equilibrium methods (Working Paper No. 9906). Centre for
System and Management Research of Information Technology, Hanoi,
Vietnam.
Desai, M. A., & Hines, J. R. Jr. (2002). Value-added taxes and international
trade: The evidence (Working Paper, November 23). University of
Michigan.

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Edmiston, D & Bird, R (2004). Taxing consumption in Jamaica: GCT & SCT.
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104-114.

ABOOD MOHAMMAD SALMEEN ALEBEL


Master of Science (International Accounting)
College of Business
Universiti Utara Malaysia
06010 Sintok, Kedah
email: aboodmo@yahoo.com

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