Value added tax (VAT) is a consumption tax levied on the added value at each stage of production. VAT is widely used in European countries and is an important source of government revenue. The document defines VAT, describes how it is calculated using the addition, subtraction, and credit methods, and outlines the four phase process for implementing VAT. It also provides details on VAT rates and implementation in Macedonia and the European Union. In conclusion, VAT has been adopted by many countries as an effective indirect tax system.

1. University American College Skopje
Principles of Macroeconomics
Valued added tax – definition,
importance and economic effects
Mentor: Ana Dimitrovska ID#1658
Dr. Nikica Mojsoska-Blazevski
December, 2009

2. Content
Introduction……………………………………………………………………3
Value Added Tax……………………………………………………………..4
Methods of Computing a VAT………………………………………………5
VAT Implementation…………………………………………………………5
VAT in other countries………………………………………………………7
Importance of VAT…………………………………………………………..8
Economic Effects………………………………………………………….…9
Conclusion…………………………………………………………………..10
References……………………………………………………………….....11
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3. Introduction
Among the prime sources for revenue within the budget of one country is the
taxation system. The government has introduced this kind of policy in order to raise
money from the domestic businesses and customers (rather then selling goods and
services) and afterwards use them by the governmental spending. Though the taxes
are actually involuntary payments collected by the authorities, still, they give power to
the government to finance any projects in favour for the country and its citizens and
provide support and intervene whenever there is a market failure or low economic
activity.
In addition to the tax policy, the administration has initiated various taxes on
which the central and local governments rely on. Among them are the taxes on
income (personal and corporate) and the taxes on goods and services which are
used as resources for the actions of the central government. Although the taxes
should not provoke any disturbance on the market place, many businessmen and
entrepreneurs are being affected by the system of payment for any made
transactions during their process of production and distribution.
Therefore, the country’s governments choose the most suitable taxation system
that will perform well for both the government and the business climate. Since the
most affected taxes are actually the ones imposed on goods and services, the Value-
Added Tax (VAT). The VAT is being used by the European countries where the
state’s revenues are generally collected by the taxation. The purpose of this tax is to
be applied only to the added value at any made transaction of the business entity
and deliver certain benefits for the tax-payer.
The aim of this seminar work is to explain the definition of the Value-Added Tax
contains the importance and the impact on the economic effects.
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4. Value Added Tax
Value Added Tax, a consumption tax which is levied at each stage of
production based on the value added to the product at that stage. VAT is typically
levied by national governments which rely heavily on revenue from these taxes.
VAT or Value added tax was first introduced by Maurice Laure, a French
economist and the joint director of the French tax authority in 1954. The system of
VAT taxation was made effective from April 10 in 1954. Though this tax system was
first applied in France, it was soon adopted by a number of other countries. Brazil
was the first Latin American country to adopt the VAT, in 1967, and Denmark's
adoption of the VAT that same year marked the start of the tax's widespread
introduction to Europe. The VAT spread rapidly in the industrial world and South
America until the late 1970s and was adopted by the developing and transition
economies only a decade later. Remarkably, the number of African countries with a
VAT increased from 2 to 30 in the 1990s.
VAT, an indirect tax, is levied on value addition of products at every stage of
production. From raw materials to the final product, at every stage, value is added to
the goods and services. Initiated in France, today VAT is widely used as a method of
taxation in most of the European countries.
VAT rates are decided on the basis of the main rules formed by European
Union. All the member states of the European Union follow these rules for deciding
over the VAT rate to be charged at every stage of production of goods. The three
main rules for determination of VAT rate are:
1. The standard rate of VAT imposed on goods and services, on which this tax
is imposed, is a minimum of 15%.
2. Members of the European Union can apply maximum of two reduced rates of
VAT, which should not be less than 5%.
3. There is a provision for the members of the EU, where, under certain
conditions, countries may impose reduced VAT rate to certain services.
There are generally three different rates of VAT, which can be charged on goods
and services. The standard VAT rate is 17.5%. For particular goods and services,
there is a reduced rate of 5%. There are also some products, which are exempt from
VAT, for which 0% VAT rate is imposed. However, the actual VAT rates levied on
products vary from one country to other.
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5. The VAT authorities of the countries decide on the rates to be imposed on
different goods and services. The value added tax system has proven to be effective
in avoiding problems that normally might arise out of the double taxation of goods
and services.
Methods of Computing a VAT
Individual firm’s VAT uses three methods for computing. These are the
addition, the subtraction, and the credit or invoice methods. The addition and the
subtraction methods involve different approaches to computing the tax base.
The credit method calculates the tax liability itself, without requiring explicit
measure of a firm’s value added. In practice these three computational procedures
are only approximately equivalent. The addition method of computing the VAT base
is to sum the firm’s payments of wages, salaries, interest, rent, and profits. These
payments represent the firm’s contribution to the value of the economy’s output in the
period, or its “value added.” This base multiplied by the tax rate indicates the amount
owed the government in value added taxes. The subtraction method computes each
firm’s value added as sales less purchases of material inputs from other businesses.
The credit method computes the tax by applying the tax rate to sales and then
subtracting taxes paid on purchases of components. Value added taxes in European
countries are usually computed by the credit method.
VAT Implementation
VAT may be implemented by businesses using the following four
phased approached :
• Process and Impact Study
• Development of Implementation
• Implementation and execution
• Post Implementation Review
1. Phase 1 requires a detailed review of your business processes and
operations.
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6. 2. Phase 2 includes a process and impact study. At the end of Phase 2
we will prepare a VAT Implementation Report. This includes a detailed
mapping exercise to identify all relevant transactions that will be
impacted by VAT as well as identify gaps. At this stage changes to
existing processes and procedures are proposed.
3. Phase 3 involves the implementation phase where the issues
identified in Phases 1 and 2 will be blended and complemented with
the legislation to revamp all relevant business processes and
operations impacted by VAT to ensure that your company is ready for
VAT implementation.
4. Phase 4 is a post implementation phase in order to review, identify
and troubleshoot any issues or teething problems that may arise. At
this stage, you would also look at new planning opportunities to
improve your processes and cash flow management.
1Republic of Macedonia is candidate country for becoming member of the
European Union and because of that it has to implement the same tax system
as the Union has. In Macedonia the Value added tax was first introduced on the
1st of April 2000, and it is one of the countries which successfully implement
this tax system. The standard rate of VAT in Macedonia is 18% and there is
reduced tax of 5%. The reduced tax is applied on some supply and importation,
like: basic agriculture products, animal feed, mineral and chemical fertilizers,
product for plant protection, water, Electrical energy, coal, fire wood, mazut,
gas and heating, drugs (medicaments), medical materials detergents and
products for body care, publications, the first supply of residential building and
apartments, made within five years after the construction, transportation of
passengers, waste disposal and services for maintaining public sanitation,
services by solicitors, accountants and auditors. The Tax payers in Macedonia
are separated in 3 categories. The first one is contains the business entities
that make profit less than 1.300.000 denars, and they are obliged to give yearly
reports for taxation; the second category is consisted of the business entities
that make profit between 1.300.000 to 25.000.000 denars, and they give tax
report quarterly; and the third category consist of business entities that make
profit more than 25.000.000 denars and they give tax report monthly.
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7. VAT in Other Countries
VAT is known by various local names in different countries. VAT rates of the
some of the member countries of the European Union and the local names used for
this taxation system in those countries are mentioned below:
Country VAT Rate Name
Standard Reduced
Denmark 25 % none Merværdiafgift
Finland 22 % 17% or 8% Arvonlisavero
Mervardesskatt
Germany 19 % 7% Mehrwertsteuer/Umsatzsteuer
France 19.6 % 5.5% or Taxe sur la valeur ajoutee
2.1%
Ireland 21 % 13.5%, Value Added Tax (English)
4.8% or 0% Cain Bhreisluacha (Irish Gaelic)
Italy 20 % 10%, 6%, or Imposta sul Valore Aggiunto
4%
Netherlands 19 % 6% or 0% Belasting toegevoegde waarde
Portugal 20 % 12% or 5% Imposto sobre o Valor
Acrescentado
Spain 16 % 7% or 4% Impuesto sobre el valor añadido
Sweden 25 % 12% or 6% Mervardesskatt
United Kingdom 17.5 % 5% or 0% Value Added Tax
Poland 22 % 7%, 3% or Podatek od towarow i uslug
0%
Source: (Value added tax (VAT) Rates) http://www.economywatch.com/business-
and-economy/rates.html
Importance
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8. The value added tax system is designed to address various problems
associated with the conventional sales tax system. In sales tax, there is no provision
for input tax credit, which means that the end consumer may pay tax on an input that
has already been taxed previously. This is known as cascading and leads to
increases consumer tax and price levels, which increases the rate of evasion and
can be detrimental to economic growth.
The value added tax system deals with these problems quite efficiently. As
VAT is imposed on value addition - at every single stage - there is no incidence of
cascading. In this way, the final consumers bear the burden of paying value added
tax. This system involves absolute transparency at every stage of taxation, thereby
making the tax system quite comprehensible and simple.
In some countries like India, the system of VAT has been designed to change
the existing system of sales taxation. Value added tax is different from the
conventional system of sales tax, because VAT is charged at every stage of value
addition - whereas sales tax is imposed on final value of transaction only.
The value added tax system allows for input tax credit, or ITC, on the amount
of tax levied at the preceding stage of the value addition chain. The allowance for ITC
is normally appropriated from the value added tax liability imposed on the following
stage of the sale of the product.
The rapid and seemingly irresistible rise of the value-added tax (VAT) is
probably the most important tax development of the latter twentieth century, and
certainly the most breathtaking. Forty years ago, the tax was little known outside dull
treatises. Today it is a key source of government revenue in over 120 countries.
About 4 billion people, 70 percent of the world's population, now live in countries with
a VAT, and it raises about $18 trillion in tax revenue—roughly one-quarter of all
government revenue. Much of the spread of the VAT, moreover, has taken place
over the last ten years. From having been largely the preserve of more developed
economies in Europe and Latin America, it has become a pivotal component of the
tax systems of both developing and transition economies.
The VAT has been seen as a key instrument for securing macroeconomic
stability and growth by placing domestic revenue mobilization on a sounder basis, so
that the International Monetary Fund (IMF) has attached considerable importance to
its proper design and implementation.
Economic Effects
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9. Imposition of a VAT would probably cause a one-time increase in prices, and
the tax would be regressive unless explicit steps were taken to reduce its
regressively. But the tax would have relatively little effect on the allocation of
economic resources or on the competitiveness of industry in world markets, except to
the extent that it reduced the deficit and caused the dollar to weaken. After all, the
primary purpose of taxation is (or at least should be) to raise revenue, not to change
economic behaviour; certainly unintended changes in behaviour induced by taxation
are not likely to be desirable.
That the VAT does not have very interesting economic effects does not mean
that the effects of substituting it for part of the present tax system would not be
significant. If a relatively neutral VAT were substituted for part of the highly distortion
income tax system, the allocation of resources might be greatly improved. Moreover,
the VAT can be expected to be more conducive to saving than the income tax.
But, strictly speaking, most of any such effects should be attributed to reduction
of the income tax, not to imposition of the VAT. Analogous statements can be made
about using the relatively neutral VAT, rather than the income tax, to raise additional
revenue.
The refund issue has become increasingly problematic in many countries in
recent years. There is a troublesome tension between the importance of assuring
prompt refunds without which the VAT loses many of its economic merits and the
desire of governments to guard their revenues against fraud and the temptation they
face to strengthen revenues by simply delaying refund payments. Indeed. Tax policy
advice has been greatly influenced by tax administration constraints because
adoption of best practice (which is the prompt refunding of all excess credits) is
simply not possible in countries with weak administrative capacity. The lack of
effective audit mechanisms is usually the primary cause of these problems, and the
importance of developing such capacity may have been underappreciated in much of
the advice and technical assistance on the VAT. The IMF currently tends to advise
paying refunds only to exporters and, sometimes, businesses importing large
quantities of capital equipment, with streamlined procedures for those with
established, reliable records in their tax dealing, while imposing some delays and
carry-forwards of credits on other taxpayers. There have been some significant
weaknesses in the VAT's implementation in developing and transition countries:
• the lack of coordination of the direct and indirect tax administrations, which
are not yet integrated in a number of countries;
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10. • the difficulty of implementing workable self-assessment systems, under which
taxpayers declare and pay taxes on the basis of their own calculations,
subject to the possibility of later audit by the tax authorities;
• the need for effective audit programs based on risk-analysis selection
methods; and
• the need to give prompt refunds of excess credits to certain taxpayers,
particularly exporters. (Because exports are zero rated, exporters will have no
output tax liability but will be entitled to a refund of the tax paid on their
purchases.)
Conclusion
Taxes are being compulsory payments that serve as instruments of a given
government to collect resources for their objectives, realization of projects and
reforms. Since the taxation is essential for the fiscal policy of one government, the
authorities are obliged to introduce proper system that will not dismantle the business
flow and stability within the country. Their aim is to minimize the effect that the taxes
might have on the production and distribution process of goods and services and
gather funds for the yearly budget.
As a conclusion we can state that the Value- Added Tax brings greater benefits
for the governmental control and business climate within one country. Having greater
transparency and being easily estimated, since every goods are taxable, the tax
authorities have greater accountability, meanwhile, the participants of the market
receive benefits from getting reimbursement for the taxes paid on purchases for
production of the final product.
References
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11. Maurice Lauré, Taxe sur la valeur ajoutée, 1954.
Philip Hardwick, Bahaduz Khan and John Langmead, An introduction to Modern
Economics, 4th edition, Longman, New Jork, 1994.
Keen, Michael and S. Smith, The Future of Value-added Tax in the European
Union,1996.
Keen, Michael and S. Smith, International Tax and Public Finance, 2000.
The economist, March 1st-7th 1997.
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