PA 546 Constantine Hadjilambrinos

Taxes on Goods and Services

Lecture 7 October 11, 2005

PA 546 Constantine Hadjilambrinos      

Advantages

Can have a broad base—significant source of revenue Can diversify the tax base—minimizes efficiency and equity problems Can extract payments from individuals with high economic capacity regardless of current income Can be used on specific goods and services to internalize externalities Possibly enhance economic efficiency—levied on what consumers

take

from the economy rather than what they

contribute

to it.

Encourage saving and investment

PA 546 Constantine Hadjilambrinos

Types

    General : Applies to all transactions Specific (unit tax): Applies to physical units Single-stage : Applies only once in production & distribution process Direct : Apply to total consumption Cons.=Income - Savings     Selective (excise): Applies only to specific transactions Ad valorem : Applies to value of transaction Multi-stage : Applies to each stage of production & distribution process Indirect : Apply to proxy to total consumption Retail sales tax, VAT

PA 546 Constantine Hadjilambrinos

Some design issues

 Multi-stage taxes can increase price of goods by an amount that is greater than the collected tax.

Example: Sales tax rate: 10% Product markup: 20% Step Cost 1 2 Markup Price B T Tax Price A T $1,000.00 $100.00 $1,100.00

$1,100 $220.00 $1,320.00 $132.00 $1,452.00

3 $1,452 $290.40 $1,742.40 $174.24 $1,916.64

$406.24

$816.64

PA 546 Constantine Hadjilambrinos

Some design issues

 Integrated firms may be advantaged by multi stage taxes: fewer embedded tax costs  Should producer purchases be excluded from tax?

If not:  Tax will not be transparent to ultimate payers  Tax will raise cost of goods and services more than the revenue it will produce  Tax will affect different goods/services differently and will change economic behavior

PA 546 Constantine Hadjilambrinos

Solutions

 Component part rule : Producer purchases that become part of products are exempt.

 Direct-use rule : Anything used directly in production is excluded.

PA 546 Constantine Hadjilambrinos

Taxation of services

Most states only tax a few services—This can be a problem in a service economy.

 Need to make distinction between “retail” services and worker employer relationships  Need to avoid taxing services delivered almost exclusively to businesses  Social policy considerations may make it best to avoid taxing medical, legal, etc. services

PA 546 Constantine Hadjilambrinos

Commodity exemptions

Sales taxes are generally regressive—higher income groups tend to save and invest greater portions of their income.

Exempting certain commodities (food, prescription medication, sometimes clothes) purports to address this regressivity.

Higher income groups tend to spend more on food, clothes, etc, so, again, they benefit more from exemptions.

Rebates

may be better option.

PA 546 Constantine Hadjilambrinos

Use Taxes

Some jurisdictions do not levy sales tax (Andorra, Oregon, Delaware, NH, tribes). Neighboring jurisdictions can loose significant tax revenue.

Most jurisdictions (all states with sales tax) levy

use taxes

paid.

on the storage, use, or consumption of taxable property on which no tax has been Use tax is extremely difficult to enforce.

PA 546 Constantine Hadjilambrinos

Remote Vendors

Vendors are the collectors of sales tax for the state. What about purchases from out-of-state vendors?

 Purchases from a local storefront . State can compel vendor to collect tax.

  Purchases from a remote vendor with physical presence in the state. State can compel vendor to collect tax.

Purchases from a remote vendor without physical presence . State cannot compel vendor to collect tax.

PA 546 Constantine Hadjilambrinos

Value-Added Tax (VAT)

VAT taxes every incremental increase in value in each step of the production-distribution process.

At each step, each business pays tax on its sales, but subtracts tax it paid to its vendors.

VAT exemptions—Relieve seller from collecting VAT on sales, but not from paying VAT on purchases. Businesses, if exempt, cannot recover VAT paid.

PA 546 Constantine Hadjilambrinos

Advantages of VAT

 Combats tax evasion & lack of vendor cooperation in sales tax collection.

 Collects tax from products imported, removes it from products exported.

 VAT provides more complete exclusion of business purchases than retail sales tax.