FRUM FISCAL dos ESTADOS BRASILEIROS 3er INTERNATIONAL SEMINAR

1
FÓRUM FISCAL dos ESTADOS BRASILEIROS3er
INTERNATIONAL SEMINAR

• THEME 1
• Fiscal Harmonization and Subnational Taxation
  State/Provincial Value Added Tax versus the
  State/Provincial Retail Sales Tax
• Dr. Horacio L. P. Piffano
• (Universidad Nacional de La Plata, Argentina)

(piffano_at_fibertel.com.ar) March, 2006
2
Introduction

• My presentation deals with

- Dual Sales Taxation (National
Provincial) in a Federal Country -
Subnational VAT versus Provincial Retail Sales
Tax in Federal Sales Tax Coordination

• References

Bird (2005) McLure, Jr., (2005) Piffano (1999,
2003, 2005)
Cnosen (1987, 2002) McLure, Jr. (1997, 1999)
Zodrow and Mieszkowski (2002)
Bird (1994, 1999 ) Bird. and Gendron (1998)
Bird. and Gendron (2001) Keen and Smith (1996)
McLure, Jr. (2000) Mintz, Wilson, and Gendron
(1994) Piffano (1999, 2003) Varsano (1995, 1999)
3
The Ideal Sales Taxation System

• 1) A single tax rate

2) Sales to businesses should be exempt
3) Sales should be taxed under the destination
principle
4) The previous three objectives should be met
at reasonable cost of compliance and
administration
5) Each level of government should have the
power and responsibility to set its own
tax rate
4
Some explanations about theIdeal Sales Taxation
System

• On the single or uniform tax rate and the
  Ramsey / Corlette
• and Hague rules. The new contributions on
  optimal taxation
• from the positive public choice point of
  view policy, tax
• administration and rent seeking lobbies (tax
  expenditure).

• On the principle of not taxing intermediate
  consumption
• imperfect markets contributions of Myles
  (1989, 1996)
• and Colangelo and Galmarini (2001).

• The subnational power to set the tax rate
  Laffer curve and
• vertical externalities concurrent tax power
  in federal
• countries conditional sovereignty. Vertical
  tax competition
• and horizontal tax competition

5
Consequences of the characteristics of anIdeal
Sales Taxation System

• From characteristics 1) and 5) follows the need
  to adopt a common or uniform tax base
  legislation. Distortions on relative prices would
  be avoided.

• Destination principle requires not to tax
  intermediate
• consumption, since though exports are free of
  tax, taxes on
• intermediate consumptions could not be rebated.

• To allow exemptions to businesses is not an
  administrative
• difficulty but the aim to improve tax revenue.
  How to avoid
• fraud in intermediate and final sales?

6
The optional solutions

• Concurrence (or dual) and coordination in federal
  (national and provincial) sales taxation and two
  possible solutions.

Subnational VAT or Provincial RST?
7
Subnational VAT Taxonomy

• ORIGIN VAT

DESTINATION VAT
Destination Deferred Payment VAT (EU)
Pure Origin VAT
Prepaid VAT (Poddar)
Modified Origin VAT (EU Commission)
Viable Integrated VAT , (Keen and Smith)
Restricted Origin VAT (EU Commission)
Canadian Dual VAT (Bird and Gendron)
Partilhado VAT (Barquinho) (Varsano)
Hybrid Origin-Destination VAT (ICMS)
Compensated VAT (McLURE)
8
Problems with Subnational VAT

• Pure Origin VAT
• Intermediate consumption is taxed so it generates
  distortion in relative prices
• Tax burden depends on the geographic localization
  of vendors (incentive to tax wars in states
  aiming to persuade investors)
• Border rebate is not possible. Exports are taxed
  and imports are exempt (anti export bias or pro
  import bias)

• Modified Origin VAT
• A costly clearinghouse mechanism is necessary
• Incentive to fraud in origin of inputs and
  transfer payments among
• firm belonging to the same economic group

9
Problems with Subnational VAT
Restricted Origin VAT - Tax
rate uniformity destroys the basic characteristic
of the Ideal Sales Taxation System - It
requires an interstate exchange information
system to avoid fraud in tax credits and a
clearinghouse mechanism
Hybrid Origin-Destination VAT - It has
both types of difficulties (Origin and
Destination) making possible tax war
scenarios though the regulation of tax rate
uniformity set by the Central Government in
interstates sales, so destroys the
basic characteristic of the Ideal Sales Taxation
System - Allows invoice sightseeing
frauds due to tax rate differentials
among states
10
Problems with Subnational VAT

• Destination Deferred Payment VAT
• Incentive to fraud in sales destination
  (invoice sightseeing)
• Commercial wars due to tax rate differentials
  among states

• Prepaid VAT
• Exports among states are made under a prepaid
  mechanism in destination. This means a financial
  benefit to subnational governments in comparison
  with the Destination Deferred Payment VAT, but
  incentive to fraud in destination is not
  eliminated.
• Any merchant can buy a certificate in the state
  with lower tax rate.

11
Problems with Subnational VAT

• VIVAT
• - VIVAT tries to solve the problem of fraud in
  destination (in the
• geographical or territorial sense), but it
  doesn't solve the problem of
• possible fraud among final purchasers (or
  non-registered merchants)
• and to intermediate purchasers (or
  registered merchants), both type
• of economic agents naturally having
  certain geographical location.
• - As Bird and Gendron have pointed out,
  VIVAT changes one kind of
• enforcement asymmetry (dealing with intra
  or interstate sales) by
• other type of asymmetry (dealing with
  registered or non-registered
• merchants).
• - A clearinghouse mechanism is needed
  because states of destination
• admit fiscal credits for the tax levy in
  the origin state.
• - VIVAT was suggested for the EU - where
  there isn't any Central
• Government like in a federal country - to
  substitute the present
• Destination Deferred Payment VAT

12
Problems with Subnational VAT

• Dual IVA
• Similar to the Destination Deferred Payment VAT,
  performing in both levels of government (like in
  Canada).
• Its authors (Bird and Gendron) trust that
  unification of tax administration will solve all
  cross border trade problems.
• They also warn about the necessary expertise and
  trust required to both tax administrations,
  federal and provincial. They don't believe this
  could be the cases of Argentina, Brazil, Russia
  and India.

13
Problems with Subnational VAT

• Partilhado VAT (Barquinho)
• Assuming the relevant case - presence of final
  tax rate differentials among states - tax burdens
  on sector's value added are different. As
  intermediate tax liabilities and fiscal credits
  cancel each other, tax burden depends on the
  geographic determination of final sales. This
  gives rise to the incentive for fraud in sales
  destination.
• To equalize tax liabilities in origin through the
  complementary federal tax rate is not sufficient.
  Allowing tax credit in destination by the federal
  level, the problem of the Destination Deferred
  Payment VAT is not resolved.
• It requires considering each taxpayer's net
  liability situation with federal and provincial
  level of governments, an a rebate mechanism of
  both levels in cases of negative net tax burden.
• It makes federal level of government to
  participate in a subnational administrative
  problem without any incentive to do so. Perhaps a
  perverse incentive could arise due to concurrence
  of sources

14
Problems with Subnational VAT

• Compensated VAT
• To average sub-national tax rates for calculating
  the federal CVAT rate, hoping to reduce tax rates
  differentials, does not solve the problem of
  cross border trade, because it maintains the
  opened possibility for fraud in sales
  destination.
• Intermediate consumption tax rate is not
  relevant. Incentive to
• fraud in sales destination will arise any
  time that final tax rate
• differential is present.
• Value Added is burden with three different tax
  rates depending on where trade takes place (sales
  inside province of origin, sales in destination
  state or interstates sales for final consumption
  in both provinces, that is, corresponding to
  cross border purchases)
• Besides, the later makes necessary a
  clearinghouse mechanism

15
Dual sales taxation and the public choice point
of view

• Strategic behavior of governments in exploiting
  the common base and
• vertical externalities. The harmonization or
  equalization of tax rates
• solution.

• Harmful vertical competition versus horizontal
  tax competition
• Theory and economic struggle

• The rent seeking society and the single tax rate

• Accountability and indirect taxation

• Subnational VAT versus Provincial RST in
  accountability principle

• Accountability, government size and
  representative democracies

16
Some final remarks on Subnational VAT Problems

• Subnational VAT has problems not present in
  case of the National
• VAT, basically due to the absent of cross
  border trade controls, so
• tax rebate is not possible (Pure Origin VAT)
  tax administration is
• complex and costly (Modified Origin VAT)
  costly and subject to fraud
• in sales destination (all kind of Destination
  VATs).

• Pure Origin VAT inhibits cross border tax
  rebates, incentives tax wars,
• and has an anti exports / pro imports bias.

• Modified Origin VAT makes possible the invoice
  sightseeing
• phenomenon in input acquisitions and frauds in
  transfer payments,
• requiring a costly clearinghouse mechanism.

• Destination Deferred Payment VAT has the
  incentive to fraud in
• sales destination, like also have Partilhado
  VAT, CVAT, Prepaid VAT,
• and all kind of Destination VAT, dual or not
  dual. While VIVAT,
• thought for the EU, is not a solution that
  fits to our federal countries.

17

• Additionally, all Dual VATs

• Leave an open door to strategic behavior of both
  levels of governments trying to maximize its tax
  revenue coming from the same tax base, inducing
  to vertical or reciprocal negative pecuniary
  externalities.

• Weaken the fiscal correspondent principle and
  contribute to create
• fiscal illusion scenarios.

• Few Subnational VAT examples in the real world

18
Problems of the RST

• Many sales to business are taxed

• Many sales to consumers are exempt

• As tax evasion is concentrated at the final
  stage of the
• production consumption chain, tax
  administration face
• a complex scenario for tax compliance control

19
Solutions to those problems

• In countries like Argentina, where Federal VAT
  is already
• operating, coordinating Provincial RST with
  Federal VAT
• makes possible and easy exempt the provincial
  sales tax to
• businesses.

• All registered firm in the Federal VAT that
  may use of
• the fiscal credit mechanism for purchases of
  inputs
• would be exempt for the Provincial tax.

• Is the differentiation of registered firms and
  non registered
• firms a difficulty? No, invoices A and B
  make it possible.

20
Advantages of the Provincial RST

• The suggested mechanism of exempt all sales to
  registered businesses in the Federal VAT, makes
  unnecessary to distinguish local sales or
  purchasers from out of state sales or purchasers,
  the big problem of Subnational-Destination VAT.

• Intermediate consumption would not be taxed
  avoiding the high cost
• of the fiscal credit mechanism in the
  Provincial tax administration.

• Compliance cost would be reduced, particularly
  in case of small
• businesses, as Bird, R. (1994) has pointed
  out dealing with the
• Subnational VAT alternative.

• A complementary solution for small businesses
  could be a Modular
• Specific Flat Tax or Monotributo (like
  the one operating at the
• Federal level in Argentina).

21
The Brazilian case is the suggested solution
possible?

• ICMS is an state or provincial tax with many
  problems. But, how can Brazilian politicians face
  the political decision of letting the Union have
  its own Federal VAT (a general one, not the
  present IPI)?

• How can Brazilian politicians face the other
  political decision of changing the present State
  ICMS by the State RST?

• I dare to suggest a Federal General VAT operating
  on the basis of a Tax Sharing mechanism under the
  devolution principle in origin, introducing the
  State RST complemented by an equalization
  transfer system for poor states, financed by the
  Union quota of the tax sharing mechanism.

• As from the administrative point of view the
  Federal General VAT operates like an Origin VAT
  inside Brazil, those production bias states
  would not loose money by the change, due to the
  devolution principle in origin. And
  consumption bias states would gain using the
  RST taxing final consumption plus the
  equalization transfers.

22
The Brazilian solution, the Mercosur solution

• The solution generates incentive to rich states
  to fight against evasion because any marginal
  increase in revenues would go back to the own
  estate. The lack of accountability would be
  minimize.

• The system makes possible a reasonable tax
  room for state autonomy
• in sales taxation, while administration and
  compliance costs would be
• minimum.

• The suggested solution for Brazil would
  facilitate tax harmonization within the Mercosur.
  Argentina should change the present Provincial
  Turn Over Tax (Impuesto a los Ingresos Brutos) by
  the Provincial RST. After these changes, both
  countries would be in condition to coordinate
  Federal and Provincial sales taxation intra e
  inter countries on the basis suggested earlier.

• After the changes both countries could
  harmonize their informatics
• technologies y create a robust exchange
  information system to fight
• against evasion and elusion maneuvers in
  regional transactions.

23
Tax evasion the importance of work divisionand
coordination in sales tax administration

• Tax evasion is really a problem in our
  countries (see next slide)

• Two present domestic Federal VAT problems
• fraud in tax credits (invoice factories)
• underground activities and evasion at the final
  stage of the chain.

• Tax credit mechanism control is or should be a
  basic duty of Federal Administration, due to the
  coverage of all transaction

• Underground activities and tax compliance
  control in final sales (retail
• level) is or should be the basic
  responsibility of State or Provincial
• Tax Administrations, due to the closer
  situation of government and
• taxpayers.

24
ARGENTINA Tax Burden and Tax Evasion (Sources
Llach, J., et al, 2005 FIEL, 2000)

• Consolidated Tax Burden (2004) 27 of GDP
• VAT 7
• Income Tax 5
• Provincial Taxes 4 (Turn Over Tax or Ingresos
  Brutos 2,6)
• Municipal Taxes 0,4

• Consolidated Tax Evasion 30 - 40 (depending
  on the source)
• VAT 33 (Llach) 30 (Libonatti-FIEL) 24,8
  (AFIP)
• Income Tax 51 (Llach) 45-50 (Di Gresia)
• Social Security 50 (Bour-FIEL) 39 (Llach)

• Some statistic comparisons ( DGP)
• Tax Evasion MAX 10,8 - MIN 8,1
• Tax on Exports (Retenciones) Tax on Finance
  Transac 4
• Operative Surplus (Resultado Primario) 4

25
VAT Tax Evasion and Productivity IndexSources
Silvani y Brondolo, FMI (1993) Ebrill, et al,
FMI, (2001)

• Argentina 0,33 (2004 7 / 21 0,33)
• 0,36 (2004 7 / 19,5 0,359)
• Uruguay 0,34
• Mexico 0,30
• Bolivia 0,28
• Canada 0,32 0,37

• Chile 0,49
• Spain 0,52
• Israel 0,54
• New Zeeland 0,67
• Portugal 0,71

26
Problems in Sales Tax Coordination

• Some problems could arise from specific or
  special treatments in some activities (tax base
  definitions tax rate differentials)

• States in USA have recently undertaken the
  Streamlined Sales Tax Project (SSTP), seeking
  to harmonize retail sales taxation. McLure hopes
  that this Project achieves enough simplification
  and makes possible to override the Supreme Court
  decision in Quill, commented later.

• International experience shows a wide
  variability in sales taxation at
• the provincial o state level of government
  (Canadian case has been
• cited as an interesting laboratory of
  experiences (Bird and Gendron,
• 1998) (see next slide)

• In Municipalities sales taxation had spread in
  many countries. Use
• Taxes (Tasa de Abasto in Argentina) and other
  traditional taxes, like
• the Tasa de Seguridad e Higiene, applied
  on the same tax base than
• the RST or the Turn Over Tax (Ingresos
  Brutos).

27
The Canadian Case

• Total Provinces 10
• One Province without Sale Taxation Alberta
• One Province with a Subnational Dual VAT Québec
  (QST) Federal (GST)
• Three Provinces with the Harmonized VAT (HST)
  Newfoundland and Labrador, Nova Scotia and New
  Brunswick
• Four Provinces with Retail Sales Tax (RST)
  British Columbia, Saskatchewan, Manitoba, and
  Ontario
• One province with Retail Sales Tax applied on
  price with Federal GST included Prince Edwards
  Island

• This laboratory of experiences brings about an
  important conclusion
• coordination in sales taxation is technical
  and politically possible in a
• federal country. The problem is to find out
  the alternative that fits in
• each case

28
The solutions for Argentina and Brazil

• Arguments presented, figures and information
  contained in previous
• tables, leads to support the solution already
  suggested for federal
• countries, like Argentina and Brazil,
  assigning RST to Subnational
• governments coexisting with a Federal VAT.

• Anyhow, an Ideal Sales Taxation System in
  federal countries requires
• the adoption of a Uniform Tax Base, common to
  Federal and State or
• Provincial level of governments, on the basis
  of the Federal VAT base.

• Uniformity of Tax Bases means a reduction of
  federal and state taxation sovereignty.
  Particularly in the suggested solution any
  decision on tax expenditure should be decided
  through a federal agreement

• That is the main cost to assume, either for the
  State or for the Federal
• level of governments, while Nation or
  Provinces maintain their power
• to set the tax rate - the basic attribute of
  the Ideal Sales Taxation
• System though under certain limits to be
  agreed.

29
Local governments should participate in the
federal sale taxation coordination

• Sales taxation has spread out in local
  governments in many countries Use Tax, Tasa
  de Abasto (Argentina), ISS (Brazil) and others
  taxes burden similar tax base that provincial and
  federal sale taxes

• Those taxes should be substituted by taxes
  based on benefit principle
• (real estate taxes included) and by federal
  and provincial transfers.
• But federalism processes in the world seems
  not to coincide with this
• recommendation

• Though at present local governments are not
  large in size, especially
• in federal countries (see next slide), this
  is not the observed trend in
• our countries they are increasingly
  important from economic and
• political point of view

30
FISCAL DECENTRALIZACIÓN A COMPARATIVE
PERSPECTIVE LOCAL GOVERMENTS (2000)(Local
budget as of GDP)

• Federal Countries Unitary Countries
• 1 Switzerland 25.9 1 Denmark 30,6
• 2 Canada 9.9 2 Sweden 23,9
• 3 Austria 9.4 3 Italy 23,5
• 4 USA 9.0 4 France 9,8
• 5 Germany 7.4 5 U.K. 9,5
• 6 Belgium 6.6 6 Portugal 5,7
• 7 Brazil 5.6 7 Luxemburg 5,7
• 8 Colombia 2.5 8 Chile 2,8
• 9 Australia 2.6 9 Bolivia 2,2
• 10 Argentina 2.4 10 Greece 2,2

31
Why harmonizing local governments taxation

• If local tiers taxation will finally adopt
  similar structure than federal and state sales
  taxation, Federal VAT State RST is clearly a
  superior solution than Dual VAT

• If frauds in sales destination arise in state
  or provincial level, is
• possible to imagine the troublesome task that
  would be operating the
• Subnational VAT at the local level of
  government

• To imaging this possibility is quite an
  interesting speculative
• exercise to understand more intuitively the
  provincial fraud case it is
• only a question of geographical size and
  distances between frontiers,
• but the problem is essentially the same

• But with an isolated local RST burdening
  intermediate consumption,
• economic loses in businesses competitiveness
  could not be avoided.
• So, federal harmonization with local
  governments included is
• necessary, making that they do not levy
  invoices type A.

32
Warning dangerous dark clouds in sales taxation

• Remote purchases and cross border trade an
  exponential growth last decades and in the future
  to come

• Use Taxes, Quill Case in USA Municipal use taxes
  in Argentina (Tasa de Abasto) Other local taxes

• E-commerce and the difficulty to tax digital
  commerce

• A new tax reform marching in the Flat Tax

33
Concluding remarks

• Provincial RST can easily be coordinated with a
  Federal VAT, in an Ideal Sales Taxation System,
  solving all the principal defects traditionally
  cited dealing with the isolated Retail Sales
  Taxation

• In cases of Sales Taxation Models where the
  principles of an Ideal
• Sales Taxation System are imperfectly
  considered, the solution is still
• possible through a Uniform Tax Base

• Abandoning state sovereignty in tax base
  definitions is a minor cost
• for subnational governments. Tax base
  definition should not be
• considered an essential attribute of State
  or Provincial Autonomy.

• Actually, even autonomy to set the tax rate
  should be limited in same
• way in a federal constitutional arrangement.
  Laffer curve and vertical
• externalities in concurrence of sources
  introduce a natural constraint
• to absolute autonomy.

34
Concluding remarks

• Considering all alternatives is sales
  taxation, Provincial RST and
• Federal VAT is a superior solution than
  combining it with the
• Subnational VAT.

• Subnational VAT have different difficulties
  depending on the modality
• (origin or destination VAT). Distortions or
  fraud are possible and all
• suggested solutions seem to be incomplete or
  impracticable in our
• countries.

• The solution Fed VAT-Prov RST avoids to tax
  intermediate
• consumption, allows to tax all final
  consumption and introduces an
• incentive for tax administration agencies to
  reduce tax evasion

• Intermediate consumption wont be taxed
  because only Invoice B
• (draw to non register purchasers) should be
  taxed, while Invoice A
• (emitted for registered purchasers) would be
  exempt.

• Reluctance to adopt Provincial RST is now
  clearly a political matter
• not a technical problem. Cooperation and
  informatics harmonization
• make possible to overcome all relevant
  technical problems.

35
Concluding remarks

• From the public choice point of view indirect
  taxation is not good for transparency (it weakens
  tax-price of public goods perception or
  Wicksellian correspondence principle), but in my
  opinion Federal VAT-Subnational VAT alternative
  in dual sales taxation is worse that Federal VAT
  Provincial RST alternative.

• A final recommendation for politicians,
  especially for local ones, is to
• be aware of the increasing difficulties in
  sales taxation due to remote
• sales and e-commerce, and also due to the
  present tendency to
• introduce radical reforms in tax structure in
  many countries pushed by
• the present violent, competitive, and
  aggressive scenario of
• globalization

• Flat Tax could be an alternative for local
  governments - not only for
• the national level - and local politicians
  should open mind, hurry up
• and take note of international experiences

36
Concluding remarks

• We know the political difficulties to decide
  such suggested
• reforms and we understand politicians
  concern about them, but they
• are the only capable to evaluate the
  political risk to undertake them

• A partial solution to cope that risk the
  agreement guarantying states or provinces to
  receive resources equal to the amount they
  obtained before the reform

• The higher challenge should have be faced by
  Brazil (see next and last
• two slides)

37
Table 6Relative importance of own state or
provincial revenuesor resources before and after
transferencesArgentina y Brazil (2000)
Concept Argentina
Brazil Own revenues before transferences
18,4 34,5 Resources after
transferences 45,0 43,5
38
Table 7 Global tax burden and sales taxation in
term of GDP Argentina y Brazil (2000)
Concept
Argentina Brazil Global tax
burden 21,0
30,0 National
17,1 19,6
Subnational 3,9
10,4 VAT / G
7,0
7,5 VAT / Global tax burden
33,3 25,0
VAT / National tax burden 40,9
- Ingresos Brutos
(Prov) / GDP 2,2
-