Certain South African tax commentators argue for a multiple VAT rate system (in addition to 14% and 0%) including a luxury goods and services rate. The argument is that extended zero ratings would make these goods and services more affordable to everyone, not only the poor, and could be funded by the VAT collected on luxury goods and services which would result in a nil net cost to the fiscus.
In Wealth of Nations (1776), Adam Smith developed the principles of a good taxation system and provided guidelines to develop and administer tax systems. Smith formulated canons of taxation which measure a good tax system against its compliance with neutrality, equality, invisibility, certainty and simplicity as well as minimum compliance and administration costs.
A tax system is neutral if the imposition or increase of the tax does not materially alter consumption patterns. Fiscal intervention could cause economic distortion, which leads to the misapplication of the scarce resources available. The equality principle encapsulates the ‘ability to pay’ and the ‘benefit’ principles.
The benefit principle justifies the imposition of indirect taxation and mandates those who benefit from consumption should pay for the benefit or use. The principle of invisibility relates to the notion that the best taxes extract spending power from the Private Sector before it has accrued too obviously to any particular individual.
The principle of certainty and simplicity demands that the nature and quantum of a taxpayer’s liability should be simple to determine and observe.
The principle of minimum compliance and administration costs necessitates that the cost to the taxpayer and fiscus of assessment, collection and administration should be kept as low as possible.
Assessing the extension of zero ratings and increasing the number of VAT rates against the canons of taxation demonstrates the undesirability. An underdeveloped socio-economic redistribution structure could justify zero rate extensions.
Multiple VAT rates or extended zero ratings may distort consumption and, as a result, may not always comply with the neutrality principle. As multiple VAT rates or extended zero rates could favour certain, and discriminate against other, commodities, multiple VAT rates and extended zero ratings may not strictly adhere to the equality or benefit principle. Differential rates make the existence of an indirect tax far more visible. Finally, multiple VAT rates or extended zero ratings increase the tax complexity, compliance and administration costs.
In Value-Added Tax International Practice and Problems, Alan Tait states that narrowly applied VAT systems create economic distortions, which necessitates increased rates to yield the required amount of revenue. VAT systems should keep exceptions and exemptions to a minimum and limit the number of VAT rates to the standard rate and potentially only limited zero rates to keep the cost of administration, compliance and economic distortion to a minimum.
Keeping the tax system ‘pure’ should be policymakers’ first priority and direct targeting mechanisms should address economic imbalances.