Tax Policy:

Tax-Credit and Subtraction Methods of Calculating a Value-Added Tax

GGD-89-87: Published: Jun 20, 1989. Publicly Released: Jun 20, 1989.

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Pursuant to a legislative requirement, GAO provided information on how choosing a method for calculating tax liability influences the ability of the tax to respond to various tax policy goals, focusing on: (1) maintaining international competitiveness; (2) offsetting the burden of the tax on the poor; and (3) compliance and administrative costs.

GAO found that: (1) a single-rate value-added tax would make low-income households pay a higher percentage of income in value-added taxes, since they spend a larger part of their income on consumption than higher-income households; (2) alternatives to reducing the regressivity of a value-added tax include providing a tax credit for low-income households on their tax returns, or imposing multiple value-added tax rates; (3) although providing refundable tax credits would be compatible with either the tax-credit or subtraction method, only the tax-credit method would be compatible with multiple rates; (4) multiple rates would be complex and would tend to increase administrative and compliance costs; (5) although exchange rates may compensate for price increases in domestic goods and services, many countries try to offset potential problems with border tax adjustments on imports and exports and avoid the effects of value-added taxes; (6) the subtraction method could be used for border tax adjustments on exports but would make verification of exported untaxed goods more difficult; (7) there were no reliable cost estimates for a simple subtraction method value-added tax or of a multiple-rate tax-credit value-added tax; (8) if all firms paid the value-added tax, additional administrative costs would total about $700 million annually and would decrease if small firms were exempted; and (9) policymakers need better information on administrative and compliance costs to make informed decisions.

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