Growing Importance of Indirect Taxes
After the financial crisis, governments in many countries continued to face strong funding and revenue requirements. Governments needed funds to finance economic stimulus plans and gradually cover the funding gaps created by economic shocks.
In this situation, indirect taxes emerged as an important source of government revenue. For many years, governments have considered indirect taxation an effective method of income and revenue generation, and this trend is expected to continue.
The movement from direct taxes towards indirect taxes has also been supported by international institutions such as the International Monetary Fund (IMF), the Organisation for Economic Co-operation and Development (OECD), and the European Commission.
According to the provided content, some international studies indicate that Value-Added Tax (VAT) has the least adverse effect on economic growth, whereas corporate income tax has a negative effect on economic growth.
Reasons for the Growth of Indirect Taxes
Another important reason for the continued development of indirect taxation is international tax competition and economic weakness. In such conditions, governments may find it difficult to continuously increase corporate income tax or personal income tax.
Indirect taxes are generally borne by consumers and are not directly dependent on the profits of businesses. Therefore, governments increasingly use indirect taxes as a source of revenue.
According to the provided content, the growth of indirect tax revenue mainly takes place through three methods:
- Expansion of VAT or consumption tax systems
- Increase in VAT or consumption tax rates
- Growth and expansion of consumption or excise taxes
Expansion of VAT or Consumption Tax Systems
The expansion of Value-Added Tax (VAT) and consumption tax systems has been an important development in indirect taxation.
According to the OECD’s Consumption Tax Trends, 2014, as of 1 January 2014, 164 countries had imposed VAT.
The geographical distribution mentioned in the provided content was as follows:
| Region | Number of Countries |
|---|---|
| Africa | 46 |
| North America | 1 |
| Central America and the Caribbean | 12 |
| South America | 18 |
| Asia | 28 |
| Europe | 51 |
| Oceania | 8 |
As a result of the widespread adoption of VAT, only a limited number of countries continued to use a retail tax. A retail tax is imposed at a single stage on goods and services and is ultimately borne by the final consumer.
Exam Point: As of 1 January 2014, 164 countries had imposed VAT, according to OECD’s Consumption Tax Trends, 2014.
Growing Adoption of VAT in Emerging Economies
The number of countries adopting VAT continued to increase, particularly among emerging economies.
The provided content gives several examples. The Bahamas introduced VAT on 1 January 2005. Malaysia introduced VAT on 1 April 2015 to replace its existing sales and service tax.
Egypt introduced a VAT law to replace the existing general sales tax system. A tax reform plan for Puerto Rico was also intended to increase general fund revenue, simplify overall tax compliance, and promote economic growth.
These developments show the increasing global preference for VAT-based indirect tax systems.
Increase in VAT and Consumption Tax Rates
Countries that had already introduced VAT or consumption taxes also began increasing their average tax rates. According to the provided content, average VAT rates were increasing over time, and the trend was particularly noticeable in Europe and OECD countries.
The average standard VAT rate reached 21.6% in European Union member states and 19.2% in OECD member countries. Before the 2008 economic crisis, the corresponding average rates were 19.5% and 17.5% respectively.
| Group | Before 2008 Economic Crisis | Later Average Standard VAT Rate |
|---|---|---|
| EU Member States | 19.5% | 21.6% |
| OECD Member Countries | 17.5% | 19.2% |
This indicates an upward trend in standard VAT rates after the economic crisis.
Changes in VAT Rates in European Countries
European VAT rates became relatively stable in 2015, although they remained at high levels.
Iceland reduced its standard tax rate from 25.5% to 24%. At the same time, its tax rebate rate increased from 7% to 11%.
In contrast, Luxembourg increased its standard tax rate from 15% to 17%.
The provided content also states that Italy was considering an increase in tax rates, while Portugal might follow a similar approach.
Thus, although tax rate changes differed among countries, the general level of VAT rates remained relatively high.
Growth of Consumption and Excise Taxes
Another major reason for the increase in indirect tax revenue is the global growth of consumption and excise taxes.
Many countries increased tobacco excise taxes. These included Denmark, Ecuador, Finland, Ghana, Malta, Ireland, the Netherlands, Norway, Russia, Slovenia, Sweden, and Tanzania.
Countries such as Lithuania, Norway, and Tanzania increased consumption taxes on alcohol.
Similarly, consumption taxes on mineral oil increased in China, Estonia, Finland, Gambia, Hungary, Norway, and Russia.
The important trend is that governments are not only increasing existing tax rates but also introducing new forms of indirect taxes.
Excise Taxes on Health-Related Products
A relatively new development in indirect taxation is the imposition of excise taxes on health-related products and unhealthy goods.
Examples include fast food taxes and sugar taxes on unhealthy foods and beverages. Such taxes are designed to increase the price of products that may create health-related problems and thereby influence consumption behaviour.
According to the provided content, government expenditure on health and welfare may increasingly be linked with such taxes. As populations age and pressure on government spending in health and welfare increases, these taxes may become more common.
Exam Point: A new trend in indirect taxation is the use of excise taxes on health-related or unhealthy products, such as fast food and sugar taxes.
Taxation of Financial Transactions
Governments have also attempted to increase taxation on financial transactions, although financial transaction taxation is not a universal international practice.
Some countries have strengthened the supervision and taxation of the banking and financial sector. In Europe, one preferred approach has been the introduction of a Financial Transaction Tax (FTT).
France introduced a financial transaction tax in August 2012. Hungary introduced a 1% tax on paid services in January 2013.
In March 2013, Italy imposed taxes on equity transfers, derivatives, and high-frequency trading.
The provided content also refers to 11 EU countries planning to impose transaction taxes on stock and bond transactions and derivative contract schemes under the Financial Transaction Tax framework. The participating member states agreed to impose the tax in January 2016, although its implementation had faced delays.
Key Points
- After the financial crisis, governments faced increased funding and revenue requirements.
- Indirect taxes became an important source of government revenue generation.
- The shift towards indirect taxes has been supported by the IMF, OECD, and European Commission.
- According to the provided content, VAT has the least adverse effect on economic growth, while corporate income tax negatively affects economic growth.
- Indirect tax revenue has mainly increased through expansion of VAT systems, higher VAT rates, and growth of consumption taxes.
- According to OECD’s Consumption Tax Trends, 2014, 164 countries had imposed VAT as of 1 January 2014.
- The average standard VAT rate reached 21.6% in EU member states and 19.2% in OECD member countries.
- Before the 2008 economic crisis, these rates were 19.5% and 17.5% respectively.
- Iceland reduced its standard tax rate from 25.5% to 24%.
- Luxembourg increased its standard tax rate from 15% to 17%.
- Governments increasingly use excise taxes on tobacco, alcohol, and mineral oil.
- Fast food taxes and sugar taxes represent a newer trend in health-related taxation.
- France introduced a Financial Transaction Tax in August 2012.
- Hungary introduced a 1% tax on paid services in January 2013.
- Italy imposed taxes on equity transfers, derivatives, and high-frequency trading in March 2013.
Quick Revision Summary
The development of indirect taxation accelerated after the financial crisis because governments required additional revenue. The major trend has been a shift towards VAT and consumption-based taxes. Indirect tax revenue has increased mainly through the expansion of VAT systems, higher VAT rates, and increased consumption or excise taxes. VAT had been adopted by 164 countries as of 1 January 2014. Governments have also introduced taxes on health-related products and financial transactions, showing the continued expansion of indirect taxation.