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Committee clarifies stance on raising VAT

| Economic factors

The Davis Tax Committee has not explicitly recommended that the value-added tax (VAT) rate be increased, it has emphasised. The committee on Monday issued a statement to correct what, it said, had been inaccurate reports about its first interim report on VAT.

These reports suggested that the committee had proposed a VAT increase as the best way for the government to raise more revenue. Instead, the committee said, its report had emphasised that a VAT increase without a significant measure of "recycling of revenue" in favour of poorer people would be "inherently retrogressive". It would have a more negative effect on inequality than would a rise in personal or corporate income tax.

"Should it be necessary to increase the standard rate of VAT, it will be important for the fiscal authorities to think carefully about compensatory mechanisms for the poor who will be adversely affected by the increase," the committee’s report noted.

These measures could include increases in social grants or strengthening the school nutrition programme.

However, the committee’s report did recognise that an increase in the VAT rate had been shown to be the most effective source of raising additional tax revenue. Other measures ranged from estate duty and those aimed at combating base erosion and profit-shifting.

"Were government to consider an increase in the VAT rate, then the increase would have to be accompanied by sustainable measures that mitigate the retrogressive effects," the committee said.

The committee concluded that an increase in the current standard rate of VAT (14%) would be somewhat inflationary in the short run as the price of standard-rated consumer goods would increase overnight.

In contrast, raising personal or corporate tax rates would be less inflationary but would have a negative effect on real gross domestic product and employment, particularly in the short run. The effect of a VAT increase on these two variables would be less severe than that of a rise in personal income tax or corporate income tax.

"It is thus clear that from a purely macroeconomic standpoint, an increase in VAT is less distortionary than an increase in direct taxes."

The committee wanted to encourage debate about the most appropriate tax system.

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