Table 11 1

Taxation as a Percentage of Gross National Product in 1966

Totalsocia l

Direct

Indirect'

SecurityTaxatio nper sent

Tex"

Taxes

contribution sper cent

per cent

per cent

France

- 38.6 6.5

17.7

14 .4

Netherlands

35.8 .13.3

10 .4

12 . 1

West Germany

34.9 10.5

14.2

10.2

.United Kingdom ,,; .

: : 31.3 11.6

—,14 .9

4 .8

Belgium

31.2 9.1

' 13 .2

8 .9

._ Italy

29.1 6.6

12 .6

9 .9

United States

28.2 14.3

8.9

5 .0

Source :

First National City Bank, New York. "Monthly Economic Letter," April 1968, p. 43.•Includes real estate and land taxes.

were produced. In other words, the con- the total of turnover taxes charged toSumer cannot avoid contributing to the products exported, the price is lowered-public expenses of his own country by and products can more readily find a;,purchasing a commodity abroad, pro- market abroad. At the same time, how-'vided, of course, that the country in ever, importing countries are permitted

._-which the consumption takes; place also - to levy the equivalent of their turnoverapplies turnover taxes . tax on foreign .products entering at. the

The two main reasons why sales-tax-frontier . 3

ing countries exempt exports and tax im-The United States Government im-

ports are : first the general belief thatposes no turnover tax, and hence has no

-these taxes fall as burdens not on busi-occasion to exempt exports and to tax

ness firms, but on consumers; hence theimports . American border tax arrange.

country in which the consumer residesInents are only used with respect to ex -

should obtain the tax revenue . This cancise taxes, which are applied to a limite d

"benefi tbe termed the

to consumers"number of products only, such as cars ,

argument .tobacco, and alcoholic beverages . Most

The second argument for exempting of the American indirect taxes are ap -exports and taxing imports can be termed plied on the state and local level . Tablethe "competition argument . " A country III compares the reliance on direct andlevying a high rate of turnover tax on indirect taxes in seven countries . Theits products going abroad will place its table clearly shows the contrast betwee nproducers at a competitive disadvantage indirect taxes applied in the Unite dwith regard to those in countries charg- States and the greater reliance on fin -ing low turnover tax rates . By rebating direct taxes in Europe . Consequently ,

3,

For an evaluation of these reasons see ; Carl S . Shoup, Excise Tax Compendium, U . S . Government Printingoffice, Washington, D,C„ 1964, Committee on Way and Means, Part I "Indirect and Direct Faxes and thei rInfluence on International 'Grade," p, 59,

17

a definite disadvantage results for theUnited States with regard to its com-petitive position in Europe because theUnited States does not tax imports an d

. . .gives no tax rebates to exports .

The Border Ad junment Proble m

When the European economic com-munity adopts its common value-addedtax system with rates of about 15%, th eorigin principle will be applied to inter-community trade . Community trade wit hthe outside world will continue to betreated according to the destination:principle, thereby leaving the latter ,subjest to border tax adjustment .

It is the current and virtually universa lpractice among countries to treat turn -

", ;over and excise taxes as costs that ar euniformly passed on in the price of theproduct. The existence of a border tax

4 ..adjustment embodied in the rules ofGATT reflects this approach .4 The bor-der adjustment tax as applied to import s .will charge foreign products the equiv-alent of the domestically applied in-direct tax . On the export side GATTrules provide for the complete rebate o fall indirect taxes charged to productsleaving the country. Not eligible forborder tax adjustment are, therefore, in -come taxes, profit taxes, payroll taxes ,property taxes, and social security taxes .Given these GATT rules, the adoptionof a common value-added tax system o fabout 15 per cent will bring new foreigntrade advantages to the Common Mar-ket, advantages which are not shared bythe outside world because of the tax sys -tem applied in the different countries .

As a result of the new border tax ad-justment, the Common Marke t's balance

of trade should be favored . CommonMarket products will be cheaper abroa dand foreign products will suffer priceincrease upon entering the Common.Market area, The changes in the Euro-pean turnover tax system is likely tocause the United States internationa ltrade position in Europe to decline .Since border tax adjustments are feasibl eonly when indirect taxes are applied,exporters from countries like the UnitedStates will have no means of `compensat -'ing for the emerging .°European border , .tax adjustment .

The United States responded to th eprospect of increased European exportrebates and higher import taxes by;bringing the matter before the Organi-zation for Economic Cooperation an d

,Developments The OECD is the 'prin-cipal international forum that couldreview the issues involved. The UnitedStates urged a standstill agreement ,under which the status quo on bordertax adjustments would be maintainedwhile the justification for border tax ad-justments could recei ,,e a thorough re-examination. Behind this position is thefeeling that the theory of tax incidencereflected in the GATT rules is open t oquestion. Many attack directly the beliefthat indirect taxes are always shifted for -ward in price while direct taxes arenever shifted, The United States chal-lenges the principle on which the GATTsystem has rested ever since it was cre-ated in 1947 . In March 1965 a workin gparty of the OECD Council was set u pto consider the questions raised by theissue .6

Special emphasis was given by th eworking party to the tax shifting contro-versy. This controversy has centered o n

4, General Agreement on 'tariffs and Trade, Basic Instruments and Selected Documents, Vol . 3, Art . 2 .

3 . Nathan N. Gordon, Tax Harmonization in the Common Market and U .S . 'tax Pollcy, In Walter J . Kress, ed . ,Proceedings o/ Annual Conlerence, (Harrisburg : National 'tax Association, 1966) pp . 417427 ,

6 . Kenneth Messere, "Border Tax Adjustment," OECD Observer, No, 30, October 1967, p, 10 .

18

the relative degree of shifting of con-sumption taxes (which are eligible fo rborder tax adjustment) on the onehand, and profit taxes (which are noteligible for border tax adjustments) onthe other. Generally speaking, the work-ing party of the OECD challenged th ebasic assumption that indirect taxes arealways treated as costs and shifted for-ward to the final consumer.

It was argued that in specific cases the-.producer will prefer to bear part of thetax burden himself to avoid prices fro mrising to the point at which the quantityof demand will decline enough to reduc enet profit . Thereby the total of turnover 'tax would no longer be shifted forwardo the final consumer. The producer

selling in his domestic market, havin gsacrificed a share of his profit by payingpart of the turnover tax himself, will fin dthe expansion of his export business veryattractive relative to domestic sales . Onexports he will not have to bear any ofthe tax costs as he does in absorbing ta xon domestic sales, but he will receive th efull rebate of all turnover taxes charge don to the product. In other words, whil ethe value-added tax seems carefullystructured to pass the tax along in anaccounting sense, no guarantee is pro-vided that the economic effects followthe accounting structure and assump-tions .

If the tax is not fully shifted for-ward in an economic sense, the inter-national trade position of the countryapplying the tax will tend to be favore dregardless of the accounting structure .To estimate correctly the portion of in-direct taxes not shifted forward in prices

poses an impossibly difficult problem .The issue is closely linked to the impactof a tax change on prices, Argumentssuggest that a rise in such taxes ma ysometimes lead to an even greater ris ein prices than the rise in tax itself, (Forexample, the initial influence of an in -crease in indirect taxes on prices wil linvolve wage increases which will in -crease costs, resulting in further pric eincreases . Producers, it is argued, ten dto take advantage of tax increases to pu tprices up additionally to, cover ,~°bther .rising costs.)?

Further complications arise becauseshifting of indirect taxes will vary fromarticle to article, depending upon theelasticity of supply and demand, accord-ing to the state of the economy, and th egovernment's monetary , and pricing poiicy . ,

A problem of equal difficulty is posedby the analysis of the effect of businessprofits taxes on prices . It has often beenassumed that corporate income taxes

. were not shifted forward in prices, butwere borne in total by the producer, Thi sassumption which is reflected in therules of GATT was contested empiri-cally by the findings of Krzyzniak an dMusgrave who hold that direct taxes areshifted forward fully in price in the shortruns These findings have been re-peatedly criticized by other leading ta xeconomists and the sub ,ect thereforeremains controversial .9 The argumentsin favor of a particular view in the shift-

__.

_ . .

. _;

ing of these taxes are abstract and veri-fication of the facts is complicated, fo rit goes beyond the estimate of the effect sof tax changes on the price of goods, i n

7. Ibid ., p . 9 ,8. Marian Krzyzantak and Richard A, Musgrave, The Shifting o/ Corporate Income Tax, Baltimore : John s

Hopkins Press, 1963 .9. R, J . Gordon, " The Incidence of the Corporation Income Tax in U, S . Manufacturing 1923 .62," America nEconomic Review, Vol, LVII, No, 4 .

10. Marian Krzyzaniak, Effects of Corporate Income Tax, Wayne State University Press . "Empirical Evidence o nthe Incidence of the Corporation Income Tax ." Journal o/ Political Economy, Vol . 73, December 1967, No, 6 ,pp, 811-821, See also the forthcoming Tax Foundation study on the federal corporate income tax,

19

The border tax adjustment controver-sy has not received much attention in thepast, because of the scarcity of informa-tion concerning the shifting of direc tand indirect taxes. It was argued thatwith the existing low rates of border taxadjustments the distorting effects on in-ternational trade could only be slight ,since over the years changes in exchangerate and general price levels would hav eoffset these distortions . 11 However, withthe European Economic Community in-.creasing its border tax adjustment, coun-tries interested in the foreign trade posi-tion can no longer ignore the effects o fborder tax adjustments . It is evident thatthe immediate effect of the adoptions o f,common value-added ta x .rates will low-er prices of Corr., munity~ exports, while

Kenneth Messere . OECD Observer, p, 9 . op, cit.12 . A. R . Prest . "The EEC Value Added Tax and the It

•164, p, S .13,- Kenneth : •Messere, OECD .Observer, ovcit ;,

prices for products entering the Euro-pean Economic Community will be in-creased. This effect can be compared toa devaluation of Common Market cur-.rency, as was pointed out by Professo rPrest in connection with the German .

.

changeover to value-added taxes . 1 2

It can justly be feared that the emerg-ing Common Market border tax adjust-ment will nullify some of the reciprocaltariff reductions negotiated : during , the

'Kennedy Round .

The OECD working party failed tomake any firm policy recommendation .It limited itself to consultation with re-gard to general policy implications con- .

. .:cerning the international trade and pay-ment;leffects-'of border tax changes . 1 3

; .K,".Dtstctct BankrReVew, Londow . :December 1967, No .

20

IV*

The UO S. 'Courses `of Action . - to

Com ensate for :Euro can Border Taxes

The renewed concern with the bordertax issue caused by the expected change Table IVin the European indirect tax structure i sclosely connected with the American Zo.mmon Market Trade Balanc e;balance of payments deficits, Export ex- With the United Statespansion is one of the most promising (Billions of Dollars)Avenues for improvement in the U .S. Imports f.o,b .

Exports to U .S .balance of payments .

1958

2,8

1.6In February 1968, the National Export 1960

3,8

2,2Expansion Council, in its advisory capac-

-'ity

to

the

Secretary

of

Commerce, 1963

5 .0

2 . 8

suggested administrative and legislative 5,41964

3 .4

action favoring the expansion of export sby proposing to study . (a) the possi- 1966

6.0

4 . 4ability of a change in GATT rules to allo wrebate payments for direct taxes ; (b ) the Source: Foreign Trade,

Monthly Statistics, Officepossibility of substituting avalue-added commaunly, 168tNo, 4upp 18 & 20,nomi C

tax as a source of some of the revenu enow raised by the corporate income tax ; might be said to confirm the argumentand (c) the adoption of a system of bor- .,that present border adjustments really;der taxes and rebates on exports based 'have no effect on international trade.

-on existing indirect taxes imposed by However, international trade problems

-state and local governments, as`well . as are likely to result from the Commonthe Federal goveinment . 1 Market adoption of the uniform value-' ,

added tax system ,The American ibalance of payments

deficit situation in recent years has been Given the favorable balance of for-

contrasted with an overall positive bal- eign trade that the United States has

;ante 'n its foreign trade accounts, Ta. maintained in past years, caution is in-ble IV reflects the positive balance the dicated, in order not to respond to theUnited States has enjoyed in its trade European border tax increase in a fish -

with the European Economic Commu- ion that might jeopardize, instead of fur -nity, ther improve the American international : .

trade position in Europe in the long run ,This positive balance of foreign trade Some of the repeatedly suggested policy

with the Luropean Common Market measures will be summarized briefl y1, National Export Expansicn Council, U,s, Department of Commerce, Resolution No, / and 2 on Taxatlan dnd

Exports, Washington, D,C, : February 2, 1968,

2 1

and analyzed to consider their possibleadverse effects .

1. The United States might wish tonegotiate changes of GATT rules withregard to the justification of border taxadjustments for indirect taxes only, inview of existing controversy with regardto the :shifting of direct :and 'indirecttaxes .

2. GATT could be asked to approv eborder tax adjustments for direct taxes .This would be in direct violation o fpresent GATT rules, but changeq ofthese rules could possibly be negotiated .

3. Another solution might be a chang efrom heavy U.S . reliance on income taxe sin favor of the adoption of turnovertaxes. If the United States cannot lick ;the .systern, perhaps it should join it .

4. Finally, one other suggestion, whic hIs less drastic but possibly more in keep-ing with U.S. international obligations ,is for the U .S. to rebate certain indirect,taxes presently not rebated ?

Asking GATT to change its rules wit hregard to border tax arrangements hasa definite appeal to many countries con-cerned, Before any decision in this direc-tion could be taken, much detailed wor kon the question of the shifting of direc tand indirect taxes would be necessary .It would be unreasonable to expectcountries presently practicing border ta xadjustments to cease to do so arbitrarily .However, an acceptable solution to theproblem might be found through func-tional modifications of the present sys-tem. To bring about these modifications

the United States might seek a standstil larrangement with the Common Marke tcountries introducing the increased ta xadjustment until firm decisions in thi smatter could be taken . If it were foundthat the principles underlying the pres-ent system are not fully valid, future bor-der tax adjustments could be limited tothe effects of taxes on prices .

That the European Economic Com-munity is willing to discuss the borde r,tax issue with the United States wa spointed out by Mr . jean Rey, Presidentof the Commission of the European Eco-nomic Community in a speech. ; beforethe National Press Club . 3

A reconsideration of the principles onwhich the present GATT rules res tmight also lead to the acceptance ofborder tax arrangements for direct taxes.This solution might not accomplis hmuch for the United States, in that cor-porate income tax rates in the U .S, donot differ much from corporate incometax rates applied in major Europeancountries. The OECD gathered statistic swhich indicate that the total tax burdenof the United States is lower than tha tof either the United Kingdom, France ,Germany, Italy, or the Netherlands, interms of general government expendi-tures as a percentage of gross domesti cproduct in 1565 . Thus the case is madethat because Europeans rely also to agreat extent on direct taxes, the bordertax adjustment for direct taxes wouldreflect this situation and the advantage sgained for the United States would con-

-sequently be slight . This effect would b eemphasized even more with regard to

2. Sidney Weintraub, "border Taxes and the General Agreement on 'tariffs and 'trade", lit National Associatio nof Manufacturers, Sy►apustaat on Taxers and International business, New York, 1965, pp . 42-47 .

Representative Thomas B, Curtis, "Border Taxes . New Urging on Old Issues ." NAM Reports, February 19 ,1968 .

3, Curtis, op, cit . Mr. Rey expressed at that occasion the Common Market's view that the U .S . balance of pay-ments problem was ►tot It balance of trade matter but a matter of domestic economic policy . He said that theEEC considers the GATT to be the correct measure of Its conduct on the border tax issue, and he said that th eadverse effects of border taxes on U .S . foreign trade had not yet been proven, He also said that Americans ha dfor years known about the border tax system that was being formulated in the EEC, and had taken no actio nuntil the present "emergency" .

22

third nations, since they would also bepermitted to apply border tax adjust-ments . It thereby becomes probable thatborder adjustment for direct taxes, i finstituted at all, would not radically alterthe relative border adjustment magni ->tude of the United States and most othe rtimportant trading countries . Finally ,even if one were to permit adjustmentsfor direct taxes, such a course woul dmeet with considerable administrative

,problems, for it would ~e virtually-;impossible to determine the preciseamount of direct tax embodied in theprice of a specific product . ' This diffi-culty would exist even if the degree o fshifting, which to complicate matter smay actually vary from product toproduct and from country to country(as well as over time), could -be accu-

rately determined . ,

Should the United States then changeits tax structure and apply turnove rtaxes? It is yet unclear how an emulatio nof the European tax system would affectAmerican exports, since the precise rela -tionship between the level of indirec ttaxes and exports is still uncertain. Arecent study by Robert Z. Aliber andHerbert Stein has attempted to sho whow a change in the mix of U .S . taxesmight affect the international competi-tiveness of U .S, products abroad,4 Inview of the complexity of this type ofanalysis, which should include possibl echanges in wages, interest, and othe rcosts, only rough indications of the likelymagnitude of the improvement in dif-- ferent circumstances is given. On thewhole, however, it appears that achange in the tax mix would affect pricesonly slightly . s A conference of experts

sponsored by the Brookings Institutionand the National Bureau of EconomicResearch in late 1963 held a similar vie won this subject . 6 The issue cannot beseparated from the question of the de-gree to which indirect taxes are shifte dforward and direct taxes are shifte dbackward, e .g,, how much of corporateincome tax reduces net yield to capitalhere and abroad. The ramifications of achangeover to indirect taxes from th edomestic standpoint would be much,more significant than its internationalaspect. Congress, having only recentlyeliminated many consumer excises ,might be very hesitant to adopt a jgen-

,oral turnover tax.

The -final suggestion, which has ac-~tually received more attention than al lother proposals, calls for the rebate of

bated by the United States . Besides levying excise taxes on a limited number o fproducts which are actually rebated onexports, the United States makes con-siderable use of indirect taxes whichcould also be rebated according toGATT rules. These indirect taxes havenot been rebated so far ; with the excep-tion of property taxes, they are usuall y'levied at the state and local level in th eform of retail sales taxes . The levy atstate and local level complicates thei ruse as a sales stimulant of Americanproducts abroad. While it has been esti-mated that the average of these indirecttaxes is about 2 per cent of export sale sprices, the impact on product lines dif-fers with the range running from 11/z percent to 4 per cent of export sales prices ?The rebate of these tax costs and a simi-lar import charge, administered throug h

4. Robert Z . Allber and Herbert Stein . "The Price of U .S . Exports and the Mix of U .S . District and Indirec tTaxes," The A►nerican Economic Review, Vol . L1V, No . S, September 1964, pp . 103-710 .

3, See Allber and Herbert Stein, Ibid.6. National Bureau of Economic Research and Brookins Institution, The Role of Direct and Indirect Taxes i n

the Federal Revenue System, Princeton ; Princeton University Press, 1964 . 313 pp .7. Wchard Lawrence, "Border Tax Bill Readied by Treasury," Journal of Commerce, February 19, 1968 .

23

. .,the customs organization, would reflectan approach that corresponds to theprinciple applicable under the value-added and turnover tax . This approach ,

-'if adopted by the United States, wouldreflect the principles and practices un-derlying the treatment of indirect taxesin Europe .

It should be considered, however,that the adoption of a border tax adjust-ment in the United States will imme-diately create new trade obstacles wit hsuch countries as Canada, Britain, Japan ,and Australia. Some of these nation spresently do not practiee border ta xadjustment . However, they could be led`to do so if the United States decided . togo ahead on this issue.

At the beginning of 1963, the Ameri-can delegation to GATT asked for thecreation of a special working party onborder tax adjustment. This requestexpresses the belief that a general revie wand possible revision of GATT rules isnecessary with regard to Articles II, IIIand XVI which govern the border ad-justment. 8

The Working Party on Border TaxAdjustments met for its first sessio nfrom April 30-May 2. The representa-tives of the United States in their open-ing, statement welcomed the possibilit yof a general review of GATT rules, andexpressed their hopes that the questionof border tax adjustments would find aconstructive and expedient re-examina-tion. The rule, were drawn up morethan two decades ago, and the economicenvironment present at that time ha schanged drastically . Levels of indirec ttaxes were much lower then and exist-ing practices and simple assumptions

8. General Agreement on Tariffs and Trade . Basic In

with regard to tax shifting seemed ac-ceptable at that time. Little attentionwas paid to questions of what might be - -harmful to the U.S. payments position,since the need was to assist other coun-tries to overcome the so-called dollar-gap and meet the requirements `oi,,post-war reconstruction .

The border tax adjustment controver-sy is not an isolated problem. The GATTworking party on border taxes ha splaced this issue in the context not onlyof the balance of payments question asa short run concern, but also in th econtext of equity requirements for inter -national trade in the long run. In thelight of these considerations the work-ing. party agreed to proceed to:

a. Analyze and re-examine how thepresent GATT rules came about .

b. Gather information about the prac-`7;tices of GATT members with regard

to border tax adjustment .

The U.S. representatives made clea rthe belief that the problem is one for thelong term, but also directly related tothe amplitude of recent and prospectivetax changes in Europe and-the-U.S.-bal -ante of payments.

It is expected that new and basic in -formation about the question of tax in-cidence will be gathered by this work-ing party, so that equitable internationa ltrade rules can be established. Clearly ,several months of highly technical dis-cussions are required before a workablesolution can be found. American officials

-are hopeful that GATT rules can be re -vamped so that trade distortions result-ing from emerging European bordertaxes can be avoided.

rtruments and 5etected Documents. Vol . 3

24

The , harmonization of turnover t̀axes ments are permitted for direct taxes .by the member nations of the European In the presence of these GATT prac -Economic Community brin f,-, about an vices equitable conditions for interne-

e

important rise in European border taxes . tional trade could only prevail if ; t allReal concern exists in the United States countries applied the same taxes andabout the trade distorting effects of the ,rates of taxes . This is evidently not the

'emerging border tax adjustments . In an case and may not be feasible . If this isenvironment of international trade fiber- not feasible, what is needed then is re-alization and reciprocal tariff reduction, vision of GATT rules with respect toresulting from the recent Kennedy border tax adjustments . A special work-' Round negotiations, an increase in Eura ing party on border tax adjustment haspeen border taxes seems .:,to contradict been created .within GATT. Having metfree trade `objectives . for the first time in April-May of this

The General Agreement on Tariffs . ,year, the a special working party on-border taxes bas-opened-discussions onand Trade allows for tl . ,~ rebate of in-

direct taxes to exports and for the appli -cation of indirect taxes to imports. Coun- GATT has played an important roletries "relying 'heavily on indirect taxes, in liberalizing international' trad ee.g., the Common Market member na- through the removal of tariffs. 'It istions, enjoy a comparative advantage 'hoped that GATT will parallel its pas tover countries relying more heavily on efforts by the effective removal of non-directtaxes, .,since-no border'tax adjust- tar ff'barriers to;international , trade .

—7

7s: - -

25

I

,

_pp erg •x

THE E.E.C. DIRECTIVES INTRODUCINGTHE COMMON VALUE-ADD ,ED'TAX SYSTEM . "

At a meeting held in Brussels on February Border adjustment taxes will therefore9, 1967, the Council of Ministers of the'Euro- rcontinue to be applied to imports enteringpean Economic Community adopted two di- the Common Market, and tax rebates willrectives on the harmonization of turnover taxes continue to be given to exports leaving thein the 'six member states . The first directive Common Market area. The rate of borderforesees the removal of the cascade type turn- _

adjustment tax to be applied to Commonover tax system in all member countries and - `Market trade with the outside world willthe adoption of a common value-added tax correspond to the value-added tax rate ap -:system. While the first directive defines the plied within the Common Market. This

-essential principles on which this system is to rate has not yet been fixed and will be thebe based, the second directive makes detailed :.object of future Common Market Councilarrangements for the application of this com- Zirectives . It is generally assumed that th emon system. The main provisions .,of .the, ';first common value-added ;tax 1 rate willbe ;about.directive,are .as follows-: 1 15 per cent .

1 . 'The common TVA system will come into The

second

directive

concerns

the-method of application of the TVA system ,force on January 1, 1970, at latest . The

national 'laws required to bring this about which each Member State is to follow. The .must be promulgated early enough-for, this following are the-main points ;dateline to !be complied with. " . 1, ,,The TVA will be a general tax on con-

sumption levied, in principle, at all stage s2 . . Before the end of `1968, the Commission of the economic process and in such a way

is required to submit to the Council pro- that it falls only on the value :added atposals indicating how and 'by what date each stage, The method of collection is a sthe harmonization of turnover taxes is to follows: the tax fcr the total turnover i s;achieve its ultimate aim, the abolition of calculated, and from this amount the totalAll taxes levied on imports and of all tax ,tax on purchases (previous tax) is sub -drawback on exports in trade between tracted, the difference being paidover .to:Member States. The Council'wiil, if possi- ;the tax :authorities ,?ble, take its decision on, ;these proposalsibefore January `1,1 .970.

- ~, TVA is to be paid on merchandise :andservices supplied within ,the country, ;and ,

Point two of this ,directive, by providing on merchandise imports .Sor the adoption of a common value-addedtax throughout the Common Market, per- 134

In principle, TVA will be charged on de -mits the changeover to the origin principle liveries of goods up to and including thefor intercommunity trade, Under the origin retail stage. Until the date on which fiscalprinciple, as noted earlier, tax frontiers frontiers are abolished, the Member State sbetween Common Market member states -will, however, be free to limit the area of ,

-

will cease to

exist,

thereby

extending: „application of TVA to stages 4p to :and_ . :.;equal market conditions throughout the including .the wholesale stage ,whole common market area . Under the

`:origin principle goods are taxed where 4. 'Taxation on services is only compulsor y+they are produced regardless

of their when they have a marked direct or in-fina'1 place of consumption, Only with re- direct effect on the prices of goods . A,gard to trade with the outside world will list of these services is given, It includesthe destination principle be retained, as the assignment of patents and trade marks ,suggested by the Neumark Commission,2 freight transport and warehousing, but no t

1 . First and Second Directives of the Council of Ministers, The Harmonization of Turnover 'faxes, February1967, CEE Press Release .

2, International Bureau of Fiscal Documentation, The E.E,C, Repotts on Tax Harmonizat(:aa, The Report ol th eFiseai .and Financial -Cummittee(Neumark Re port') . Amsterdam ; I963, p, 149,

26

: banking services . It is left to the Member of these waivers may, however, not excee dStates to impose such taxes as they may the total effect of reliefs previously granted

_ • , _ • ;deem appropriate in respect of the large within the framework of social policy.

; :group of services not included in the list :A .

The directive provides for a special prose -" (e.g .

those

supplied by

doctors,

hair- " ,dure in exceptional cases where a Memberdressers and others who usually supply State considers it necessary to introduce.services only to private individuals) . special measures designed to simplify the

:.5 . . ''The place where the service is taxed is to collection of taxes or prevent fraudulen t

- be the place where the service in question practices .is used or exploited, The Council, acting 9, 'Each Member State may at its discretionon a proposal of the Commission, may apply'

small firms, with respect to whic hhowever make special :provisions depart- the api,Aication of the normal TVA syste mng from this rule. would encounter difficulties, such specia l

,8,

Previous taxes imposed on deliveries of arrangements as it may deem most suitablemerchandise, on services or on merchan- in the light Hof national :requirements 'and,.dise imports are deductible from the TVA resources .

. 'payable on the relevant turnover . Nor- 10. 'With regard to taxation of agriculture, themalty, previous taxes may be deducted Commission is called upon to submit t oin full and directly. In order to alleviate the Council as soon as possible proposalsdifficulties connected with the change-over to ' the new system, Member States

_ for common implementing procedures re -=

may, however, during a transitional period,acting to trade in agricultural products, 3

make partial deductions for capital goodspoint 10 of the second directive of the Coun-

Cil of Ministers indicates that a special arrange -each year (deductions pro rata temporis ). or'

,or exclude capital goods either wholly or,

for the taxation of the agricultural secto rpartially from the system of deductions . will be applied, The Commission of the Euro -

In addition, the Member States are free, pean Communities in February 1968 submitte dto the Council a proposal for a third Counci lafter consultation within the Community ,

to bar deductions in respect of capital directive on the harmonization of turnover taxe sgoods, either wholly or in part, for reasons with regard to the agricultural sector,connected with the current business situa- The proposed directive will include the agri-;tion, cultural sector in the common value-added tax

'7:,

Although Member States are free, untilsystem, permitting agriculture to integrate itsel finto the general economy but avoiding discrim-

fiscal frontiers are removed, to determine ,ination among the different producers withi n.,tax rates and exemptions independently, the community, It is anticipated that the pro-the directive sets certain limits to their visions concerning agriculture can go into effec tdiscretion in this field . Where exemptions by January 1, 1970, the date at which the Com-~', ;are concerned, deduction of previous tax anon Market is to adopt its common value .will normally not be allowed, Reduced added tax system, The proposed directive for-

-rates may not be cut below a certain min- Sees that deliveries and imports of agricultura limum. Until fiscal frontiers are removed, roducts shall be subject to a common low rate ,both these rules may, however, be waived It is expected that the Council will fix the rat efor precisely defined social reasons for the to he applied to agricultural goods at abou tbenefit of final consumers . The total effect 'half the normal rate of tax on value-.added,a

3, first and Second Directives of the Council of Ministers, op, ri p ,4, •Commission of the European Communities, Spokesman's Group . Press Release, February, .1966., Proposal fordirective ,on .application ,of .the ,tax ,on value added ,to aurnover in agricultural products,

27

A endix _ Il .

~TuEGERMAN LAW;ON VALUE!-ADDED TAXES. :':

It should be understood that the change value-added tax law .6 Subject to the tax are al lbrought about by 'this new law is actually a pre- deliveries and services, including those to sel fliminary step in the direction of the common !and self consumption as well as imports . Thevalue-added tax . While it is expected that the ~exemption from value-added taxes are de-

"Netherlands will also adopt a national value- scribed in Articles four through nine . Exemptedadded tax system, it is unlikely that Belgium, from the value-added tax are exports, services

Atatly, and Luxembourg will devise a value- and sales abroad, services rendered by insur -atdded tax system of their own before adopting ante companies for clients established abroad ,the communal value-added tax system by Janu- Postal transactions and internal navigation ar eary 1, 1870 . The German value-added tax law s also exempted from value-added taxes, as wel las put Into effect by the beginning of 14168 - .us certain foreign'"exchange and capital trans-replaces the former cascade type of turnover actions . Occasionally, the option to renounc etax. This new tax applied to all deliveries of the right to exemption is granted by the law, a s,goods, including self consumption and delivery ~ in the case of internal navigation and leasing orto self, as well as services and imports . Taxable renting of land and similar operations . Furtherpersons are those who engage in transactions exemptions

from

value-added taxation arewithin the scope of industrial, crafts, conuner- granted to health and social services .

<_cial, or professional activity . Only small busi -,nesses whose annual turnover does not exceed The tax base, which in principle is the pricethe equivalent value of $5,000 tare exempted of the product or service excluding the turnove rfrom this tax, The tax base is the sales price of ,ax is defined in Article 10 ; however for importsproducts, while the method of determining that tux base will be the value declared for cus-

-value added is the deduction method, allowing toms purposes (A► .icle 11) plus customs dutiesfor a credit for the amount of tax paid at pre- and any special, -: ponsunintipa '.tax, 'excluding , .vious stages of production, The accumulation turnover'tax,sof capital goods is exempt from value-addedtaxation. There are two tax rates, the normal The tax of 10 percent is fixed by the law a srate of 10 percent which is to be increased to 11 the normal rate . 9 It applies however to the net

_

`percent by June 30, 1868, and the special rate ,

price so that the actual tax rate charged-

of 5 percent which is to be applied to certain amounts to 8 .08% . A reduced rate of 5 percen t"sectors of the economy, for example agriculture, is applied to u limited number of operationsThis special rate will be raised to 5Vh percent connected with specific products (In realityby June 30, 1888, These are also the rates that the rate applied is 4,78°.b) ; tt . agriculture, b ,will be imposed on foreign products entering operations connected with the exercise of aGermany, The German value-added tax law liberal profession as defined in Article 18, Para-allows few exemptions . The principle ones are graph 1, item 1 of the income tax law, lu As.

-banking, cotntnun~cation, waterborne transport, pointed out earlier, the present rmes are to b eand the leasing of real estate, short lived, The German Bundestag has alread y

The following shall present a brief summary enacted an amendment increasing the tax rat eof the major provisions expressed in the German to 11 percent and 5.5 percent respectively, l l

13 . Commerce Clearing House, German Vditie-Added Tax Law, translated by H, Karsten 5chmldt, others, Cht-cago, 1%7,145 pp ,

6,

Ibid., Articles 1, 2, 3 ,7 . Ibid,, Articles 4, 5, 6, 7, 8 and 9 ,tt,

Ibid., Article to ,9, Ibid„ Article 12 .

10 . The law considers a liberal profession to be any Independent activity of it scientific, artistic, literary, Instruc -tional, or educational nature ; the Independent professional activities of doctors, dental surgeons, veterinarians,

- -lawyers and notaries, patent agents, surveyors, engineers, architects, chemical engineers, auditors, tax experts ,economic experts, public accountants, tux advisors, medical orderlies, dentists, remedial gymnastic supervisors ,translators, marine pilots, and similar professions ,

28

Imports will be charged value-added taxes o f- - equal rates as applied to domestically produced

products by means of border tax ndjustments . 1 2On the other hand, exports are not subject t othe new tax, for value-added taxes are refunde din, full on exports .

The tax liability for deliveries and other per-formances 'of the entrepreneur include sel fconsumption and delivery to self, 1 3

Article 14 gives the express provision makin gthe issuance of invoices compulsory. At thesame time included in this article is specifi cinformation to be contained in each invoice .

In total, the German Value-Added Tax Law;covers 33 articles, dealing with the differen t

- -aspects connected with the changeover t ovalue-added taxation. The articles 15-33 are ofa more general nature concerned with the re-quirement to keep books establishing the ta xperiod, and the taxing of entrepreneurs withlow total turnover, etc .

Exceptions are made for the articles con-cerned with long-term adjustments as called forby the changeover to,. this new turnover taxsystem.

Article 15 of the German Value-Added TaxLaw calls for the complete deduction of turn-ovf!r taxes on capital assets by January 1, 1988 ,Hcwever, the economic ramifications of thisapproach were not feasible . Inevitably, it wouldhave resulted in business decisions to foreg onew investments until 1988. Furthermore, i twould have resulted in a heavy drain on gov-ernment revenues . The law takes a differen tapproach which in effect provides for a step b ystep deduction over a five year period . 14 How-ever, all further fixed asset additions throug h1972 will be subject to a quasi investment tax ,This tax, levied at an 8 per cent rate in 1988,declines gradually to zero . 1 5 Similar adjust-ments were necessary with regard to long-termcontracts, Contracts entered into prior to Octo-ber 1, 1987 which were to be fulfilled, whetherin whole or in part, subsequent to the effectiv edate of the new tax had to be reconsidered ,Should the added-value tax be higher than theformer cascade turnover tax, the supplier wil lbe at a disadvantage were the contract price

to remain the same, If the value-added ta xwere lower, the purchaser would be at a disad-vantage. The new law provides for readjust-ment of the contract, where the total tax burde nincreases or decreases materially, 1 6

The licensing agreements in effect before th evalue-added tax also had to be re-evaluated . 1 7As licensing agreement royalties are subject t oturnover taxation and, further, as there is gen-erally only one transaction, the new tax couldresult in a substantially greater burden to th elicenser . Moreover, the German licensee wil lhave the right to deduct this tax from the taxpayable by hitn on his own sales . In order toalleviate changes resulting from the change-over to value-added taxes long-term contrac treadjustments are worked out .18

Considering the effects of the new value-,, .added tax on prices, it is very difficult to mak eany valid observation as of yet . The switch tothe new tax in Germany has not been an easyone, and it will take months before things wil lsettle down again . Some firms have-taken ad-vantage of the changeover to a new tax systemto raise prices sharply, perhaps because the ydid not know how the new tax would work, o r'because they were unable to calculate itsimpact correctly, Some businesses simply raise dthe old prices by 10 percent, although the ol d.prices already contained former turnover taxcharge. Presumably, both the present slow paceof the West German economy and existing com-petition will limit unrealistic price rises. Biggerand more sophisticated producers have re-frained from increasing prices, knowing ho wmuch the old turnover tax had affected prices .The leading car manufacturers, for example ,have kept their price list unchanged, as hav emost book and newspaper publishers . Industria lbuyers of such products in fact find themcheaper, as they will be able to charge the taxelement in the price against their own taxliability,

It should actually be possible for the pricesof many types of food to go down, as th ereduced rate of only 5% is applied to thoseitems, Whether in fact the price of food will b elowered remains to be seen, and will depen dabove all on local competitive situations . be-tween retail outlets,

11, $undesgesetxblatt, Tell 1, October 18, 1967, (Added value tax law, )12, Commerce Clearing House, Garman Added Value Tax Law, Article 11 ,13 . Ibid ., Article 13 ,14, Ibid ., Article 15 ,15, Ibid., Article 30, The rate is 8% of all additions made In 1968 ; 7% of all additions made in 1969 ; 6% of al l

additions made in 1970 ; 4% of all additions made in 1971 ; 2% of all additions made In 1972 and zer othereafter .

16, Ibid ., Article 29, point 2 .

17, For discussion see Jacob Strobl, "Germany's Added-Value Tax ; Its Impact on Licensing", German Amerl.can Trade News, (New York), Vol, 21, No, 10, October 1967 .

18, Commerce Clearing House, Ger►nan Added Value Tux Law, Article 29,

29

=

- -

By the end of last year, the German American of -2.9% and +1 .3% . Even after July 1, 1968Chamber of Commerce published the results of —when TVA rates are to be increased from 10%

"' -a study undertaken by the Association of Ger- and 5% to 11% and 5 .5% — consumer pricesman Consumer Organizations, giving a broad should still average 0 .8% below current levels .outline of the effects of value-added tax on The research organization noted, however, thatprices, 19 The Association found : utility costs will rise almost 6%, hotel , prices

about 5% .•-Food (which accounts for about 34% of th e

money spent by an average . worker's family) It is still unclear just what effect the ne wwill mostly be cheaper ; tax will have on prices for imports and exports .

Common Market tax experts point to a com-ro :

— Manufactured goods (about 30%) will stay bination of short-run and long range factors a sthe same with small

reduction sabout

price re the reason why an immediate appraisal is im -on some products being offset by increases possib:e. The answer to this question is com-on others ; plicated, because the former turnover tax, bein g

— Services (about 15%) `will be somewhat both cumulative and hidden within the grosscostlier ; " selling price of products, cannot easily bercom -

pared with the new tax system .— :-Utilities and gasoline (combined, about 6% )

will gradually rise in price over the next six Nevertheless, occasional increases of charge smonths. against imported products have been observed.

It is claimed, however, that these increasesThe Association's report includes the following result from their having been undercharged i n

-table (some items appear in more than one col- comparison with domestic goods before Januar yumn because the information was gathered 1, 1968.

"' from many sources in different localities) . Present evidence indicates that the change -.A second, unrelated study made by a major mar- over to the new tax system for both imports an dket research organization supports the Associa- exports may give some items a competitive ad -tion 's conclusions. The market research firm vantage they did not formerly enjoy . Othersfound that consumer goods prices will decline have lost their former advantages while stillby a weighted average of 1 .5%, with extremes others are not affecte&at .all.2 0 . .

19. German Business Weekly, (New York), December 27, 1%7 ,20. For more discussion on the effects of value-added tax on foreign trade see :

1 . German American Trade News (New York), Vol, 21, No. 9, September 1967, pp . 5 .6 ,2 . Peat, Marwick, Mitchell do Company, Effects uJ the New Tax on Added Value on Your Business Opera.

lions to Germany. (Frankfurt : 1%7), 21 pp .

LOWER

UNCHANGED

HIGHERCost of services .

Vacation sRail tickets

CommutingDry cleaning

Commuting

Hair carsTelephone calls

Inns and hotel sPostageHair care

Manual tradesHealth Resorts

Cost of utilities

Water WaterElectricityGasoline

Cost of consumer goodsKitchen rangesLight fixture sSewing machine sSmall appliance sGlasswareKnitted and woven goodsFurniture

ChinewereMajor appliancesUsed carsTiresRecordsCamera souterwear

30

.APpendix IIITHE vAME•ADDED TAX

The consumption type of value-added tax_ The manufacturer deducts from the total taxcan be described as a retail sales tax, of $58 the $31 which were included in the pric e

The base to which this tax applies is the total of the materials he bought . The producer there-'fore renders only $25 of taxes to the tax author-of sales receipts of a . firm less the payment'p ''ities which is the tax of the value added bymade to other firms for goods and services, `him. The retailer will be charged the tota lAlternatively, the tax base or the total of value . amount of value-added taxes charged to theadded is equal to the sum of wages, interest -"product, This amount will then have to be pai dand rent payments to individuals, plus profits, by the final consumer upon purchase of the

The value-added tax explicitly grants credit product . Direct taxes, (such as corporate in -4or all taxes paid at earlier stages of production. come taxes), allow' no border tax adjustment.The advantage of correct tax assessment a teach stage of production is however combined Under TVA the correct border taxes are pos-with the administrativei complexity of multiple Bible, which is not the case under turnove r

taxes. Furthermore, TVA does not favor verti-cally integrated producers as can be observe d

With regard to capital accumulation, the under cascade type turnover taxes, l Thereby-value-added tax system as applied in Europe internal neutrality is guaranteed, irrespectiv e-allows for the complete deduction of all capital of the number of transactions the product ha sexpenditures from the tax base in the year of gone through before reaching its final con- . .

–purchase. Total deduction of capital expends- -Sumer. Integrated and,non-integrated business-" `

-

--tures is said to be the consumption type of is, taxed alike ,

;value-added tax, as compared to the incom e'type of value-added tax which allows for depre- External neutrality is also guaranteed by theciation of capital : equipment in the Years it Is value-added tax system . By rebating the tota lused.

- amount of turnover taxes to exports and impos --` ing a border adjustment tax to imports that wil y

An example will illustrate how value-added ',be equivalent to the domestically applied turn -taxes were applied in France before 1988, over tax, domestic and foreign goods are place d

Value-Added Taxation with a Rate of 20% *

total amount

Amount of tax

Pricecha

ed

Included

exclusivePurchases

In bill

In price

of taxMaterials $100

$20

$ 80

Fuel

45

9

3 6Containers

10

2

8

Value added by the producernot Including ta x

Tax payable by producer

Selling price of product

280

56

224

*This rate Isa~a s

piled to a base that Includes the tax itselfi the effectiv enormal rats distinguished from the nominal rate) Is 25% of theprice before e tax ,

1, Vertical integration eliminates the changing over Into different hands, which thereby avoids turnover taxation ,

v

31

10025

can the same competitive tax level . The cascadetype turnover tax with regard to internationalcompetition has disturbing effects, since theborder tax applied to imports will be higher orlower than the turnover tax domestically ap --plied. This curbs or stimulates imports respec-tively . On the rebate to exports side the samedisturbances to competition occur wheneverthe refund of turnover taxes is unduly highsince it then becomes an export subsidy.

While turnover taxes generally apply to con-sumption only, value-added taxation include sservices in its tax base as well . The tax base ,

- . , therefore is considerably wider than that o fturnover taxes. Consequently, the yield fro many given tax rate will be higher and mor estable for value-added taxes than for turnove rtaxes. Provided, of course, that exemptions, ifgranted at all, are kelii at the. absolute min-imum.

Value-added taxation in the light of the evi -°dence cited above reveals a definite superiorit yover the cascade type turnover tax . Neverthe-

._ less, TVA bears certain inconveniences .

Aside from the multiple tax levy, as affordedby the TVA, problems arise whenever differen ttax rates prevail within a particular countr ywith regard to the rebates to be given for taxespaid on preceding stages of production, Thi sproblem is amplified when goods change fro mone tax bracket into another.

It should be noted here that France presentlyapplies four separate rates while Germany ha sone standard value-added tax rate and a re-duced rate for a limited number of productsincluding agricultural goods . Similar problemsarise whenever exemptions are given to specifi c

'sectors of the economy, since it precludes th eachievement of optimum neutrality with re-spect to competition at the retail level . It is alsodifficult to determine the consequences of ex-emption and/or differential rates in connectionwith the shifting of the tax to the ultimateconsumer .

The country considering the change-over tovalue-added taxation faces particularly difficul tproblems. Defining the base to which value-added tax should be applied requires importan tdecisions . Difficult questions arise in connec-tion with the treatment of unrealized gains orlosses in real property, the tax treatment ofrents, interest, and dividends, especially amongfinancial institutions, to only mention a few .2At present France and Germany both exemp ttheir entire finance industry from value-addedtaxation . 3 Small enterprises, shopkeepers, an dcertain professions might have to be exemp tfrom taxes if their total income does not excee da certain amount . Agriculture, providing thebasic needs of a nation, might require a prefer-ential tax treatment, In this enumeration onlysome of the sectors that will require special

"consideration under a value-added tax syste mtire mentioned .

2. For a more detailed description of the different areas requiring special attention see Stanley S . Surrey, "Taxation for stabilization," Canadian Tax Journal, Vol. XIV, No . 3, May-June 1966, pp, 248-249 .

3, 'Commerce Clearing House, Ue Gentian Value-Added Tax Law, Article IV, Part 10, -

32