Determinants of value - added tax revenue : a cross section analysis

Value-added tax (VAT) has become a major tax instrument in over 50 countries and an important element in tax policy advice to developing countries. But few studies have empirically tested some basic hypotheses about the performance and key feature of VAT as a revenue-raising instrument. The authors examine the main determinants of VAT revenue in a simple cross-country framework using data from 34 countries to answer certain key questions: What empirical relationship emerges from existing data on VAT revenue and VAT rates for countries with a single VAT rate? How much, on average, can a 1 percent increase in the VAT rate be expected to raise VAT revenue as measured by VAT-to-GDP ratio? What key determinants of VAT revenue emerge from a cross-country analysis of the full sample of countries? Is there a statistically significant difference in VAT revenue performance between countries with a single VAT rate and countries with multiple VAT rates? The results of their regressions generally confirm the conventional views on the key variables influencing VAT revenue performance: the rate, the base, and rate dispersion. The rate and the base coefficients are significant and with the expected positive sign in all of the estimated versions of the model. An estimated model is used with appropriate cavaets to predict VAT revenue potential in countries (such as Bulgaria) that are thinking of introducing a single rate VAT. They also find that - other things being constant - VAT generates higher revenue in countries with a single VAT rate than in countries with multiple VAT rates. The difference in the estimated models for the two country groups is statistically significant, indicating a structural change. However this change in the pattern of VAT revenues cannot be explained exclusively in terms of differences in rate structure. A satisfactory explanation must include other factors, such as the base and tax administration capacity. The key policy implications are simple: to provide superior revenues, VAT should be levied in a single rate on as broad a base as possible. And tax administration and enforcement must be tough to ensure compliance.