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I don't like the VAT/GST systems of indirect taxation because of several reasons, one of the reasons being stuff like Input Credit makes it quite complicated.

I was wondering what would be the problems with an indirect tax where the tax is only charged if sold retail? I would define a retail sale as something which is not sold to a reseller or to someone who adds value to it & sells them. All non-retail sales don't get taxed at all. Since this is a single point of taxation, there is no need for input credit. Those who do non-retail sales are taxed only income tax on their incomes.

I want that different states of a country be able to have their own tax rates for goods sold in their state.

I was wondering what would be the disadvantages of such a system. I can think of a few issues

  • How do you ensure something is actually a retail sale? For e.g. I may buy a years supply of something for home use, so it would be difficult to differentiate based on quantity whether it's a retail sale or not.

  • Let's say I manufacture & sell some good. I purchase parts from a vendor. The vendor may work out an agreement with me where by he sells me stuff without any receipt - I show the money I paid him as money spent on manufacturing that part myself so I don't lose out on my income tax. And the vendor gives me small discount because he doesn't have to show the sale at all & he doesn't have to pay income tax? Is this a loophole? Is there a way to fix it?

What other problems can happen because of a simple taxation system like this? Can they be fixed?

Alternately, what is a simple indirect tax system which any country has successfully implemented?

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I was wondering what would be the problems with an indirect tax where the tax is only charged if sold retail?

These taxes do exist in some places, for example USA has a sales tax which is only charged at point of sale.

However, such sales tax has some serious disadvantages. While theoretically sales and VAT tax would deliver the same revenue (Zodrow 1999)1, sales tax makes government enforcement very difficult.

VAT has large administrative burden compared to sales tax, but that administrative burden is there not just for shits and giggles but for reason. All that administration allows data to be collected at each step of production process which then can be analyzed to figure out which companies are cheating on their taxes.

With sales tax the administrative burden is smaller but it is much more harder to catch people who are cheating on the sales tax.

Now the incentive to cheat on your taxes increases approximately exponentially with the size of the tax, since tax burdens have exponential (approximately quadratic) relationship with tax rate.

As a consequence VAT is in essence only practical solution to use when government wants to levy high consumption taxes. Average OECD country has VAT rate of 20%, meaning that fifth of the value of the goods is collected as tax. In addition that is average, many developing countries have VATs that are as high as 26-25%. That creates huge incentive for tax evasion.

It is not a surprise that its US with its minimal consumption taxes (average sales tax in US is 6% nothing compared to the 20% OECD average VAT) that uses the sales tax, and even they could probably raise more revenue with equivalent VAT. Based on my reading of broad literature for any sales tax above of 2.5-5% it is worth while to switch to VAT system.

Can they be fixed?

The thing is that VAT is the cost-efficient solution (from the perspective of the government) to the problems of sales tax.

Most of the administrative burden of VAT is outsourced by government to companies themselves that have to make their accountants to do most of the job. Next, verifying that sales actually did take place under sales tax is very difficult and costly. Since under sales tax there is no paper trail it is difficult to verify if companies do not keep some goods out of the accounting and sell them without the tax, it would require a lot of enforcement that would have to be done manually (e.g. hiring agents provocateurs etc).


1: In real life sales taxes often have smaller coverage that in essence a political choice, theoretically they are perfectly equivalent

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  • $\begingroup$ So let's say General Motors in the US gets the steering wheel made by a vendor. Vendor supplies 1000 units of the steering wheel & invoices General Motors - there is absolutely no tax levied in that transaction? No tax, no excise duty or any other kind of tax? The only tax the vendor has to pay is his company's income tax? $\endgroup$
    – user93353
    Nov 26, 2022 at 11:42
  • $\begingroup$ Most of the administrative burden of VAT is outsourced by government to companies themselves that have to make their accountants to do most of the job - this is the part I dislike, it disadvantages the small business owner & provides a moat to the big companies which have armies of lawyers & accountants. $\endgroup$
    – user93353
    Nov 26, 2022 at 11:44
  • $\begingroup$ @user93353 there is no consumption tax levied on that (I dont know if there are some other non consumption tax) either under sales tax or VAT - to be clear under VAT the vendor charges nominally VAT but general motors would be able to get back the VAT from US government so it would not actually pay any consumption tax $\endgroup$
    – 1muflon1
    Nov 26, 2022 at 11:45
  • $\begingroup$ @user93353 well it sucks, but thats the only way how you can raise taxes as high as to 25% and not loose most of tax revenue to evasion. $\endgroup$
    – 1muflon1
    Nov 26, 2022 at 11:47
  • $\begingroup$ to be clear under VAT the vendor charges nominally VAT but general motors would be able to get back the VAT from US government - I am confused now, because in your answer you said that sales tax/VAT is not charged to the vendor in the USA & it's only charged at the point of sale. $\endgroup$
    – user93353
    Nov 26, 2022 at 11:47

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