VAT vs. Sales Tax: What Is the Difference and Where Are the Risks

The question of replacing VAT with a sales tax will now be debated long and hard.

To understand why such proposals are being made, let us first look at what VAT and a sales tax actually are.

VAT is a value-added tax.

In theory, VAT is calculated as the tax rate multiplied by value added.

In our system, value added is calculated by the indirect method: sales revenue minus intermediate consumption of goods, works and services (GWS).

Broadly speaking, then, value added consists of wages and profit.

Indirect taxes are ultimately always paid by the consumer, not the producer.

Accordingly, the higher profits and wages are, the more VAT flows into the budget overall.

VAT paid on imports of GWS is also creditable, so in theory it is deducted from the total taxable base.

Exporters, meanwhile, do not pay VAT, because they are entitled to deduct the VAT previously paid (charged on the GWS they purchased). There are two ways to do this: offset, and an actual VAT refund from the budget.

Since exporters have no domestic sales, all of them try to obtain a VAT refund. But getting VAT back is very difficult, as I explain below.

VAT has several problems, some objective and some subjective:

1. The objective problem. When profits across the country fall (which is relevant now, given falling prices for the main commodity groups) and wages fall too (when profits decline, staff are cut and the overall taxable base shrinks), VAT revenue to the budget falls. This affects budget revenues. To resolve the budget problem (I will write a separate article on this with Zharas), the principle of taxation could be changed and VAT replaced with another tax. On the surface, consumers would see no increase and might even see a reduction, but in practice the overall burden would rise.

2. The subjective problem: refunds of export VAT. The main problem with VAT is whether an exporter can recover the VAT it paid while producing its export goods. This is critical for exporters. Naturally, in bureaucratic terms, the tax authorities are in no hurry to refund VAT, because they are under pressure to meet their budget revenue targets.

The current principle of VAT administration is to build a pyramid of suppliers: if even one supplier has not paid its VAT, the VAT is not refunded in full. The key problem is that tax officials take a subjective view of whether the supplier failed to pay precisely the VAT that you claimed as a credit. It often happens that the same unpaid VAT of a single supplier is used as grounds for denying refunds to several buyers. It is practically impossible to prove that the supplier paid precisely your VAT.

The state also shifts the supplier's responsibility onto the exporter, even though, legally and economically, the exporter has no influence over whether its supplier pays VAT. Moreover, such an exporter cannot even sue the supplier, since it is not a party entitled to demand payment of taxes.

This approach introduces a great deal of subjectivity into refund decisions and allows tax officials to manipulate the figures.

The only solution to this problem is a complete overhaul of the VAT refund system. But that would require a separate article.

Sales Tax

It is still hard to understand what is meant by a sales tax. Russia has experience with one. There, in addition to VAT, there used to be a sales tax, which was a regional tax. Each region set its own rate, but it could not exceed the rate set at the federal level.

In Russia, this tax was levied only on retail sales and was not creditable.

If something similar were introduced in Kazakhstan, it is hard to say how justified it would be, because a tax on retail sales would not replace all VAT revenue, or else the rate would have to be very high.

If, instead, something like a turnover tax were introduced for all enterprises, it could in fact significantly exceed VAT revenue, and it would not depend on profits or wages. But there is a danger that such a tax would directly accelerate inflation in the country, which would hurt consumer demand. Naturally, there would then be no VAT refunds from the budget, and such a tax would simplify the whole process of paying taxes.

At the same time, the more processing stages there are in the country, the more tax falls on the end consumer, since a turnover tax arises at every stage. Yet we want Kazakhstan to have many stages of production and high value added. This principle of taxation would not encourage domestic processing.

Therefore, the introduction of a turnover tax needs to be approached very carefully, with painstaking calculations, unless the sole goal is to increase budget revenue.