Six Arguments Against a Turnover Tax

Those with a professional education in taxation probably know the various principles of taxation. The basic principle is fairness, which implies an equal tax burden on every economic agent.

It is universally acknowledged that a turnover tax (which for some reason we have decided to call a "sales tax") is one of the most unfair taxes, and that apart from being simple to collect, it brings no benefit whatsoever.

This state of affairs only shows that the path chosen is the one easiest to administer, while the efficiency of the tax is ignored. After all, the main task is to fill the treasury, not to develop the economy.

But enough philosophizing: I want to explain why I hold this position on the tax.

It so happened that taxes came to play not only the role of replenishing the treasury but also the role of stimulating the economy. As a result, various kinds of taxes emerged that support some sectors or areas and restrain others.

1. A sales tax supports the extractive sectors and kills high-tech ones

I will try to explain why this happens.

In practice, any primary raw material goes through stages of processing. Each subsequent stage of processing will carry an additional burden in the form of a 5 percent tax, and the further along the chain the stage, the higher the tax burden on that type of raw material.

This is a fact, and it will hit material-intensive industries especially hard, first of all petrochemicals, which we so much want to develop.

The more stages of raw material processing a country has, the higher the cost of the final product. Industrialization will suffer and stall at the third or fourth stage. Yet our policy, it seems, is exactly the opposite: to encourage higher stages of processing. Our goods will therefore become uncompetitive in this respect.

I think it would be easy for the National Chamber of Entrepreneurs (Atameken) to run such calculations, given the variety of manufacturing companies among its members.

2. A sales tax will hurt exporters

Currently, exporters have the right to deduct all input VAT. So when they sell finished products for export, they recover the VAT and end up with a net cost of production that contains no indirect taxes. By introducing a sales tax, we would simply make our exported finished products uncompetitive, because the sales tax embedded in materials, fixed assets and services would not be refunded. The question is, did we not want to create export-oriented industries and support them in every way?

3. What will be done about import VAT if a sales tax is introduced?

What about the goods we import? Will they be subject to VAT? If import VAT is retained, the tax rate will effectively be 17 percent: on top of the 12 percent, a further 5 percent will have to be paid down the chain, since imported goods are mostly traded by wholesalers and few people buy goods abroad directly for personal use.

On the other hand, those who import goods for production needs will have to pay VAT that cannot be recovered, which again makes the goods more expensive. There is a risk of growth in gray-market sales, since 17 percent is a lot.

And if there is no import VAT, our producers will be at a disadvantage compared with imports. Finished products, for example from Russia, would bear only 5 percent, while a domestic producer's goods would carry 15 percent, because every stage of their processing was subject to the sales tax. Our producers would again suffer.

4. A sales tax will hurt small and medium-sized businesses

Under an even-handed tax system, a diversity of businesses develops, and SMEs are always the foundation of any developed state. The mobility and innovativeness of SMEs allow them to widen the range of goods. But a sales tax creates a problem. To minimize tax payments, companies will merge processing stages within a single enterprise. This will kill SMEs, because they will have more stages in their chains and will suffer from unequal competition. The result will be less diversity and greater monopolization of the market by large players.

5. A sales tax will hurt rural residents

Large players can sell in big cities because it is less costly, but supplying rural areas while bypassing retailers is simply not possible. A rural resident will therefore always have one or two more stages in the chain than an urban one, which will make goods more expensive for local people.

6. A sales tax will expand the shadow economy

To avoid paying taxes, people will devise various evasion schemes, especially at the second and third stages. Contracts for processing and for the provision of services will become popular. In other words, the later stages will try to save on taxes and will invent various schemes of tolling arrangements, consignment of goods for sale, and so on. Tax officials will fight this and try to settle the question of what counts as turnover. I think they will even cite IFRS on revenue recognition and look at whether all the risks associated with the goods have been transferred, rather than at the physical goods themselves.

These are the risks that await us if a sales tax is introduced. All countries are moving away from this, while we, for some reason, are reverting to a relic of the past.

Later, I will try to write my comments on the retail tax.