Against a Sales Tax: How to Fix VAT by Allowing Credits Only Upon Payment

Together with my colleagues, in our proposals for the anti-crisis program, we wrote that we are against introducing a sales tax (a turnover tax).

We live in a progressive world, and the introduction of taxes that the rest of the world has abandoned inevitably suggests that it is being done out of desperation.

The main argument for introducing a sales tax (a turnover tax is a more accurate name) is that too large a share of VAT never reaches the budget because of sham businesses. Those who run VAT schemes have ample resources, so fighting them is difficult. So the authorities take the easiest path and introduce a simple tax, yet for some reason nobody looks at the risks such a tax brings. The problem is closed by creating new problems, which will then have to be fought all over again, not to mention the economic and social consequences, but more on that later.

Let us first understand what the main problem with VAT is. The main problem is that VAT from sham businesses that do not pay it is taken as a credit.

The scheme looks roughly as follows.

Company X buys goods, works, or services from Company Y, and Company Y issues an invoice with VAT shown separately. When the return is filed and VAT is paid, it is almost impossible to trace whether the previous counterparty actually paid the VAT. So Company X claims the stated VAT as a credit and reduces its VAT payments, while Company Y simply does not pay that VAT and becomes a problem company. This is roughly how payments to the budget are reduced. The scheme is especially popular among construction companies, which use fictitious invoices, and it is almost impossible to verify whether the service was actually rendered or the goods actually delivered.

In fact, the solution to this problem is very simple to understand, but rather difficult to implement.

I propose considering the following option for reforming VAT:

The VAT that is accepted as a credit should be switched from the accrual method to the payment method.

In other words, until the counterparty has paid the VAT, that VAT cannot be claimed as a credit.

With the introduction of electronic invoices, each invoice will be unique (its uniqueness can be verified by the business identification number (BIN) and a sequential number assigned to each organization). Accordingly, until the tax authorities show the status "Paid" for input VAT, it will be impossible to claim that VAT as a credit.

A company that pays VAT would file a return with incoming and outgoing invoices, and the tax authority's system would automatically calculate the amount payable on the basis of the invoices already paid by the preceding supplier.

This solves all the problems with VAT credits and unpaid VAT.

The only drawback is that, across the entire tax system, all VAT payers will have to shift their payments by one quarter. In the first quarter, many will pay VAT without a credit, because there will be no "Paid" status yet for the input VAT from their counterparties, who file their VAT returns in the same period. But this will happen only once, and after that the problem is resolved completely.

As for the sales tax (turnover tax), the question is not the rate but the nature of the tax. Any rate above zero will cause problems and risks that will have to be fought later:

1. From the state's point of view, it will be impossible to forecast revenues, and revenue targets will constantly be missed (unless they are set too low). Such a tax invites optimization through schemes that consolidate supply chains, through various agency agreements, and through understated sale prices. Every year optimization will take place and budget revenues will shrink.

2. Imported goods will not carry the sales tax in their cost, unlike goods produced in Kazakhstan, and the higher the degree of processing, the greater the share of the sales tax embedded in the cost. This will create competitive distortions with the other Eurasian Economic Union (EAEU) countries.

3. Exports are a similar matter. Even if a deduction is provided for exports, it will not be possible to deduct the entire sales tax, because from the second stage of processing onward it will be problematic to calculate and confirm the share of the tax.

4. Exporters that import components and fixed assets. Many exporters that import equipment and materials will immediately raise the cost of their products by the amount of the sales tax, because they will not be able to recover it. This applies first of all to subsoil users. Calculating compensation through subsoil use taxes will be quite difficult, since every subsoil user has a different cost of production while the sale price is the same. The result would be a heavier burden on more capital-intensive enterprises, while those with easily developed deposits would receive privileges.

This is not an exhaustive list of possible risks, so I believe all the risks for and against should be weighed before any decision is made on whether to introduce a sales tax.