This article is a write-up of a presentation made to the Maldives National University Open Forum “Ilmy Foavahi” on 26th February 2014. Both the presentation and the paper offer a personal response to the question; GST vs Import Duty- which is a superior tax?
GST vs Import Duty- which is the superior tax?
Ibrahim Athif Shakoor
Before examining the question, GST vs Import Duty; which is the superior tax? it is perhaps important to take a while to essay the lens through which tax and it's import is examined in this article. What is tax and and why are death and taxes the two things that us human beings are unable to avoid?
The Theoretical Underpinning.
Oliver Wendell Holmes famously said that “taxes are the price of civilization”. And herein lies the very crux of the issue of the role of tax in today’s economies. While free market economists will emphasize that taxes distort the price of a good or a service artificially, and will therefore, shift the demand curve, the need for taxes are not denied today, except perhaps on the fringes of the far-right.
Even in today’s center-right mainstream, it is largely understood and accepted that while economic agents should be left, as much as possible, to their devices to produce goods and services and to trade freely, the state is recognized as an ‘interested party’ that has to be dealt with. Therefore, the fact that there is a role of the state to play is no longer in doubt and the debate has moved on to the degree of state involvement and the perennial argument about minimizing state involvement in the economy vs the inflated extremes of a welfare society.
Depending on the economic philosophy of the people, the state will either provide basic security and infrastructure to allow economic agents to go about their business of producing economic wealth, or provide a whole spectrum of services including social protection and attempt social and ethical equality. Or indeed, something in between. The degree of tax imposed on the people, will, therefore depend on the form and format of the prevailing economic model of those presently in power; even if it is not so easy to always understand, who holds and control the reins of power in all its myriad manifestations.
However, whether the state provide for basic services or manage a welfare state, it will require tax income from the people to fund such services. It is the tax dollar, provided by the producers of economic wealth that allow for the state to provide these services. For, without state provision of essential security, individuals will not be able to devote full time for production of wealth and services.
Therefore, it is the tax dollar that has allowed for the building of bridges, roads, airports and other essential infrastructure. It is the tax dollar that offer care for the elderly and the needy. The tax dollar that keeps the policeman on the road and the thief behind the bar. The student at the university library and the surgeon in the operating theatre.
Civilization therefore, depends on the state being able to provide security and basic infrastructure and it is the taxes paid by economic agents that allow the state to do so. It is, therefore, in this context that the Wendell Holmes meant that taxes are the price of civilization.
Goods and Service Tax (GST)
Throughout history, taxes required by the state has been collected in various forms and guises. The two most known taxes in the Maldives; GST and BPT were introduced in the middle of 2011 and it is from this point forward that most of us have come to be familiar with the concept of paying tax. Some even believe that, as a population, Maldivians did not pay tax pre 2011 preferring to believe at times that state services were provided free of any charge. However, the truth is that Maldivians have always paid tax. In early days tax were paid “in-kind” including dried fish. Stories abound of katheebs travelling to Male’ with the vaaru or jizee that needed to be paid to the Sultan. In later years, until the advent of GST and BPT in mid-2011, license fees, import duties and bed tax from the tourism industry composed of the majority of state revenue.
Goods and Services Tax (GST) bill was gazzetted in October of 2011 and it was from this point on that paying tax to the government became popular as a concept. GST is a form of Value Added Tax, the concept of which was first introduced in 1954 in France to offset some of the disadvantages of the then prevailing sales taxes. Although, Sales Taxes are in theory supposed to be collected only from the end consumer, it is a difficult tax to implement and the decision of whether a product is at the end stage, often becomes arbitrary and therefore difficult to enforce and thereby to collect.
A Value Added Tax, by its nature is supposed to avoid the arbitrariness of the sales tax by taxing the degree of the value added by the seller, every time there is a transaction. When the buyer is not an end user, but has bought the good or service as input for additional value addition, the goods or services purchased are a cost to the business. The GST paid by the seller can be deducted from the tax charges it has to pay when it sells the goods or service after value addition.
By recognizing several stages of value addition and by applying the same tax rate at every level of the value addition chain, GST simplifies many complications of the sales tax and as the end user tax is the same as a sales tax, GST has been gaining favor in many countries in recent times.
GST as its name denotes targets goods and services; both intermediate and final and is therefore; especially in comparison to Import Duty as a means of collecting state revenue, a superior tax.
However, for all its advantages especially over Customs Duty; GST is a complicated and a difficult tax to collect and to compute. Each seller in the value chain has got to, not only calculate the value added at that stage of production, but also receive the proper documentation to enable the producer to deduct the tax already paid to the previous seller, lest the seller pays double GST. This require sophisticated documentation to be kept and records maintained. This is especially difficult to the small trader whose capacity to maintain adequate records to satisfy the tax authorities are always limited.
GST like all sales taxes and most other value added taxes, imposes the same rate on both the rich and poor alike. Therefore, the richest of the rich pays the same GST on his daily meal of rice, meats and accompanying condiments as the poorest of the poor does. While some may argue that this makes the GST a fair and equal tax, the amount of GST paid by the poor, in relation to his disposable income is considerable. Hence, many observers believe that many proportional taxes are regressive in their nature because it imposes a heavier burden on the poor. Regardless of the terminology preferred, GST is not a progressive tax and is regressive in the nature of its impact.
GST for all its popularity is still considered by many as an Indirect Tax because it is collected by an intermediary; the seller, to be paid to the tax authorities, instead of a tax like Personal Income Tax which is paid directly by the incumbent. However, because the tax burden cannot be shifted and has to be paid every time by the buyer, it is indeed termed as a direct tax by some commentators.
Import Duty is recognized more as an instrument of state sovereignty rather than a tax in its own right. It is used more in erecting trade barriers, protecting infant industries and preventing externalities rather than a means for collecting revenue to the state.
Unlike Maldives where 99.999% of goods are imported, a considerable portion of goods traded in other countries are produced in-country. Therefore, the majority or a considerable portion of traded goods within a country would not incur customs duty and is therefore not a valid comparison or an effective alternative to the GST, or any other form of Value Added Tax or indeed even a Sales Tax.
However, in the Maldives, because almost all traded goods are imported, the imposition of an Import Duty at the border, seem to have been, and remain as the most effective way for the Government to collect tax on traded goods. From very early times, especially before Tourism became the mainstay of the Maldivian Economy and the bed tax and resort rents started to play an important role in state revenue, import duty was the most important source of state revenue accounting for 71% of state revenue in 2007. However, since the introduction of GST, BPT the importance of Import Duty as a revenue generator has reduced accounting for 16% of tax revenue in 2014. Yet, it is important to note here that the latest amendments has, again increased import duty levels and will therefore, play a more sizable role in revenue hereafter. Therefore, over time, while Import Duty has not always been recognized as a tax, in the Maldives, it has and continue to play an important role in state revenue.
When viewed as a means to collect revenue from traded goods in a country like the Maldives, Customs Duty is seen to be an effective, cheap and simple method of collecting relevant tax revenue. The possibility of tax evasion is minimal and the effort required to maintain records and prepare documentation is on the larger wholesalers who are quite capable of preparing and maintaining adequate records. The smaller traders only have to bear the mark-up passed on by the importer and the volume and nature of records that need to be maintained by them is minimized.
However, while Customs Duty in the Maldives, may act as a reasonable alternative to a Tax on traded goods, it cannot be used to collect state revenue from services provided within the country. Hence an Import Duty would, even in the case of Maldives, miss a major component of the target portfolio from which the state intends to collect tax.
Customs Duty also cannot target in-country value addition and offers incentive to importers to break down major items into components and then assemble them to be sold thereby incurring a lesser tax rate in many countries including Maldives and even in Australia where Japanese made cars are imported as parts and assembled in Australian cities.
Customs Duty, like the GST is also an Indirect Tax and is also, for the reasons stated before, a tax that is regressive in nature of its impact on the poor.
Customs Duty needs to be paid at the entry point forcing importers to pay duty on inventory, some of which may spoil, damage or indeed get mislaid and therefore never get sold. Business people, because they are business people, avoid this loss by passing on a dead loss percentage on the goods sold. A component of the sale price may also include an interest component for the blocked cash for Customs Duty paid at the border is recovered only when the item is sold. The result, therefore, is that Customs Duty does in fact result in marginally higher prices for the consumer as importers hedge for such losses on their inventory and for loss of interest on blocked cash.
GST vs Import Duty
As sated above, in most countries and under most context, a case cannot be made of a real debate between the relative merits of GST and Import Duty, especially in the normal sense the two terms are used in most countries. However, in the particular case of Maldives, because of the high incidence of imported goods in the trading basket, it could be of real interest to examine the relative merits of both GST and Import Duty as a means of collecting state revenue.
The relative advantages and disadvantages have been examined above and has been summarized in Table 1 below.
|Easy to collect||Cannot target in country services|
|Easy to calculate||Cannot target local production|
|Cannot target in country value addition|
|Paid by Importer|
|One off single payment|
|Paid before sales are realized|
|Prices increased to recover from potential losses in inventory and blocked cash|
|Regressive in Impact|
|Target both Goods and Services||Complicated to calculate|
|Act as a sales tax in final transaction||Difficult to collect|
|Targets Value addition at every stage||Expensive for small traders|
|Inventory is not taxed||Regressive in Impact|
|Buyer pays the tax||Indirect Tax|
Based on the table, if the objective is to collect revenue from traded goods, perhaps the recourse to Import Duty maybe a better option, if only for today. Yet, as in-country value addition increases, the effectiveness of Import Duty will decline over time.
However, as a means of collecting tax revenue from the trade of services, Customs Duty is not a viable alternative and GST; for all its complications and burden on the small trader, is the only viable option even in the face of some many variations of the Value Added Tax now in practice in many countries of the world.
While GST remains the preferred option, the challenge is on the tax authorities to make the GST an easier tax to pay such that the incidence of tax avoidance is lesser and therefore resulting in higher tax revenue.