PA 546 Constantine Hadjilambrinos
Taxes on Goods and
Services
Lecture 7
October 11, 2005
PA 546 Constantine Hadjilambrinos
Advantages
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Can have a broad base—significant source of revenue
Can diversify the tax base—minimizes efficiency and
equity problems
Can extract payments from individuals with high
economic capacity regardless of current income
Can be used on specific goods and services to
internalize externalities
Possibly enhance economic efficiency—levied on what
consumers take from the economy rather than what
they contribute to it.
Encourage saving and investment
PA 546 Constantine Hadjilambrinos
Types
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General: Applies to all
transactions
Specific (unit tax):
Applies to physical units
Single-stage: Applies only
once in production &
distribution process
Direct: Apply to total
consumption
Cons.=Income - Savings
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Selective (excise): Applies
only to specific transactions
Ad valorem: Applies to
value of transaction
Multi-stage: Applies to each
stage of production &
distribution process
Indirect: Apply to proxy to
total consumption
Retail sales tax, VAT
PA 546 Constantine Hadjilambrinos
Some design issues
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Multi-stage taxes can increase price of goods by
an amount that is greater than the collected tax.
Example:
Sales tax rate: 10%
Product markup: 20%
Step Cost
Markup Price B T
Tax Price A T
1
$1,000.00 $100.00 $1,100.00
2
$1,100 $220.00 $1,320.00 $132.00 $1,452.00
3
$1,452 $290.40 $1,742.40 $174.24 $1,916.64
$406.24 $816.64
PA 546 Constantine Hadjilambrinos
Some design issues
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Integrated firms may be advantaged by multistage taxes: fewer embedded tax costs
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Should producer purchases be excluded from tax?
If not:
 Tax
will not be transparent to ultimate payers
 Tax will raise cost of goods and services more than the
revenue it will produce
 Tax will affect different goods/services differently and
will change economic behavior
PA 546 Constantine Hadjilambrinos
Solutions
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Component part rule:
Producer purchases that
become part of products
are exempt.
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Direct-use rule:
Anything used directly in
production is excluded.
PA 546 Constantine Hadjilambrinos
Taxation of services
Most states only tax a few services—This can be a
problem in a service economy.
 Need to make distinction between “retail”
services and worker
employer relationships
 Need to avoid taxing services delivered almost
exclusively to businesses
 Social policy considerations may make it best to
avoid taxing medical, legal, etc. services
PA 546 Constantine Hadjilambrinos
Commodity exemptions
Sales taxes are generally regressive—higher
income groups tend to save and invest greater
portions of their income.
Exempting certain commodities (food,
prescription medication, sometimes clothes)
purports to address this regressivity.
Higher income groups tend to spend more on
food, clothes, etc, so, again, they benefit more
from exemptions. Rebates may be better
option.
PA 546 Constantine Hadjilambrinos
Use Taxes
Some jurisdictions do not levy sales tax (Andorra,
Oregon, Delaware, NH, tribes). Neighboring
jurisdictions can loose significant tax revenue.
Most jurisdictions (all states with sales tax) levy use
taxes on the storage, use, or consumption of
taxable property on which no tax has been
paid.
Use tax is extremely difficult to enforce.
PA 546 Constantine Hadjilambrinos
Remote Vendors
Vendors are the collectors of sales tax for the
state. What about purchases from out-of-state
vendors?
 Purchases from a local storefront. State can
compel vendor to collect tax.
 Purchases from a remote vendor with physical
presence in the state. State can compel vendor
to collect tax.
 Purchases from a remote vendor without
physical presence. State cannot compel vendor
to collect tax.
PA 546 Constantine Hadjilambrinos
Value-Added Tax (VAT)
VAT taxes every incremental increase in value in
each step of the production-distribution
process.
At each step, each business pays tax on its sales, but
subtracts tax it paid to its vendors.
VAT exemptions—Relieve seller from collecting
VAT on sales, but not from paying VAT on
purchases. Businesses, if exempt, cannot
recover VAT paid.
PA 546 Constantine Hadjilambrinos
Advantages of VAT
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Combats tax evasion & lack of vendor
cooperation in sales tax collection.
Collects tax from products imported, removes it
from products exported.
VAT provides more complete exclusion of
business purchases than retail sales tax.