One of the arguments often put forward in support of changing to a consumption tax system is that it would be much simpler and therefore likely to result in fewer compliance problems. The system most frequently proposed is a value-added tax (VAT) for business, and a wage tax (that could be progressive) for individuals. Wealthy individuals whose income consisted in large part of capital gains and other investment income would pay little or no direct tax.
How does the claim about compliance hold up? Bahro Berhan and Glenn Jenkins have written an article that looks at efforts to control VAT evasion. They suggest that controlling VAT evasion may produce high compliance costs. The article considers measures used to control VAT evasion in Northern Cyprus and Boligiva and concludes that the measures undertaken in those two countries have imposed significant costs on employers and employees--amounting to about one and one half times the total cost of administering the domestic tax system and 5% of the revenues collected by the VAT system.
The following is an excerpt from the abstract of the paper (available from the authors).
"Although it is sometimes claimed that Canada's GST [equivalent of a VAT] is self-enforcing--vendors cannot evade tax on sales because purchasers will want to produce evidence that the tax has been paid in order to claim input tax credits--in reality GST fraud is big business. Solutions to GST evasion generally involve increased audits and therefore increased complaince costs for taxpayers and increased administrative costs for governments, which represent a diversion of resources from more productive activities and an economic loss to the country." [emphasis added]
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