VAT attacks!

Like the theory of the second best that the 2006 congress marks, the value added tax (VAT) is now fifty years old. Judged by the extent and speed of its spread around the world, and the revenue that it raises, the VAT would seem to have been a remarkable success. Over the last few years, however, it has come under a series of attacks. This paper considers three of the most prominent of these. One is the fear (raised mainly in the United States) that the VAT actually does too good a job of raising tax revenue—which raises the empirical question of whether it has indeed proved as effective a source of revenue as its proponents claim and its opponents fear. The second is the view that the VAT does a bad job of taxing the informal sector—and that tariffs might consequently be a better revenue-raising instrument for many developing countries. The third attack is the most literal, by criminals rather than theorists: in the European Union and elsewhere, sophisticated VAT fraud, targeting its refund provisions, has become a serious concern. The paper also argues, more generally, that the many unanswered questions concerning the VAT reflect an unfortunate disconnect between the development of the tax itself and of second best tax analysis. I am grateful to Ben Lockwood and Stephen Smith for allowing me to draw on our joint work, and to Vidar Christiansen, Sijbren Cnossen, Isaias Coelho, Alain Jousten, Victoria Perry, and Emil Sunley for many helpful comments and suggestions. Views and errors remain mine alone, and should not be attributed to the International Monetary Fund.