VAT Exemptions: Consequences and Design Alternatives COMPARING THE TREATMENT OF CHARITIES UNDER VAT AND RST Walter Hellerstein Francis Shackelford Professor of Taxation University of Georgia Law School Centre for Business Taxation, Oxford University Fiscal Institute, Tilburg University Worcester College, Oxford April 15, 2010

Table 1 Good RST = Good VAT PurchasesSalesOutput TaxInput Tax Credit VAT Liability Tree Farmer$0$100$10$0$10 Paper Mill$100$150$15$10$5 Printer$150$300$30$15 Retailer$300$500$50$30$20 Total$50 10% VAT

Table 2 Good RST = Good VAT PurchasesSalesOutput (Sales) Tax Input Tax Credit Sales Tax Liability Tree Farmer$0$100“Exempt” Sale for Resale N/A$0 Paper Mill$100$150“Exempt” Sale for Resale N/A$0 Printer$150$300“Exempt” Sale for Resale N/A$0 Retailer$300$500$50N/A$50 Total$50 10% RST

Table 3 Charities Under a Good VAT PurchasesSalesOutput TaxInput Tax Credit VAT Liability Tree Farmer$0$100$10$0$10 Paper Mill$100$150$15$10$5 Printer$150$300Taxable? Zero-Rated? $15 ? Charity$300$500Taxable? Zero-Rated? Exempt? ?? Total ? 10% VAT

Table 4 Charities Under a Good RST PurchasesSalesOutput (Sales) Tax Input Tax Credit Sales Tax Liability Tree Farmer$0$100“Exempt” Sale for Resale N/A$0 Paper Mill$100$150“Exempt” Sale for Resale N/A$0 Printer$150$300“Exempt” Sale for Resale N/A$0 Charity$300$500Taxable? “Exempt”? [Zero-rated] N/A ? Total ? 10% RST

U.S. State Reality: Bad RST Limited Taxation of Services –e.g., charities(!) Substantial Taxation of Business Inputs –40% of tax base by most estimates –Sale-for-resale exemption narrowly applied

Table 5 Charities Under a Bad RST PurchasesSalesOutput (Sales) Tax Input Tax Credit Sales Tax Liability Tree Farmer$0$100“Exempt” Sale for Resale? N/A$0 Paper Mill$100$150“Exempt” Sale for Resale? N/A$0 Printer$150$300Taxable? “Exempt”? [Zero-rated] N/A ? Charity (Services) $300$500Taxable? “Exempt”? [Zero-rated] N/A ? Total ? 10% RST

Current Treatment of Charities Under U.S. RST Sales to Charities –“Exempt” [zero-rated] in roughly half the states Definitional problems abound –Taxable in roughly half the states Limited exceptions (e.g., Red Cross) Sales by Charities –Goods generally taxable –Services generally exempt (as “outside scope”)

Policy Concerns Goods –Purchase exemption [zero-rating] (B2B) Revenue losses Unfair competition (on sale of “competitive” charitable services) –Sales exemption [zero-rating] (B2C) Revenue losses Unfair competition

Policy Concerns Services –“Exemption” [zero-rating] of purchases by and sales to charities part of overall structural defect in RST –Expansion of RST to services would create issues similar to those encountered with goods

Conclusion Good VAT = Good RST –Desire to assist charities should be addressed outside the RST to avoid revenue losses and administrative complexity and to maintain fiscal neutrality –Assistance should be provided by other means such as direct subsidies