This study uses an input-output model to examine the effects of substituting a consumption-type value-added tax for the existing business turnover tax on both aggregate and individual prices as well as on the distribution of disposable income among households. It is an application of so-called differential tax incidence and a follow-up study of the previous work published as Economic Papers (58) by this Institution. The present study includes a discussion of the proposed tax reform, the model used, and the empirical results obtained.
By using actual input-output coefficients and other related data for the year 1984, this study first estimates the required compensating VAT rate under four tax-shifting conditions, depending on whether the two taxes involved in the substitution are completely shifted forward or not. It is found that the required VAT rate is not very sensitive to the shifting conditions regardless of whether the criterion of equal nominal revenues or equal nominal budgetary balances is adopted. Under the assumption of complete forward shifting for both the business tax to be abolished and the VAT to be introduced, the required VAT rate, which is sufficiently high for the government to purchase the original bill of goods and services while keeping the same original nominal level of budgetary surplus or deficit unchanged, is estimated to be approximately 5.2 percent. Moreover, under the same shifting condition, the required VAT rate would be about 4.6 percent if only the lost nominal revenues were to be recovered.
Second, the study indicates that at the 5% level of the VAT rate to be officially imposed, the tax substitution would cause average consumer prices to increase by about 2 percent while the prices of capital goods and export goods would approximately decrease by 1.4 percent and 1.5 percent, respectively, under the assumption of complete forward shifting for the old and new taxes. If it is further assumed that the prices of petroleum products and electricity would be kept constant, the increase in consumer prices would be less than 1.5 percent while the increases in the prices of capital and export goods would be about 1.5 percent.
Finally, the study also shows that the tax substitution would be regressive but it would not be great enough to affect income distribution adversely.
