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How effective will VAT reduction be?

By Vo Dinh Tri (*) – Tran Anh Tu (**)

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To support the program on socio-economic recovery and development, the Government has decided to reduce the value added tax from 10% to 8%. The reduction of two percentage points will narrow the national budget revenue in 2022 by an estimated VND49.4 trillion. Still, whether the policy will pay off remains questionable.

Why is VAT reduction needed for economic recovery?

When an economy faces turbulence, one of the short-term fiscal policies to stimulate consumption is VAT reduction. The efficacy of this prescription has been proven, with many economies having taken the pill to cope with the Covid-19-induced crisis such as Germany, Italy, South Korea, Spain, the UK and China, among others.

In principle, a VAT reduction will lower prices of commodities and services for end-users. In other words, consumers can buy more with the same amount of money, or pay less for the same amount of commodities or services. Less costlier commodities and services are among the important factors behind the consumption drive.

Vietnam has recently made the move by cutting the VAT from 10% to 8% to stimulate consumption so as to lend support for economic recovery. This policy is by no means a new one, as it was already introduced in 2009 to deal with the impact of the global financial crisis.

The degree of effectiveness of VAT reduction to cushion the Covid-19 impact varies from country to country, with some initial experiences having been recorded. In the UK, for example, the VAT reduction only paid off when taken at the right time – social distancing was eased, and the policy applied to tourism and catering services. In Germany, meanwhile, the VAT reduction has spurred the consumption of durable goods, with the most positive response seen among the youth with a low net income.

VAT reduction also carries negative aspects

A VAT reduction normally works in a mechanism through which a drop in the budget revenue is compensated for by benefits for consumers, but in certain instances, the policy is not implemented to that effect. In Finland, for example, when the VAT for hairdresser’s service was slashed from 22% to 8%, but service providers offered just half the intended amount for clients. As such, consumers could not enjoy the entire benefits, as service providers also gained a share in this case.

Given the case in Vietnam, an apparent negative aspect is a hike in tax compliance and tax management costs.

The new policy took effect on February 1, 2022, but guidelines have yet to be issued. It was not until February 16, 2022 that the General Department of Taxation organized an online conference to provide businesses with guidance. Therefore, enterprises have not been given timely support, and it took them much time to comply to the new policy. This stagnancy will adversely affect the ability and cost of their compliance as it is difficult to pinpoint product lines – amounting to the thousands – subject to the VAT reduction.

Another hiccup relates to addressing complaints and disputes, if any, between enterprises and customers as enterprises face numerous inquiries on the VAT rate applicable to each product line, or between enterprises and the taxman. This problem will certainly impact business in the long run.

Regarding the cost of tax management, tax officers directly supervising enterprises are facing huge pressure in terms of compliance and guidance for enterprises to ensure that they adhere to the tax policy. This pressure can only be relieved if the tax agency has prepared itself and provided its officers with training to address issues that may arise before a new tax policy is issued. In reality, however, this preparedness is absent. From the perspective of enterprises, the tax agency’s image will be blurred if tax officers fail to provide guidance over specific issues in an accurate and timely manner.

It is still too early to assess the effectiveness of Vietnam’s VAT reduction policy, and it is unknown if any research will be conducted for such assessment. The effectiveness of the tax incentive also depends on the tax rate cut, what products and services are entitled to the policy, the time it takes effect, and the period of application. In the case of Germany, the reduction was launched in the second half of 2020, applicable to two groups of taxable items, from 19% to 16% and from 7% to 5%. Vietnam, meanwhile, cut the tax for the group subject to the 10% VAT only on a line-item basis, not for all products and services.

For the immediate future, it is expected that the taxman renders maximum support for enterprises to benefit from the new tax policy, alongside equipping tax officers with necessary tools so that they can fulfill their duty while working with enterprises.

(*) IPAG Business School Paris and University of Economics HCMC

(**) National Economics University

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