The tax debate: Why raising VAT in Vietnam is just a bad idea

I remember clearly having a conversation about value added tax (VAT) with my government professor at Boston College.

He told me that after he was invited to join the Council of Economic Advisers under President Bill Clinton, he got a call from Joseph Stiglitz, the American economist who received the Nobel Memorial Prize for Economic Sciences in 2001. Stiglitz asked him: “If you were allowed to make a proposal to reform government finance in the U.S., what would it be?”

My professor responded without hesitation, saying that the U.S. should replace corporate income tax with VAT.

He said the latter is transparent and avoids one entity from being responsible for paying a number of taxes, and that it's also the most important source of revenue in many countries.

It is because VAT “has no eyes”. It does not distinguish the rich from the poor, men from women, or the old from the young. Those who use the same product will have to pay the same tax.

I’m not surprised by the recent proposal made by Vietnam's Minisitry of Finance to raise VAT, but I am disappointed. It will have negative impacts on economic efficiency and social equality, and it will not help the country deal with its high public debt and state budget deficit.

Why so?

According to the Ministry of Finance, the main reasons for raising VAT are to balance the state budget and to cut public debt. The ministry said the current rate of VAT in Vietnam is too low compared to “international practices”, so raising VAT would kill two birds with one stone: balancing the state budget and playing by global rules.

First of all, I have to say that there is no such thing as an “international practice” for VAT. Rates vary from from 5 percent in Taiwan to 25-27 percent in most European Union countries. In Southeast Asia, VAT ranges from 7 percent in Thailand to 12 percent in Singapore and 17 percent in China.

The 10-percent rate in Vietnam is around average in a regional context, and not as low as the finance ministry has described.

Secondly, raising VAT will create more social inequality. VAT has no eyes, an the rich and the poor are just the same.

Both low-income and high-income earners spend most of their money on essential products, and these products cost just the same for both poor and rich people, including the tax. Therefore, the burden is heavier on low-income earners.

Thirdly, economic theories prove that when a tax is raised, both producers and consumers have to spend more, which reduces economic efficiency.

In Vietnam, where economic expansion mainly depends on household expenditure and companies have to cover high input costs, both “official” and “unofficial”, imposing more tax on consumers and businesses will only make things worse.

Around 30 percent fewer companies are paying corporate income tax now than they were in 2010, so should a government that “creates and develops” and “stands side by side with companies” make them pay more tax? 

The fourth problem is the enforcement of the tax increase. Ghost companies have already been set up to avoid tax, so if VAT is increased there would be even more reason for companies to hide.

Not only that, VAT already accounts for 27.5 percent of the state budger, far more than the average of 21.4 percent it pumps into European economies, where VAT stands at 21.3 percent on average. This also implies that increasing VAT would not necessarily help the state budget. 

In conclusion, the two reasons the finance ministry has given for raising VAT - balancing the state budget and cutting public debt - but that doesn't tell the whole story.

The cause of Vietnam's high public debt and state revenue losses is not due to its inability to collect revenue, it's down to inefficient use of the state budget. Raising VAT to top up to the state budget would not get to the the root of this problem, it would simply add to the overspending and result in more ineffective mega-projects that will remain half-finished for years.

The “international practice” the finance ministry should apply right now is using the state budget more efficiently, not raising taxes.

* The writer is a doctor of economics who is now director of research at the Fulbright Economics Teaching Program in HCMC, and research fellow at the Harvard Kennedy School. The opinions expressed are his own.