Introduction

The emergence of the consumption based Value-Added Tax (VAT) and its
unprecedented success in the developed world, motivated largely by its greater efficiency
and buoyancy, encouraged the developing countries to adopt VAT during the decades of
the eighties and nineties. However, with the exception of a few, many countries faced
multiple difficulties in the adoption and implementation of VAT. Pakistan, undeterred by
the concern generally expressed in the developing countries, decided to take the bold
initiative and move forward with the introduction of VAT in the country, the goal being
to develop it into a major national tax.

Value added tax

Value added tax (VAT) is similar to a sales tax. It is a tax on the estimated market value
added to a product or material at each stage of its manufacture or distribution, ultimately
passed on to the consumer. Maurice Laur, was first to introduce VAT on April 10,
1954, although German industrialist Dr. Wilhelm von Siemens proposed the concept in
1918. Initially directed at large businesses, it was extended over time to include all
business sectors.

Principle of VAT

The standard way to implement a VAT involves assuming a business owes some
percentage on the price of the product minus all taxes previously paid on the good. If
VAT rates were 10%, an orange juice maker would pay 10% of the 5 per litre price
(0.50) minus taxes previously paid by the orange farmer (maybe 0.20). In this example,
the orange juice maker would have a 0.30 tax liability. Each business has a strong
incentive for its suppliers to pay their taxes, allowing VAT rates to be higher with less tax
evasion than a retail sales tax. Behind this simple principle are the variations in its
implementations, as discussed in the next section.
Why vat is imposed

The VAT is a requirement set by the IMF for Pakistan when it agreed to an emergency
package of $7.6 billion in November 2008 to avert a balance of payments crisis and shore
up reserves.

The loan was increased to $11.3 billion in July last year, a lifeline for the nuclear-armed
U.S. ally.

The IMF said last week Pakistan had indicated the VAT would be rolled out on July 1,
but analysts are sceptical about its impact because they say the government has not done
enough to make taxpayers aware of what it entails.

Pakistanis are already grappling with 13 percent annual inflation, and chronic power
shortages. VAT, which will replace a general sales tax, could add to prices, although
economists say its long-term impact on inflation would be minimal.

The Advantages of VAT

The VAT system gains more support as time passes. Supporters of the "Value Added
Tax" claim that the pervasiveness of tax evasion in the United States would effectively
stop if it switched to VAT. They also claim that a VAT is more fair to all levels of
consumers.
Identification

VAT is a tax system found in European countries which adds a charge to every step of
the sale process until a product or service reaches the retail stage.

Prevents "Double Charging"

The traditional sales tax system used in the United States allows the states to charge a sales tax
and the local/county to charge a sales tax; an effective double charge. The VAT tax system
prevents this by having a flat rate and charging only when a value is added to the product.
For example, with a 20 percent VAT tax, when a logger sells $1,000 worth of wood he
pays $200 in tax minus the VAT he paid on his tools. The next person in the chain, says a
carpenter, makes desks and sells them for $3,000. The carpenter would pay $400 in tax
because the logger already paid $200.

Reduces Cost of Evasion

In a normal sales tax system based on a percentage of the final sale, the government
takes a 100 percent hit when someone avoids the sales tax. In a VAT system,
avoiding the tax at any one stage does not completely avoid the tax. Not only does
this give people less incentive to evade taxes, governments who use this method see
a greater amount of income than from a normal sales tax.

More Transparent and Neutral

A VAT that requires the seller to put the amount of VAT already paid on the sale of
receipt increases transparency. This helps tax authorities track how much VAT has been
paid, and whether a business is trying to evade the tax. Because this acts like a corporate
tax a VAT is much better at preventing the use of complex accounting practices to avoid
paying business taxes. Since the tax is the same at all stages, it is very hard to lobby
against any inherent bias in the rate.
Downside
The main downside to the VAT system is the increase in the amount of accounting a
business needs to perform. This can especially hurt developing countries and small
business. Developing countries may not have enough people with knowledge of
accounting principles to help business keep track of the tax. Small businesses may not be
able to afford to devote resources and time to cross checking where VAT is coming from.

PROBLEMS OF VAT
There seems to be a lot of confusion among the public, as well as officials and
analysts on the mechanism and impact of VAT.
The government has yet to finalize the rates for the proposed VAT.
Under the IMF program, Pakistan is also required to increase the power tariff by
April 1, but that deadline has passed.
The government had already raised electricity charges by more than 16 per cent
since October, but the IMF is seeking a further hike.
There is very little chance that Pakistan will be able to meet the July 1 deadline
for VAT to be fully in place, though gradual implementation as soon as possible
may strengthen its case for future installments of the loan.