The Search for Alternatives to Exempt Treatment of Financial Services Under a Value-Added Tax
GST IN RETROSPECT AND PROSPECT, pp. 123-154, Richard Krever and David White, eds., Thomson Brookers, 2007
32 Pages Posted: 26 May 2009
Date Written: May 25, 2009
Most countries with a value-added tax (VAT) exempt financial intermediation services from the tax. While exemption is generally perceived to be undesirable, it is also widely regarded as unavoidable because of technical difficulties in applying VAT to these services. This paper reviews the standard rationale for exempt treatment and then considers the relative merits of two recent challenges raised in the tax literature. The first challenge involves the application of cash flow taxation to financial intermediation services in a manner that is consistent with an invoice/credit VAT. The second challenge proposes a comprehensive system of zero-rating of financial intermediation services, which is supported by a characterization of the household consumption of such services as non-taxable. The author argues that each of these alternatives to an exemption system suffers from both theoretical and practical implementation difficulties that make maintenance of exemption the preferred approach in the short term. There is, however, a much simpler alternative to these fundamental reform options. Many of the interpretative problems and associated inefficiencies that plague an exemption system arise from the need to distinguish between taxable and exempt financial services. The author argues that these difficulties can be eliminated, to a large extent, by basing the distinction on the form of prices.
Keywords: consumption taxes, exemptions, financial institutions, GST, VAT
JEL Classification: G2, H3, H35
Suggested Citation: Suggested Citation