Academic journal article Journal of Accountancy

Who Said the World Isn't Flat?

Academic journal article Journal of Accountancy

Who Said the World Isn't Flat?

Article excerpt

The proposals to replace the current federal income tax have been the subject of intense debate. Given the current political climate, they may even become a reality. Indeed, if the Republicans gain more seats in Congress, not to mention the White House, the pipe dream of Main Street Americans doing their tax returns on postcards could come true. While such radical change is a long way off, competing proposals and the inevitable opposition of special interests contribute to a feeling that a unified vision may never be achieved, much less enacted into law.

In addition to its numbing complexity, the present system is considered defective because it is costly to administer, biased against savings and investment and puts U.S. businesses at a disadvantage when they try to sell goods in countries with consumption-oriented tax models. Many have long felt the system inherently unfair, providing the wealthiest Americans the majority of the benefits.

To replace the present system, four major reform proposals have been suggested, each with a number of secondary provisions, which are discussed below.

VALUE ADDED TAX

House Ways and Means Committee chairman Bill Archer (R-Tex.) supports a complete switch to a VAT (details of his version have not yet been released, however) to encourage investment and savings by taxing consumption, to rid taxpayers of the tedious task of complying with current regulations and to bring the "underground economy" within the tax net. VAT critics point to its regressive nature (it's likely lower- and middle-income taxpayers will bear the greatest burden as more of their income is directed towards consumption), the fact such a revenue collection mechanism has never been used in this country, the potential for large administrative costs and fears a VAT could be adopted without concurrent elimination of the income tax.

VAT is imposed and collected on the value added at each stage in the production and distribution of good or services. Thus, the tax base for a VAT is generally the difference between the value of an enterprise's sales (outputs) and purchases (inputs). Value added calculation can be done several ways, including the credit-invoice method, the subtraction method (also known as a business transfer tax) and the addition method. Historically, other countries have favored the credit-invoice method.

Credit-invoice method. This imposes a tax on sellers (normally disclosed on the sales invoice) that is arrived at by applying the tax rate to the sales price of goods or services. A business credit is allowed for all VAT paid on purchases of taxable goods and services (inputs). Nonbusiness consumers are not eligible for such credits.

The credit system avoids multiple taxes on the total final purchase price so the net tax paid at a particular production or distribution point is based on the value the taxpayer adds at that stage. Theoretically, the cost to the ultimate consumer embodies the tax paid at all levels of production and distribution. Taxpayers can calculate the tax by subtracting the cumulative tax on purchase invoices from the cumulative amount on sales invoices. Exhibit 1, page 40, provides an example.

Exhibit 1: Example of Credit-Invoice Method VAT

Assume Boris Morgan sells felled trees to a paper mill for $1,000.
Morgan was not subject to tax on anything used in producing the
trees. The paper mill processes them into rolls of paper and sells the
rolls to a distributor for $1,300. The distributor cuts the rolls into
sheets, packages them and sells the packages to retail stationery
stores for $1,500. The stores sell all of the packages to nonbusiness
consumers for $2,000. The jurisdiction in question levies a broadbased
10% VAT. The tax would be determined as follows:

Production                       VAT on        VAT on      Net VAT
stage          Sales             sales       purchases

Landowner      $1,000 x . … 
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