The International Monetary Fund has expressed concern over implementation of "incomplete" value added tax system in developing countries, saying it will reduce the benefits of the new taxation method as it omits service and other vital sectors.
"While VAT has been adopted in most developing countries, it frequently suffers from being incomplete in one aspect or another and many important sectors like services, wholesale and retail sector have been left out of the VAT net," says an IMF document.
It also said that the credit mechanism in the VAT system is excessively restrictive (that is, there are denials or delays in providing proper credits for VAT on inputs), especially, when it comes to capital goods.
"As these features allow a substantial degree of cascading effects (increasing the tax burden for the final user), they reduce the benefits from introducing the VAT in the first place.
The IMF report on "Tax Policy for Developing Countries" says rectifying such limitations in the VAT design and administration should be given priority in developing countries.
It says many developing countries (like many OECD countries) have adopted two or more VAT rates as multiple rates are politically attractive.
About the excise system in developing countries, the IMF report said the most notable shortcoming is that there is "inappropriately" broad coverage of products, often for revenue reasons.
The report said the economic rationale for imposing excise is very different from that for imposing a general consumption tax.
While the consumption tax should be broadly based to maximise revenue with minimum distortion, the excise should be highly selective, narrowly targeting a few goods mainly on the grounds that their consumption entails negative externalities on society, the report said.
It said the goods typically deemed to be excisable included tobacco, alcohol, petroleum products and motor vehicles.