The regressivity of a value added tax: tax credit method and subtraction method — a Japanese case

Masayuki Tamaoka

Fiscal Studies, 1994, vol. 15, issue 2, 57-73

Abstract: Value added tax (VAT) is often described as a regressive tax because it taxes consumption, and the propensity to consume tends to decrease as income rises. Countries that maintain progressive tax systems take several measures to remove the regressivity of VAT. These measures include (i) exempting food and social necessities and (ii) taxing luxuries at high rates and necessities at low rates. VAT of the subtraction type has two main variants, namely the tax credit method and the subtraction method. These two types of VAT have theoretically the same effects on a firm’s liability for VAT and a firm’s decision on price in cases where there is only one rate and there are no exemptions. However, in cases where multiple rates and exemptions3 are implemented, these two types of VAT no longer have the same effects on a firm’s liability for VAT and a firm’s decision on price. In the European Union, multiple rates are used to mitigate the regressivity of VAT in several countries.4 In a recent EU Directive, the EU proposed a dual-rate structure, namely a standard rate of at least 15 per cent and a minimum rate of at least 5 per cent. Also proposed was the abolition of internal border controls by switching from the destination principle to the origin principle. This means that each Member State can set its own VAT rates to mitigate regressivity and to secure its revenue.5

Date: 1994
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