Page Nav






"Disadvantages of Value Added Tax (VAT): Burden, Cost of Living, Complexity, Evasion, and Competitiveness"

  Value Added Tax (VAT) is a consumption tax system that is widely implemented by governments around the world. While VAT has several advant...


"Disadvantages of Value Added Tax (VAT

Value Added Tax (VAT) is a consumption tax system that is widely implemented by governments around the world. While VAT has several advantages, such as generating revenue and providing a stable source of income for governments, it is important to also consider its disadvantages. 

This article will explore the drawbacks of VAT, including the burden it places on lower-income households, its impact on the cost of living, administrative complexity, the potential for tax evasion, and its effects on business competitiveness.

Understanding these disadvantages can help in evaluating the effectiveness and fairness of VAT systems and inform discussions on potential improvements or alternative tax policies.


Disadvantages of VAT:

1.Burden on lower-income households:

2.Increased cost of living:

3.Administrative complexity:

4.Potential for tax evasion:

5.Distortion of economic behavior:

6.Impact on business competitiveness:



 Disadvantages of vat:


The Value Added Tax (VAT) is a widely used consumption tax system implemented in many countries around the world. While VAT has several advantages, it also has some disadvantages. Here are a few of them:


1)Burden on lower-income households:

One of the key disadvantages of VAT is its impact on lower-income households. Since VAT is typically applied uniformly on goods and services, regardless of income levels, it can disproportionately affect individuals or families with lower incomes. Here's why:


a) Higher proportion of income spent on consumption:

Lower-income households tend to spend a larger portion of their income on essential goods and services, such as food, housing, and utilities. As VAT is levied on these goods and services, the tax burden becomes a higher percentage of their overall income compared to higher-income households, who have more disposable income to allocate towards savings or non-taxable expenditures.


b) Limited ability to claim exemptions or deductions:

While some countries have provisions to exempt or reduce VAT rates on certain basic goods and services, these measures may not fully alleviate the burden on lower-income households. Additionally, the administrative complexity of claiming exemptions or deductions may deter eligible individuals from benefiting from them.


c) Less ability to shift the burden:

When businesses face higher costs due to VAT, they may pass on the tax burden to consumers by increasing the prices of goods and services. However, lower-income households have limited ability to absorb these price increases or shift the burden to others, as they may have fewer alternatives or substitutes for essential goods and services.


d) Impact on disposable income and standard of living:

VAT can reduce the disposable income of lower-income households, limiting their ability to meet basic needs or save for the future. This can have a negative impact on their overall standard of living, making it harder to escape poverty or achieve upward mobility.


2)Increased cost of living:

Another disadvantage of VAT is its contribution to the increased cost of living. Here's how VAT can impact the overall cost of goods and services:


a) Passed on to consumers:

VAT is typically a tax imposed on businesses at each stage of the supply chain. However, businesses often pass on the burden of VAT to consumers by incorporating the tax into the prices of their goods and services. As a result, consumers end up paying higher prices for the products they purchase.


b) Cascading effect:

VAT is levied at every stage of production and distribution, which can lead to a cascading effect known as "tax pyramiding." Tax pyramiding occurs when the tax is applied to the value added at each stage, including inputs, intermediate products, and the final product. This can result in an accumulation of taxes within the supply chain, ultimately increasing the cost of the final product.


c) Inelastic goods and services:

Certain goods and services have an inelastic demand, meaning that their consumption is not significantly affected by price changes. Examples include basic necessities like food, healthcare, and utilities. Since these goods and services are essential for daily living, consumers have limited flexibility to reduce their consumption even if prices rise due to VAT. 

Consequently, the increased cost of living can have a more substantial impact on households' budgets, particularly for low-income individuals and families.


d) Impact on disposable income:

When the cost of goods and services rises due to VAT, it reduces consumers' disposable income. Disposable income is the amount of money available to individuals after paying taxes. As VAT increases the price of goods, individuals have less discretionary income to spend on non-essential items or savings, affecting their overall financial well-being.


3)Administrative complexity:


Administrative complexity is another disadvantage associated with the implementation of VAT. Here are some reasons why VAT can be administratively burdensome:


a) Compliance and record-keeping requirements:

VAT systems typically require businesses to maintain accurate and detailed records of their transactions, including sales, purchases, and VAT paid and collected. This involves significant administrative effort, especially for small businesses that may lack the resources or expertise to handle complex record-keeping requirements.


b) Tax registration and reporting:

Businesses must register for VAT and comply with periodic reporting obligations, which may involve filing VAT returns and providing detailed information about their transactions.

Meeting these requirements can be time-consuming and may require businesses to invest in specialized accounting software or hire professional assistance to ensure accurate reporting.


c) Complexity of VAT rules and regulations:

VAT systems often involve intricate rules and regulations that dictate how the tax should be applied to different types of goods, services, and transactions. Determining the correct VAT treatment for specific items can be challenging, leading to potential errors or misunderstandings that could result in penalties or disputes with tax authorities.


d) Cross-border transactions:

VAT becomes even more complex when it comes to cross-border transactions involving imports, exports, or services provided to foreign entities. Businesses must navigate additional rules related to VAT exemptions, reverse charges, and documentation requirements.

Complying with these rules requires a thorough understanding of international VAT regulations and may necessitate engaging customs agents or tax advisors.


e) Audit and enforcement:

Tax authorities need to enforce compliance with VAT regulations, which involves conducting audits, investigating potential non-compliance, and ensuring that businesses are accurately reporting and remitting the appropriate VAT amounts.

This process adds to the administrative burden for both tax authorities and businesses, particularly those that may be subject to frequent audits or inspections.


f) Small business challenges:

VAT systems can pose particular challenges for small businesses with limited resources. The administrative complexity, costs associated with compliance, and potential penalties for non-compliance may disproportionately affect smaller enterprises, which often lack the infrastructure and expertise to manage complex tax requirements.


4)Potential for tax evasion:

One significant disadvantage of VAT is its potential for tax evasion. Here's why VAT systems can be vulnerable to tax evasion:


a) Complexity and loopholes:

VAT systems can be complex, with numerous rules, exemptions, and thresholds. This complexity can create loopholes and opportunities for businesses or individuals to exploit gaps in the system, intentionally or unintentionally, to avoid or evade VAT payments.

Tax evaders may manipulate invoices, misclassify goods or services, or engage in other fraudulent activities to reduce their VAT liability.


b) Cash-based economy:

VAT evasion is more prevalent in cash-based economies where transactions are conducted in cash, making it easier to conceal income and avoid detection. Cash transactions leave little or no paper trail, making it difficult for tax authorities to track and verify transactions, leading to higher chances of VAT evasion.


c) Underreporting and underpayment:

Some businesses may intentionally underreport their sales or manipulate their records to understate their VAT liability. This can be done by under-declaring the value of goods or services sold, inflating deductible expenses, or engaging in other fraudulent practices to reduce the amount of VAT owed.


d) Missing trader intra-community (MTIC) fraud:

MTIC fraud, also known as carousel fraud, is a form of VAT evasion that occurs in cross-border transactions within the European Union (EU) and other jurisdictions. It involves exploiting the VAT exemption for intra-community trade by setting up a chain of companies involved in fictitious or fraudulent transactions, with the aim of reclaiming VAT from tax authorities without actually paying it.


e) Weak enforcement and detection:

VAT evasion can be facilitated by ineffective enforcement and detection mechanisms. Insufficient resources, lack of technological capabilities, and inadequate coordination among tax authorities can hinder the identification and prosecution of tax evaders. This allows evasion schemes to go undetected and contributes to revenue losses for governments.


f) Informal economy:

VAT evasion is prevalent in informal or underground economies, where businesses operate outside the formal tax system. Informal businesses may intentionally avoid VAT registration or fail to charge VAT on their sales, giving them a competitive advantage over compliant businesses.

The absence of proper oversight and documentation in the informal sector makes it difficult for tax authorities to enforce VAT compliance.


5)Distortion of economic behavior:


Another disadvantage of VAT is its potential to distort economic behavior. Here's how VAT can lead to distortions in the economy:


A) Shift in consumption patterns:

VAT can influence consumer behavior by increasing the prices of certain goods and services. As a result, consumers may shift their preferences towards goods that are subject to lower VAT rates or are exempt from VAT. 

This can distort market demand and lead to resource misallocations, as consumers may choose goods based on tax considerations rather than their actual needs or preferences.


b) Impact on business decisions:

VAT can affect business decisions, particularly regarding pricing, production, and investment. Businesses may need to adjust their pricing strategies to account for the VAT burden, which can have an impact on competitiveness, market positioning, and profitability.

 Additionally, the VAT treatment of inputs and capital goods may influence investment decisions, potentially leading to suboptimal choices or inefficient allocation of resources.


c) Tax planning and avoidance:

The presence of VAT can incentivize tax planning strategies or tax avoidance activities by businesses. They may seek ways to structure their transactions or reorganize their operations to minimize VAT liability. This can lead to artificial arrangements, such as setting up complex supply chains or engaging in aggressive tax planning schemes, solely driven by VAT considerations rather than genuine economic or business needs.


d) Distortion of price signals:

VAT can distort price signals in the market, affecting the allocation of resources and the efficiency of markets. The tax burden imposed by VAT may not be fully transparent to consumers, as it is embedded in the final prices of goods and services. 

This can obscure the true cost of goods and inhibit price signals from effectively guiding consumer choices and market dynamics.


e) Compliance costs and administrative burden:

The administrative complexities and compliance costs associated with VAT can impose a burden on businesses, particularly small and medium-sized enterprises (SMEs). These costs can divert resources away from productive activities and innovation, creating a burden on businesses that may hinder their growth and competitiveness.


6)Impact on business competitiveness:

VAT can have an impact on the competitiveness of businesses, particularly in international trade. Here are some ways in which VAT can affect business competitiveness:


a) Export competitiveness:

When a country has a high VAT rate, it can increase the production costs for businesses, which can make their exports more expensive compared to goods produced in countries with lower VAT rates. Higher production costs due to VAT can reduce the price competitiveness of exports in the global market, potentially leading to a decrease in export demand and market share.


b) Compliance costs for cross-border trade:

VAT systems can introduce additional administrative and compliance costs for businesses engaged in cross-border trade. Businesses need to understand and adhere to the VAT regulations of both the exporting and importing countries, including requirements related to documentation, VAT registration, and reporting. 

These additional compliance costs can put businesses at a disadvantage compared to domestic competitors and create barriers to entry for small and medium-sized enterprises (SMEs) in international markets.


c) Tax refund delays:

In some cases, businesses engaged in exports may be eligible for VAT refunds on inputs used in the production of export goods or services. However, the process of obtaining VAT refunds can be time-consuming and bureaucratic, leading to delays in receiving the refunds. These delays can tie up working capital for businesses, potentially impacting their cash flow and competitiveness.


d) Complexity for multinational companies:

VAT systems can be particularly challenging for multinational companies that operate in multiple jurisdictions. Each country may have its own VAT rules, rates, and reporting requirements, leading to administrative complexity and potential compliance issues.

Multinational companies need to invest resources in understanding and managing the VAT implications of their cross-border operations, which can add to their costs and administrative burden.


e) Impact on import competition:

VAT can also affect the competitiveness of domestic businesses that compete with imported goods. When imported goods are subject to VAT at the border, it can increase their prices and make them less competitive compared to domestically produced goods. This can affect domestic industries and create challenges for businesses that face import competition.



In conclusion, Value Added Tax (VAT) has its share of disadvantages. It can place a burden on lower-income households, contribute to the increased cost of living, introduce administrative complexity, create opportunities for tax evasion, and affect business competitiveness. 

While governments attempt to mitigate these issues through exemptions and targeted policies, it is important to be aware of the potential drawbacks of VAT and consider strategies to address them effectively.

Read More:

VAT Registration: Explaining the Process and Requirements for Businesses

No comments