© 1992 International Bank for Reconstruction and Development / The World Bank
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A SIMPLER CONSUMPTION-BASED ALTERNATIVE TO THE INCOME TAX FOR SOCIALIST ECONOMIES IN TRANSITION
The tax systems of socialist economies in transition will distort resource allocation, create inequities, and cause administrative headaches if not reformed. These countries have weak tax administrations, lack experience with mass taxes based on voluntary compliance, and need to encourage domestic saving and foreign investment. This article suggests an alternative to the conventional income tax that is more suited to these conditions.
Attempting to tax real economic income raises complicated timing issues (when to recognize income and allow deductions) and may require complex adjustments for inflation. The simplified alternative tax (SAT) avoids these complications and provides a general incentive for saving and investment less subject to abuse or distortions than tax holidays and other tax gimmicks in vogue in countries emerging from socialism.
The key elements of the SAT are separate taxes on income from labor and capital, immediate deduction for all business expenditures, no deduction for interest, and no taxation of interest or dividends. (Interest could be treated as under an income tax, at some cost.) Although the marginal effective tax rate is zero, the government shares in extraordinary returns to investment. The article discusses potential problems (including distributional implications, tax losses, and foreign tax credits) as well as advantages of the SAT.
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