VAT treatment of public sector bodies: the Canadian model

The goods and services supplied by the sector that consists of government entities, public sector bodies, non-profit organizations, charitable organizations (hereafter collectively referred to as the PNC sector) continue to elude the best practice under the value-added tax (VAT): the full taxation of goods and services supplied by the PNC sector, with credit for tax paid on purchases made in order to render the supplies. Although there are very few genuine conceptual problems preventing the full taxation of such supplies under the VAT, some roadblocks remain in the way. Often, they come in the form of policy concerns revolving around social objectives and income distribution. Those explain to a large extent the exceptional (and exceptionally complex) treatment of PNC supplies under the VAT in many countries. Complexity often arises because exemptions may be restricted to particular items (goods and services), or apply to supplies rendered by certain types of entities, or a combination of both. Other times, obstacles come in the form of political inertia and barriers.

While the consequences of the VAT-exempt treatment of the supplies made by the PNC sector are well understood at the theoretical level, there has been little quantification of its economic effects. They are believed to be quite important when taken together. Such effects includes distortions, compliance costs, administrative costs, and the cost savings from using tax or expenditure policy instruments that are better suited than the VAT to achieve distributional and other social objectives. In aggregate, the distortions from the exempt treatment of the PNC sector are likely to be significant, especially in developed countries where the PNC sector can account for an important proportion of the gross domestic product.