The Macroeconomic Impact of the IMF Recommended VAT Policy for the Fiji Economy: Evidence from a CGE Model

Abstract

Value Added Tax (VAT) is a general consumption tax levied on goods and services. In September 2002, in the face of mediocre economic performance, deteriorating government finances and stagnant investment levels - all due to the political coups of 2000 -an increase in VAT was recommended to Fijian policy makers by the IMF as a remedy to Fiji's problems. The Fiji government, without an in depth economy wide repercussions of a VAT policy, welcomed it by announcing a 25% increase in VAT in its 2003 budget. Beginning 1 January 2003 all goods and services were levied a VAT rate of 12.5%. In this paper, we use a computable general equilibrium model to examine the economy wide effects of this VAT policy. We find that while the VAT improves government revenue and brings about a small 0.6% increase in real GDP, it fails to address investment levels. VAT actually leads to a decline in investments and a reduction in real consumption and national welfare. We highlight that large amounts of tax revenue are owed to government. This is three times more than what government will collect from the 25% increase in VAT. In this light, an alternative to VAT is to upgrade government's tax collecting mechanism. From this we deduce that the IMF policy is misdirected.