Equity is always and everywhere a central issue in taxation. From one perspective, the principal rationale for taxes in the first place may be thought of as an attempt to secure equity. After all, governments do not need taxes to secure money because they print the money in the first place. The role of the tax system is instead to take money away from the private sector in as efficient, equitable, and administratively least costly fashion as possible. Equity, with efficiency and administrability, is thus one of the three principal objectives in designing any tax system.

Of course, exactly what is considered to be equitable (or fair) by any particular person may differ from conceptions held by others and in the end only through the political institutions within which countries reconcile (if they do) conflicting views and interests can a countrys views of what constitutes an equitable tax system be defined and implemented although of course the results of this process may diverge widely from what others may think of as fair.

In general, equity issues may be approached at two different levels.

First, one may consider the details of exactly how different taxes impose burdens on taxpayers who are in the same and different economic circumstances.

Secondly, one may instead focus on the overall effects of taxation on the income and level of well-being of different people. The policy implications of these two different ways of approaching the equity of taxation may be quite different, with economists tending to take the second approach while much popular discussion of taxation instead takes the first approach. Focusing on the implications for equity of details of particular taxes leads, for example, to proposals to alter the rates and structures of particular taxes such as VAT. Although such proposals may improve horizontal and vertical equity within the limited group subject to the full legal burden of the tax, the same changes may sometimes actually exacerbate inequity more broadly considered. From the perspective of social and economic inequality, what matters in the end is surely the overall impact of the budgetary system on the distribution of wealth and income rather than the details of particular fiscal instruments like VAT. Nonetheless, such considerations are seldom given much weight when it comes to tax design, a process which almost invariably proceeds on a tax-by-tax basis.

In many countries, for example, consumption taxes are generally considered to be highly regressive. Some may note that taxes on consumption are less regressive on a lifetime rather than annual perspective, but given the relatively short life expectancies in many economic transition countries (ETC) and the subsistence level at which many people in such countries live daily, such refinements are likely to carry little weight. It is thus not surprising to find that many ETC provide for reduced VAT rates or exemptions for certain basic items such as some foods, passenger transport, medical services, and cooking fuel. In some countries, substantial differences exist in consumption patterns between income groups. More generally, however, the common riposte to such policies is that whatever small degree of progressivity they may achieve could be more effectively and fairly attained through small changes in the income tax or by adjustments in transfer payments, although in countries in which the poor do not as a rule suffer from income tax or benefit from transfer payments this observation is largely irrelevant.

The conventional argument that there is unlikely to be much gain in imposing differential luxury rates under a VAT even in ETC given the efficiency and administrative costs to which such differentiation gives rise, seems convincing, especially since more can be done with less collateral damage through excise taxes on such commodities, if desired. But the conventional case for imposing VAT at a uniform standard rate and on as broad a base as possible in such countries seems less convincing.

A uniform VAT is likely to increase the price of many goods essential to the poor. Because the poor may consume a relatively small amount of such products, it is undoubtedly true that, much of the benefit of such exemptions will go to the non-poor. Nonetheless, in view of both the relatively heavy tax burden from such taxes on the poor in some ETC and the general inability of governments in such countries to provide offsets to such tax burdens through other fiscal adjustments, some such offset often seems quite justifiable.

Zero-rating for distributive reasons, however, is perhaps inadvisable in countries like Albania already facing many difficulties with VAT refunds, and exemptions increase cascading and by breaking the VAT chain make effective enforcement more difficult. Perhaps, therefore, a reduced rate might be the best approach, although more careful analysis is needed of exactly what level and form of relief is best for the particular circumstance of a particular country. There are too many instances in which the items taxed (or not taxed) in different ways appear to have been chosen arbitrarily by fiat rather than in a reasoned fashion to make one comfortable with the state of our knowledge on this issue. Moreover, even if a country has worked out sensibly what is best at a point in time, the issue needs to be revisited from time to time, both because of the exemption creep and because since circumstances change what is sensible may well change also

A final point that deserves mention with respect to VAT and equity in ETC is the importance of the shadow economy. Many ETC have a large economic sector that is effectively not subject to direct taxation. This reality clearly should affect how one assesses the effects of different fiscal instruments on equity. It is not at all impossible; for instance, that in some cases even a uniform broad-based VAT may be more progressive than more nominally progressive taxes (such as the personal income tax) that in practice burden only a limited group of wage-earners.

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