An-loh Lin

D. K. Stout

Stephen P. Dresch

English

Research Papers in Economics

This PDF is a selection from an out-of-print volume from the National Bureau of Economic Research
Volume Title: Substituting a Value Added Tax for the Corporate Income Tax: First-Round Analysis
Volume Author/Editor: Stephen P. Dresch, An-loh Lin, and D. K. Stout
Volume Publisher: NBER
Volume ISBN: 0-884-10474-5
Volume URL: http://www.nber.org/books/dres77-1
Publication Date: 1977
Chapter Title: Appendix A Methods Used to Compute the Value-Added Tax
Chapter Author: Stephen P. Dresch, An-loh Lin, D. K. Stout
Chapter URL: http://www.nber.org/chapters/c3835
Chapter pages in book: (p. 187 - 194)Appendix A
*
MethodsUsed to Compute
the Value-Added Tax
A.1 GENERAL DESCRIPTION
Theanalysis of the possible effects of a single-level value-
added tax (VAT) and of a two-level VAT have been com-
puted by the Econoscope Group of Cybermatics, Inc., and
are based on the methods used in the quarterly economic analysis
service of Econoscope.
Although based on input/output tables previously published by
the Department of Commerce, the Econoscope table used to analyze
the VAT has been revised to represent the year 1969 with sufficient
accuracy for the purposes of the study. For each quarter-year of its
normal operation, Econoscope routinely updates the I/O table with
newly available data. For the VAT study, four quarterly tables
have been consolidated into a single table for 1969. Some further
specifications of this table are as follows:
1.The number of sectors is 106.
2.The Standard Industrial Classification (SIC) coverage of 95 of
these sectors is shown in Appendix B.
3.The I/O table is in 1969 prices.
4.Domestic final demand data are drawn from a variety of sources.
a. Personal consumption expenditure (PCE) from the Bureau
of Economic Analysis (BEA), formerly the Office of Business
Economics.
b. Constructure from the Bureau of the Census.
*Appendices A and B were prepared by Milton L. Godfrey, Cybermatics, Inc.
187188 Substituting a Value-Added Tax for the Corporate Income Tax
c.Producers durable equipment (PDE) from the BEA-Securities
and Exchange Commission survey of capital investment ex-
penditures. Estimating procedures are used to remove the
construction portion of capital investment, leaving the PDE
investment of corporations. Other government data sources
are used to enable Econoscope to estimate noncorporate and
agriculturalinvestment in PDE. The consolidated figures
from these processes reconcile with the national income
accounts as published in the Survey of Current Business.
d. Since foreign trade iscritically important in considering a
VAT, processing of the export and import data is covered in
detail in section A.2.
e. Federal government expenditures are based on published
Budget figures modified by later reports on actual expendi-
tures.
f. State and local government expenditures are based on the
most recent Census of Governments and other summaries by
federal agencies, by the Conference Board, and others.
5.The value added for each sector in 1969 has been reestimated for
this VAT study. The major procedures followed are described
in section A.3.
A.2FOREIGN TRADE
Exportsof domestic merchandise as reported by the Census in Sched-
ule B classifications are grouped by Econoscope into seven major
end-use categories according to the Census definitions. Each group
is then classified by SIC and assigned to the appropriate I/O sector.
The category, "other exports," excluding reexports,isthen
augmented by adding nonmerchandise exports classified to match
the I/O sector definitions.
Military grant shipments and monetary transactions of government
are excluded. Hence, Econoscope estimates of exports differ from
the balance-of-payments reports to the extent of these government
transactions.
Export values at port of embarkation are converted to producers'
prices for each I/O sector by subtracting transportation, trade, and
insurance costs. The sums of the deductions are entered as pur-
chases from the transportation, trade, and insurance sectors for
each of the seven end-use groups.
The basic reference for classification is U.S. Foreign Trade Statis-
tics Classifications and Cross-Classifications with revisions to January
1, 1970. The end-use categories are: food, feeds, and beverages;
industrial supplies and materials; capital goods, except automobiles;Methods Used to Compute the Value-Added Tax 189
automobiles,vehicles, parts, and engines; consumer goods, nonfood,
except passenger cars; special category; and exports, n.e.c.
For the conversion from Schedule B classifications to SIC classi-
fications we follow the correlation table in U.S. Foreign Trade
Statistics Classifications. However, we deviate from this table to
conform to the standard BEA practice in I/O tables. The basis for
this deviation is the I/O requirement that each product be assigned
primarily to only one industry. For example, the Census classifies
petroleum coke as primary to the petroleum industry arid classifies
coke from coal as primary to either the chemical or steel industry,
depending on where it was made. Since coke from any industry
is chemically the same, for I/O purposes we define coke as primary
to the chemical industry only, and classify it as secondary to or by.
product of the other industries.
The nonmerchandise export trade included in the category ex-
ports, .n.e.c.,is as follows: gold exports, electric energy exports,
freight valuation adjustment, transportation of foreigners on U.S.
carriers, other travel expenses of foreigners in the United States,
fees and royalties paid to American industry, other services sold in
export by private industry and government, and income on U.S.
investments abroad. In general, these items conform to the defini-
tions used in the quarterly reports on the U.S. balance of payments
issued by the Department of Commerce.
Imports of merchandise for consumption are taken from Census
reports and converted to SIC classifications to match the input!
output definitions. They are further classified as competitive or non-
competitive imports. By estimation, Econoscope adds insurance
and freight costs to the published foreign port values to get a elf.
value of imports.
Nonmerchandise import data is collected from several sources.
However, information from the balance-of-payments report in the
Survey of Current Business is used as a control on the process so that
our estimates can be successfully reconciled with the national income
accounts.
Noncompetitive imports are all shown in the body of the I/O table
as a purchase by the actual buying industry from the import sector.
-Competitiveimports are all shown in the body of the I/O table as
a purchase by the industry that makes the competitive product.
We assume that further distribution of these imports follows normal
trade channels. This is identical to one of the methods used by the
BEA in the official I/O tables for 1958 and 1963. However, since
this is a "dummy" transaction, the value added of the competitive
domestic industry is not affected by the imports and reflects only
the actual sales of the domestic industry.190 Substituting a Value-Added Tax for the Corporate Income Tax
A.3 ESTIMATION OF VALUE ADDED
Forthe base year of an I/O table, the value added is an accurate re-
port of what happened. However, when an I/O table is applied to
other years with changed prices, making the assumption that value
added is a fixed portion of sector expense can lead to major errors
in estimating profitability or other details.
The value-added sector covers three major items, labor, deprecia-
tion, and profit as well as some minor items.' Although more than
half of gross income of some industries goes to value added, the
i/O tables show no breakdown into labor, depreciation, etc. Instead,
value added is treated as a lump sum, in contrast to the fine detail
shown for purchases of goods and services. However, as indicated
earlier,itisdesirable to break value added into components of
labor, depreciation, etc. Information on these components is avail-
able from a variety of government files but none of these is an exact
match to the I/O tables. The major differences are of three general
types: (a) a different definition of value added (in the Census files),
(b) different definitions of industry than those used in I/O tables
(grQss product originating files), and (c) data on enterprises which
contain establishments in two or more industries (SEC and Internal
Revenue Service data). Only the data file for gross product in current
and constant dollars, by industry is establishment-based and is con-
structed using the same definition of value added as the I/O table.
A summary is published annually in the July issue of the Survey of
Current Business (Tables 1.21 and 1.22) and the file in full detail
is available on magnetic tape. This file will be referred to as gross
product originating or GPO. Sixteen industries in the GPO file can
be matched almost exactly to the I/O sectors.
For Econoscope, we developed a method for estimating the
details of value added to match our updated I/O table for each
quarterly period, and we used the same procedure for this study. The
base for estimating 1969 is BEA data on the reconciliation between
gross product originating and the I/O table for 1963. This shows the
changes in allocations of value added due to the different sector
definition in GPO.
For 1969 we have assumed a continuity of the patterns of 1963
and have reallocated accordingly. While almost all sectors are affect-
ed to some extent, the major impact of shifted value added falls on:
new construction,repair and maintenance construction, crude
petroleum and natural gas, petroleum refining and related industries,
wholesale and retail trade, business services, and auto repair.
1. The minor items include interest payments, net rental income, transfer
payments, inventory valuation adustment, subsidies from government. For
government enterprises it includes a net surplus item.Methods Used to Compute the Value-Added Tax 191
Thecauses of reallocation can be separated into seven major
classes, described in the following paragraphs:
a. Force account.This covers new and maintenance construction
work performed by the employees of other industries; for example,
the construction and maintenance of distribution systems by electric
power companies.
b. Industry reclassification.This covers situations where the GPO
industries and the I/O secotrs are differently defined: for example
SIC 138 (oil and gas field services) is considered part of the crude
petroleum and natural gas industry in the GPO file, while in the
I/O table itis considered part of the new and maintenance con-
struction sectors.
c. Installation work.This covers the installation labor supplied
by manufacturers of elevators, escalators, heating and air-condition-
ing equipment, and other items where the installation labor should
be applied to the construction sectors.
d. Manufacturer's sales offices.Where these offices are separate
from the plants or mines and perform only a marketing function
apart from retailing, the associated costs are transferred to the trade
sector of the I/O table.
e. Trade activity.This covers direct wholesale and retail sales of
nontrade sectors, for example, the sale of drugs by hospital dispen-
saries, which is reallocated to the trade sector of the I/O table.
f. Manufacturing activity.This covers manufacturing processes
performed in stores or warehouses. It is reallocated to the appro-
priate manufacturing sector. Examples are food processing in retail
stores, or custom-made clothing fabricated in retail stores.
g. Service activity.Some wholesale and related establishments
sell services that are normally provided by sectors such as trans-
portation, warehousing, equipment rental, auto repair, and others.
In each case the associated costs are reallocated to the proper service
sector.
The impact of these reallocations of value added is small in many
sectors. The accompanying table shows the net effects of shifting
on selected sectors where the change is substantial.
A.4DEPRECIATION AND
CAPITAL INVESTMENT
Inthis study, gross capital investment is not subject to the VAT.
Since a large part of the funds for investment are generated by de-
preciation charges (normally part of value added), we estimated the
straight-line depreciation flows using IRS Bulletin F [U.S. Treasury192 Substituting a Value-Added Tax for the Corporate Income Tax
Table A-I. GPO-I/O Value Added Reconciliation
GPO File
Value Added, 1969
(millions of dollars)
Increase I/O Table
All construction 43,685 60,403 +38.3%
Crude petroleum and
natural gas 10,861 7,218 —33.5
Petroleum refining and
related industries 7,235 7,868 +8.7
Wholesale and retail 155,421 142,474 —8.3
Business services 20,470 24.172 +18.1
Auto repairs 4,704 10,320 +119.4
Department] modified to conform to the actual service lives of fixed
capital assets (see Survey of Current Business, December 1966).
The composition of capital investment purchases of each in-
dustry was estimated on the basis of 1969 data on total purchases
by type, 1969 data on total expenditures by each industry, and
earlier data on purchase patterns of each industry.
Since dependable data on capital stocks by industry are not
available at the necessary level of detail, the rate of growth of real
product of each industry was used to determine the portion of
capital investment for expansion and the portion for replacement
of retired capital stocks. Hence, the replacement and expansion
investments of each industry were estimated. The replacement part
was deducted from value added and from final demand, and added
to the proper cell in the body of the I/O table. To determine the
reasonableness of this procedure, total estimated depreciation was
compared with total depreciation in the GPO files with the follow-
ing results:
Estimated 1969 depreciation: $59,594 millions
GPO 1969 depreciation: $76,715 millions
The IRS data used for the gross product originating file reflects the
accelerateddepreciation schedules of recent years. Hence, the
difference above is in the expected direction.
A.5CORPORATE PROFIT TAXES
Corporateprofit taxes are reported only on an enterprise base. The
GPO file shows profits, but not taxes, on an establishment base.
Hence, while our tax estimates for each I/O sector are reasonable
approximations, there is no benchmark that can be used for valida-
tion. The Census report titled EnterpriseStatistics 1963 provides.,
Methods Used to Compute the Value-Added Tax 193
themost recent data on the structure and industrial coverage of
enterprises, bridging the enterprise-establishment gap to some extent
It was necessary to assume that tax liability ratios (tax to profit)
based on enterprise data could be applied to establishments. How-
ever, it was necessary to deviate from this practice for the petroleum
industry (sectors 8 and 45, and for medical, educational services, and
nonprofit organizations (sector 95).
A very large part of oil field operations of the petroleum industry
are run by integrated corporations. The GPO files show on an es-
tablishment base that oil field operations are profitable while re-
finery operations show a net loss. The GPO operations figures for
1969 (in millions of dollars) are:
Oil and Gas Fields Refineries
Corporate profits 4,102 -265
Noncorporate profits 285 5
Total 4,387 —260
After adjustment to I/O definitions by reallocation of value added,
the 1969 corporate profit and tax figures (in millions of dollars) are:
Oil and Gas Fields Refineries
Corporate profits 3,321 —228
Corporate tax liability 698 —54
The negative income tax of the petroleum refining industry
must be viewed as a tax credit for the crude petroleum and natural
gas industry. In a similar fashion the net loss indicated by the medi-
cal, educational services, and nonprofit organization sector must be
viewed as a tax credit primarily for the wholesale and retail trade
sector.

Substituting a Value Added Tax for the Corporate Income Tax: First-Round Analysis

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