James M. Bickley
Specialist in Public Finance
Both a value-added tax (VAT) and a national sales tax (NST) have been proposed by participants in the tax-reform debate as replacement taxes for all or part of the nation's current income tax system. In addition, there is congressional interest in using a consumption tax to finance national health care.
A firm's value added for a product is the increase in the value of that product caused by the application of the firm's factors of production. A VAT on a product would be levied at all stages of production of that product. VATs differ in their tax treatment of purchases of capital (plant and equipment). The type of VAT used by developed countries—termed a consumption VAT—treats a firm's purchases of plant and equipment the same as any other purchase. A firm's net VAT liability is usually calculated by using the credit-invoice method. According to this method, a firm determines its gross tax liability by aggregating VAT shown on its sales invoices. Then the firm computes its net VAT liability by subtracting VAT paid on purchases from other firms from the firm's gross VAT liability. This net tax is remitted to the government. The subtraction method can also be used to calculate the VAT. Under this method, the firm calculates its value added by subtracting its cost of taxed inputs from its taxable sales. Next, the firm determines its VAT liability by multiplying its value added by the VAT rate. A flat tax, based on the proposal formulated by Robert E. Hall and Alvin Rabushka of the Hoover Institution, is a type of modified subtraction method VAT.
In contrast to a VAT, an NST would be a federal consumption tax collected only at the retail level by vendors. an NST would equal a set percentage of the retail price of taxable goods and services. Retail vendors would collect the NST and remit tax revenue to the federal government. Both a VAT and an NST are frequently assumed to be ultimately paid by consumers. For calendar year 2007, CRS estimated a VAT or NST would have raised net revenue of between $46 and $86 billion for each 1% levied if used as a replacement tax. Alternatively, if the VAT or NST would have been used as an additional revenue source, than those revenue estimates would be reduced by 25% because of partially offsetting declines in income tax revenues.
The operating differences between a consumption VAT and an NST have important policy implications. On the one hand, the administrative cost of a VAT would exceed that of an NST because a VAT would require more information to be reported and audited. Also, an opportunity exists for an NST to be collected jointly with state sales taxes, but a federal VAT offers no readily available joint collection possibilities. A VAT would require more time to implement than an NST because a VAT is more complicated, covers more firms, and is a new tax method. On the other hand, a consumption VAT with the credit method more easily excludes inputs from double taxation than does an NST. A consumption VAT would be easier to enforce than an NST. It is in the self-interest of a firm to have accurate purchase invoices so that it can obtain full credit for prior VAT paid. Tax authorities can double check the accuracy of the VAT remitted by any firm because data are collected from producers at all levels of production. For a given year, a VAT could have a broader base than an NST because a VAT is easier to enforce. A VAT may be less visible to consumers than an NST. A VAT is levied at all stages of production, and policymakers have the option of not requiring the amount of VAT to be shown on retail sales receipts. As of March 19, 2010, the following bills concerning an NST or VAT have been introduced in the 111th Congress: H.R. 15, H.R. 25, S. 296, S. 741, H.R. 1040, S. 963, S. 932, H.R. 4529, and S. 1240.
Date of Report: March 19, 2010
Number of Pages: 10
Order Number: RL33438
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Wednesday, March 24, 2010
James M. Bickley