James M. Bickley
Specialist in Public Finance
Long-term fiscal problems, which were exacerbated by the recession that ended in June 2009, resulted in widespread concern about the need to formulate a fiscal solution to the high budget deficits and growing national debt. The levying of a value-added tax (VAT), a broad-based consumption tax, has been discussed as one of many options to assist in resolving U.S. fiscal problems. A VAT was not included in the report of the National Commission on Fiscal Responsibility and Reform but was included in the report of the Debt Reduction Task Force of the Bipartisan Policy Center.
A VAT is imposed at all levels of production on the differences between firms’ sales and their purchases from all other firms. For 2011, a broad-based VAT in the United States would raise net revenue of approximately $55 billion for each 1% levied. Most other developed nations rely more on broad-based consumption taxes for revenue than does the United States. A VAT is shifted onto consumers; consequently, it is regressive because lower-income households spend a greater proportion of their incomes on consumption than higher-income households. This regression, however, could be reduced or even eliminated by any of three methods: a refundable credit against income tax liability for VAT paid, allocation of some of VAT revenue for increased welfare spending, or selective exclusion of some goods from taxation.
From an economic perspective, a major revenue source is better the greater its neutrality—that is, the less the tax alters economic decisions. Conceptually, a VAT on all consumption expenditures, with a single rate that is constant over time, would be relatively neutral compared to other major revenue sources. A VAT would not alter choices among goods, and it would not affect the relative prices of present and future consumption. But a VAT cannot be levied on leisure; consequently, a VAT would affect households’ decisions concerning work versus leisure. For a firm, the VAT would not affect decisions concerning method of financing (debt or equity), choice among inputs (unless some suppliers are exempt or zero-rated), type of business organization (corporation, partnership, or sole proprietorship), goods to produce, or domestic versus foreign investment.
The imposition of a VAT would cause a one-time increase in this country’s price level. But a VAT would not necessarily affect this country’s future rate of inflation if the Federal Reserve offset the contractionary effects of a VAT with a more expansionary monetary policy. If the United States continued its policy of flexible exchange rates, then the imposition of a VAT would not significantly affect the U.S. balance-of-trade. There is no conclusive evidence that a VAT would substantially change the rate of national saving more than another type of major tax increase. The administrative costs of a VAT would be significant but relatively low if measured as a percentage of revenue yield. In comparison to other broad-based consumption taxes, VATs have produced relatively good compliance rates. A significant gross receipts threshold for registration could reduce the costs of administration and compliance. Data suggest that 15 to 24 months would be required to implement a VAT. Whether or not a federal VAT would encroach on the primary source of state revenue, the sales tax, is subject to debate. A federal-state VAT could be collected jointly, but a state would lose some of its fiscal discretion.
The prevailing view of tax professionals is that an optimal VAT would have the following characteristics: a broad base, a single rate, the credit-invoice method of collection, the destination principle, and a significant sales threshold for registration.
Date of Report: January 21, 2011
Number of Pages: 39
Order Number: R41602
Price: $29.95
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Document available via e-mail as a pdf file or in paper form.
To order, e-mail Penny Hill Press or call us at 301-253-0881. Provide a Visa, MasterCard, American Express, or Discover card number, expiration date, and name on the card. Indicate whether you want e-mail or postal delivery. Phone orders are preferred and receive priority processing.
Specialist in Public Finance
Long-term fiscal problems, which were exacerbated by the recession that ended in June 2009, resulted in widespread concern about the need to formulate a fiscal solution to the high budget deficits and growing national debt. The levying of a value-added tax (VAT), a broad-based consumption tax, has been discussed as one of many options to assist in resolving U.S. fiscal problems. A VAT was not included in the report of the National Commission on Fiscal Responsibility and Reform but was included in the report of the Debt Reduction Task Force of the Bipartisan Policy Center.
A VAT is imposed at all levels of production on the differences between firms’ sales and their purchases from all other firms. For 2011, a broad-based VAT in the United States would raise net revenue of approximately $55 billion for each 1% levied. Most other developed nations rely more on broad-based consumption taxes for revenue than does the United States. A VAT is shifted onto consumers; consequently, it is regressive because lower-income households spend a greater proportion of their incomes on consumption than higher-income households. This regression, however, could be reduced or even eliminated by any of three methods: a refundable credit against income tax liability for VAT paid, allocation of some of VAT revenue for increased welfare spending, or selective exclusion of some goods from taxation.
From an economic perspective, a major revenue source is better the greater its neutrality—that is, the less the tax alters economic decisions. Conceptually, a VAT on all consumption expenditures, with a single rate that is constant over time, would be relatively neutral compared to other major revenue sources. A VAT would not alter choices among goods, and it would not affect the relative prices of present and future consumption. But a VAT cannot be levied on leisure; consequently, a VAT would affect households’ decisions concerning work versus leisure. For a firm, the VAT would not affect decisions concerning method of financing (debt or equity), choice among inputs (unless some suppliers are exempt or zero-rated), type of business organization (corporation, partnership, or sole proprietorship), goods to produce, or domestic versus foreign investment.
The imposition of a VAT would cause a one-time increase in this country’s price level. But a VAT would not necessarily affect this country’s future rate of inflation if the Federal Reserve offset the contractionary effects of a VAT with a more expansionary monetary policy. If the United States continued its policy of flexible exchange rates, then the imposition of a VAT would not significantly affect the U.S. balance-of-trade. There is no conclusive evidence that a VAT would substantially change the rate of national saving more than another type of major tax increase. The administrative costs of a VAT would be significant but relatively low if measured as a percentage of revenue yield. In comparison to other broad-based consumption taxes, VATs have produced relatively good compliance rates. A significant gross receipts threshold for registration could reduce the costs of administration and compliance. Data suggest that 15 to 24 months would be required to implement a VAT. Whether or not a federal VAT would encroach on the primary source of state revenue, the sales tax, is subject to debate. A federal-state VAT could be collected jointly, but a state would lose some of its fiscal discretion.
The prevailing view of tax professionals is that an optimal VAT would have the following characteristics: a broad base, a single rate, the credit-invoice method of collection, the destination principle, and a significant sales threshold for registration.
Date of Report: January 21, 2011
Number of Pages: 39
Order Number: R41602
Price: $29.95
Follow us on TWITTER at http://www.twitter.com/alertsPHP or #CRSreports
Document available via e-mail as a pdf file or in paper form.
To order, e-mail Penny Hill Press or call us at 301-253-0881. Provide a Visa, MasterCard, American Express, or Discover card number, expiration date, and name on the card. Indicate whether you want e-mail or postal delivery. Phone orders are preferred and receive priority processing.
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