In its January 2011 report, the Congressional Budget Office (CBO) estimated that America's expanding spending policy will generate a combined deficit of nearly $8.5 trillion over the ten-year period from 2011 to 2021. Significantly, 30% of this projected overspending ($2.5 trillion) will be incurred in 2011 and 2012 alone. These projections are in spite of the CBO's warning last year that, "[t]o keep federal deficits and debt from reaching levels that would substantially harm the economy, lawmakers would have to significantly increase revenues, decrease projected spending, or enact some combination of the two." In light of this cautionary apprisal, a European-style value added tax (VAT) has emerged as a potential solution. Indeed, just this week, Jeffrey Owens, a director of the Organization for Economic Cooperation and Development (OECD), called for international agreement on a VAT structure at a lecture at NYU's School of Law.
Components of a good tax. There are four components of a good tax:
1. a tax should be fair and equitable;With that being said, while it is true that the United States is the only major nation without a VAT, it does not necessarily follow that VAT is an appropriate or even viable solution for the United States. To the contrary, a U.S. VAT would be inequitable, hidden, inconvenient, and inefficient.
2. a tax should be transparent;
3. the time and manner of tax collection should be convenient for the taxpayer; and
4. tax administration should be efficient.
A U.S. VAT would be inequitable. A tax is considered to be equitable if citizens pay tax in proportion to their respective abilities. Under American tax policy, a taxpayer's ability to pay is measured in terms of available revenue for spending. In this regard, a U.S. VAT would be inconsistent with the ability to pay principle insofar as it measures taxpayers' ability to pay in terms of consumption rather than available revenue. In addition, a U.S. VAT would be inequitable in the sense that taxpayers would bear dissimilar tax burdens. A fair tax requires equal sacrifice from all taxpayers, but the incidence of a U.S. VAT would fall primarily upon lower income taxpayers because lower income taxpayers will spend higher percentages of their incomes on VAT.
A U.S. VAT would lack transparency. A value-added tax is a hidden form of taxation because those who ultimately pay it - i.e. consumers - are unaware of what they are paying. The hidden nature of a U.S. VAT would be particularly problematic because hidden taxes are easily increased by the government with little taxpayer resistance. Accordingly, once a value-added tax is introduced into the U.S. Tax Code, the rate of taxation is almost certain to increase. Indeed, there is a historical correlation between increased revenue and increased spending in the United States.
For every dollar increase in tax revenue between 1970 and 1980, federal spending increased by $1.22. For every dollar increase in tax revenue between 1980 and 1990, federal spending increased by $1.29. For every dollar increase in tax revenue between 1990 and 2000, federal spending increased by $1.90. Thus, any increase in tax revenue generated by a U.S. VAT would almost certainly be accompanied by a larger increase in spending. This increased spending will, in turn, trigger an increased VAT rate to sustain the higher levels of spending.
A U.S. VAT would be inconvenient. One of the purported virtues of a value-added tax is that it is administratively desirable because it is difficult to evade. But what makes a value-added tax essentially self-enforcing is meticulous recordkeeping. Indeed, in order to ensure receipt of credit for VAT paid on inputs, each firm must keep detailed records of all sales and purchases. Ironically, this same record-keeping makes VAT immensely inconvenient for taxpayers. Indeed, the General Accounting Office has projected taxpayer compliance costs for a broad-based multiple rate VAT to be between $5.9 billion and $10.3 billion (adjusted to 2011 dollars).
A U.S. VAT would be inefficient. As an initial matter, it should be emphasized that the adoption of a U.S. VAT would require a large-scale expansion of the Internal Revenue Service. The General Accounting Office has projected administrative costs of a broad-based single-rate VAT at $2.5 billion per year, with transition costs of approximately $2.6 billion. It must also be emphasized that a U.S. VAT would require multiple rates to counteract its inherently regressive nature. The General Accounting Office has projected additional costs between $791 million and $1.23 billion to administer a multiple-rate VAT. In 2010 dollars, a multiple-rate VAT would increase administrative costs by between $791 million and $1.23 billion. Moreover, because a U.S. VAT is being proposed as an additional source of income, rather than as replacement for the income tax, these costs would be in addition to the current costs of administering the income tax.
- Congressional Budget Office, Budget & Economic Outlook: Fiscal Years 2011 to 2021
- Adam Smith, Wealth of the Nations
- John. R. McGowen (The Tax Foundation), More U.S. Revenue? An Analysis of the European Community VAT
- Daniel Mitchell (The Heritage Foundation), How a Value Added Tax Would Harm the U.S. Economy
- Leah Durner, Harley Duncan & Jon Sedon, Why All the Buzz About VAT?
- Gilbert E. Metcalf, Value-Added Taxation: A Tax Whose Time Has Come?
- Consumer Price Index (CPI) Conversion Factors