Policy Documents

Research & Commentary: VAT Will Increase Both Debt and Taxes

July 15, 2010

A value-added tax (VAT) is a sales tax applied at each stage of production for a good or service, instead of only at the point of final sale. The VAT’s tiered embedding hides the overall tax impact on a consumer item and makes it easier for politicians to increase the tax rate.

In April, the U.S. House of Representatives overwhelmingly approved (on a vote of 85-13) a nonbinding resolution, sponsored by Sen. John McCain (R-AZ), denouncing any attempt to impose a VAT in the U.S. In May, a Zogby poll showed 53 percent of Americans oppose introducing a VAT to lower the deficit, while only 24 percent favor the idea.

Despite overwhelming public and Senate opposition to a VAT, the White House appears to be seriously considering such a tax. White House advisor Paul Volcker, President Barack Obama’s debt and deficit commission, and other big-government advocates have said a VAT should be considered. Major spending obligations – Social Security, Medicare, and the federal government’s new trillion-dollar health care plan – will likely bolster these advocates’ VAT fervor in the coming years.

Most VAT proposals suggest lowering the U.S. corporate tax rate, currently the second-highest among all OECD countries, in exchange for a VAT. Corporate tax rates are in dire need of reduction, but replacing them with a VAT would stunt economic growth and lead to even higher taxes. Government spending has grown 45 percent faster in VAT nations than in those without one, according to a study by the U.S. Chamber of Commerce. In the 10 major OECD nations that have VATs, the average increase in rates since implementation of the VAT has been a staggering 62.7 percent. Of those 10 nations, only Canada has lowered its VAT, The Wall Street Journal notes.

A VAT is also expensive to administer. Florida State University economics professor Randall G. Holcombe estimates the net costs of implementing a VAT, including deadweight loss, compliance, and administrative costs, range from $75.5 billion for a 1 percent tax to $233.8 billion for a 10 percent tax.

Imposing new taxes to pay down the deficit and fund unsustainable entitlement programs is irresponsible. Without real, extensive entitlement and spending reforms, the United States will not be competitive in the global economy and our national debt will continue to balloon.

The following articles offer additional information on the value-added tax.

 

A Tax that Would Finance the Road to Serfdom
http://www.cato-at-liberty.org/2009/10/14/a-tax-that-would-finance-the-road-to-serfdom/
Daniel Mitchell, a Cato Institute senior fellow, provides a short summary and video explaining what a VAT is. He says defeating such a tax is a necessary step in controlling the size of government.

The Value Added Tax
http://www.budgetandtax-news.org/article/28028
In this Mercatus Center working paper, Florida State University economics professor Randall G. Holcombe analyzes the costs and revenues associated with implementing a VAT at various rates.

Value-Added Tax: No Easy Fix for the Deficit
http://www.budgetandtax-news.org/article/28029
Curtis Dubay of The Heritage Foundation concludes a VAT would not be effective at closing the nation’s budget deficit. He writes, “If Congress implements a VAT as an additional tax, businesses and individuals would try to avoid it through fraud, severely limiting a VAT’s ability to close budget gaps.”

The Wrong Policy at the Wrong Time
http://reason.com/archives/2010/03/04/vat
Veronique de Rugy, an economist at The Mercatus Center at George Mason University, explains how a VAT would do little to curb the nation’s looming debt problem. She writes, “Looking for new sources of revenue moves our attention from what can and should be done now: slow or stop spending increases and reform entitlements, sooner rather than later.”

Value Added Tax: Basic Concepts and Unresolved Issues
http://www.budgetandtax-news.org/article/28033
Alan D. Viard, a resident scholar at the American Enterprise Institute, and Robert Carroll, executive in residence at American University, outline the pros and cons of using a VAT as both an income tax replacement and a revenue enhancement. They conclude, “Economists have long been enamored with consumption taxes, including a VAT, because of their economic efficiency. But this efficiency is also a potential problem because this feature may be one explanation for the growth in government in many developed economies.”

What You Should Know About a VAT
http://www.uschambermagazine.com/article/what-you-should-know-about-a-vat
Dr. Martin Regalia, senior vice president for economic and tax policy and chief economist at the United States Chamber of Commerce, provides a quick overview of the two most common ways of applying a VAT, the credit-invoice method and the subtraction method.

The Perils of the Value-Added Tax
http://www.washingtonpost.com/wp-dyn/content/article/2010/04/16/AR2010041603993.html
Washington Post columnist George Will argues we should not consider taxing consumption unless the 16th Amendment is repealed. He writes, “Adding a VAT without subtracting the income tax would constrict Americans’ freedom much more than the health-care legislation does.”

 

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For additional information on this and other topics, visit the Budget & Tax News Web site at www.budgetandtax-news.org and The Heartland Institute’s Web site at www.heartland.org.

If you have any questions about this issue or the Heartland Web site, please contact Legislative Specialist John Nothdurft at 312/377-4000 or jnothdurft@heartland.org.