Former Federal Reserve chairman Paul Volker, now an advisor to President Obama, floated the idea of a value-added tax as a solution to the nation's deficit crisis, and the President in a recent interview seemed open to this "novel" idea, but the Senate, in a non-binding vote, shot it down 85-13. I've been hearing more and more about value added tax in the past weeks as a means for providing revenue to balance the budget.
What is a Value Added Tax?
A value added tax, or VAT, is a tax on consumption; it is sometimes called a national sales tax. A VAT is imposed on all stages of production and distribution; for example, it taxes the forestry company, then the sawmill, then the wholesaler, then the furniture maker, all of whom pass the higher cost on the consumer.
What are the Benefits and Drawbacks of a VAT?
Benefits of a VAT for the U.S.
- A VAT could eliminate the labyrinthine U.S. income tax system, since the VAT is so much more efficient and would bring in more revenue.
- A VAT would also solve the problem of lost online sales taxes, since the imposition of a VAT would mean that all sales, even online sales, would be taxed.
- A VAT would provide additional income to reduce the deficit and fund critical programs like health care for every American.
VAT Drawbacks/Problems:
- VAT's are hugely regressive, with the cost falling mostly on the poor and lower income individuals and families.
- It will be difficult, if not impossible, to eliminate the IRS and the income tax system in the U.S., so the VAT will be just another tax imposed on the American people.
- If the VAT replaces state sales taxes, the states will raise a fuss. The state sales tax system is extremely complex, with some states not charging state sales tax and others taxing at different rates, including local option taxes charged by cities and counties. Eliminating this mess could take many years. If the VAT does not replace state sales taxes, it would add another layer of taxes to the already high tax burden Americans bear.
- VAT calculations would be costly for businesses to administer. Each business would have to calculate VAT on every product, at every step of the process. These costs, of course, would be passed on to consumers, along with the VAT rates.
- The VAT is largely hidden from consumers, so it could be raised without them raising much of a fuss, unlike income taxes.
Like every new idea, this one has both problems and benefits. Given the state of the deficit, I don't see the discussion about the VAT going away any time soon. I'll keep you advised as I hear more.