Value Added Tax Issue Summary

Value Added Tax Headquarters

Issue
In recent months, some Washington policymakers have suggested that a Value Added Tax (VAT) be enacted to help reduce the federal deficit.  Specifically, some believe that it is likely that the National Commission on Fiscal Responsibility and Reform, whose mission is to recommend policies by the end of 2010 that will improve the long-run fiscal outlook, will include a VAT in their recommendations.  

Background
There are many kinds of VATs around the world.  The most common is similar to a national sales tax and is paid by the consumer at the cash register.  Economists agree that whether the VAT is paid directly by the consumer and remitted by the retailer, as is true with the “credit-invoice” VAT, or is paid by business through a subtraction method VAT, the economic incidence of the tax is on consumption and will cause consumer sales to decline.

Retail Impact
A federal tax on consumption will dampen consumer spending.  Retailers will reduce operations, closing stores and reducing employment.  Some retailers will go out of business, especially smaller retailers whose margins are slimmer so they will be forced to pass the entire burden of the tax onto their customers.

Message Points

• Consumer spending is 70% of GDP, and the economy will not come out of recession until the consumer regains his footing.  To impose a direct tax on consumption at this time will further depress consumer spending and lengthen and deepen the current recession.

• Retailers employ 1 out of 5 Americans.  The retail industry will bear much of the burden of a consumption tax, and many jobs in the retail industry will be lost.

• A VAT would greatly hurt the states. 45 states rely on sales taxes as a major source of revenue.  The enactment of a federal consumption tax would crowd out the ability of the states to raise their own sales taxes at a time when they are desperately in need of revenue.

• A VAT is a highly regressive tax, hitting lower and middle income taxpayers much harder than wealthier individuals.  Lower and middle income individuals need to use most of their earnings to purchase necessities.  Wealthier individuals have the ability to save a much larger percentage of their earnings.

• Consumption taxes will hurt senior citizens more than working-aged citizens, since seniors are generally living off of their savings, which were already taxed when earned.

• In OECD countries that have VATs in addition to income taxes, the VAT rates have risen greatly (doubled in the U.K.) as the size of government has grown.