Implications of Different Bases for a VAT

Implications of Different Bases for a VATEric Toder, Jim Nunns, Joseph Rosenberg

A value added tax (VAT) with a broad base and a VAT that excludes food, housing, and medical care would both impose larger burdens as a share of income on low-income than on high-income taxpayers. A rebate aimed at low-income taxpayers would reduce their VAT burden more than exclusions of selected goods and services. A broad-based VAT that was accompanied by a rebate consisting of an earnings credit up to a ceiling amount and an adjustment in cash transfer payments would impose relatively smaller burdens on lower than on higher income taxpayers throughout most of the income distribution.

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I. Introduction

The federal budget outlook is unsustainable over the long run. The latest (June 2011) projections by the Congressional Budget Office (CBO) show the ratio of publicly-held debt held to GDP, which was 40 percent at the end of 2008, rising from 69 percent in 2011 to 187 percent in 2035 under their Alternative Fiscal Scenario, which assumes that current federal spending and revenue policies will largely continue. Even under CBO's Extended-Baseline Scenario, which assumes that all of the 2001-2003 tax cuts expire at the end of 2012, the AMT will no longer be patched, and that Medicare and other health-related spending will be held to modest growth rates, debt held by the public is projected to rise to 84 percent of GDP by 2035. Rising debt levels increase the chance of a fiscal crisis, a sudden spike in the interest rate the federal government must pay on its debt that would necessitate large adjustments to spending, revenues, or both. More gradual adjustments could be better designed and less damaging to long-run growth and social welfare.

Two prestigious groups, the President's National Commission on Fiscal Responsibility and Reform and the Bipartisan Policy Center's Debt Reduction Task Force, both recommended a sweeping set of changes in taxes and spending policies to address future deficits and eventually reduce the ratio of publicly held debt to GDP below its current level. The Debt Reduction Task Force recommendations included adopting a "debt reduction sales tax" structured as a valueadded tax (VAT). A VAT is a broad-based tax on household consumption that is collected incrementally by businesses at each stage of their production and distribution of goods and services. VATs are an important source of revenue for nearly all countries, and among major countries, the United States is alone in not imposing a VAT.

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