A number of scholars and economists have brought to attention the lack of a VAT in the United States. Currently implemented by every other nation in the OECD (Organization for Economic Co-operation and Development), including much of Europe, some argue that a VAT would help to increase revenue and revise the overly complex US federal tax code – a frequent point of discussion in national politics.
What Makes a VAT Different?
If you’ve ever traveled in Europe, you’re at least passingly familiar with the VAT or Value Added Tax that is applied to almost all sales. In its most basic form, a VAT is a consumption tax, but unlike the Sales Tax imposed by many US States and Cities, a VAT applies to all points of purchase, representing taxation on the value added to a product or service.
Here is a simple example of how sales and value added tax differ, starting with a transaction performed in a system without tax.
- No Tax – A manufacturer produces a chair, spending $25 on raw materials and selling the completed chair to a retailer for $35. The manufacturer’s gross margin is $10, the balance remaining after that sale. The retailer then sells the chair to a consumer for $50, leaving a gross margin of $15.
- Sales Tax – Sales tax is applied only to the final consumer. So the manufacturer of the above chair will still spend $25 for the raw materials needed in the chair. The retailer will still pay $35 for the chair. But when the retailer sells that chair to a consumer, a 6% sales tax (for example) will apply and the consumer will pay $53 instead of $50, with the $3 tax going to the government.
- VAT – Value added tax is different in that taxation occurs at every stage of the process without the total tax on a single product growing. So in this case, the seller of the raw materials to the manufacturer will charge an additional $1.50 (6%) tax to the manufacturer. The manufacturer charges the same 6% to the retailer, subtracting what they paid to the government through their taxes. The retailer does the same, charging the consumer $53 and subtracting what they have already paid, submitting it to the government.
The end result is that each stage of the supply chain is taxed on the value they add to the finished product or service, ensuring equal taxation across the board. By subtracting the previous VAT paid, the manufacturer and retailer are able to recuperate the majority of their expense and maintain the same gross margin, the consumer pays the same tax, and the government collects tax on all commerce, even if the finished product isn’t ultimately sold to a consumer.
The Pros and Cons of VAT in the United States
How would a system like this work in the United States and what are the relative benefits and potential cons?
Let’s start with the pros.
A value added tax equalizes the tax burden to manufacturers, retailers, and to some degree consumers. In the current system, retailers are forced to handle the entirety of sales tax collection and payment to the government. Starbucks collects and pays the full 10% back to the government for all purchases at its locations, whereas the manufacturers of their cups, equipment, and ingredients aren’t responsible for handling these transactions.
Additionally, a VAT is a consumption tax. If you spend less money, you pay fewer taxes. This applies not only to consumers, but to retailers and manufacturers, rewarding those with more efficient supply chains and operating models. It also stops situations in which retailers or service providers don’t report their revenue from consumer sales. Because every step of the process is taxed, the electrician, auto mechanic, or plumber (all of whom have to purchase pars and therefore pay VAT) will be more inclined to report revenue and charge tax to their customers, increasing revenue to the government.
There are cons to a VAT system as well.
To start, the United States depends heavily on the structure and operation of its States. States rights have long dictated many issues related to commerce – it’s one of the reasons a National Sales Tax doesn’t yet exist, and why so many states administer and manage their own Sales Tax.
There would certainly be concerns over the implementation of a national VAT. Would it be additional tax for those living in states and cities with sales tax, or would it supplant those taxes and would income distribution be required? These are important questions the new tax code would need to address. Another major concern with the VAT is that taxes are only collected on what you spend.
Let’s look at example in which a national VAT replaced part or all of the national income tax. For a wealthy individual who makes $1 million a year but only spends $150,000 of that (saving the rest), the VAT will only apply to a portion of their income. For someone who makes $50,000 a year and spends all of it, VAT applies to all of what they earn. While the VAT could be implemented as an additional tax, there will always be a concern over who it affects and what percentage of their income would be affected.
Does a VAT Solve the US Revenue Problem?
While it may seem on the surface that the US would be open to potential solutions such as a VAT, politically, it’s difficult to see Congress and then the individuals States choosing to go along with such a model. To be sure, the uphill slog that has occurred in Congress the past few years to implement a national sales tax model is clearly indictative of a culture that is torn and not anywhere close to agreement on a model that could be applied across the board.
While VAT models work well in many other developed countries, only time will tell if such a model ever becomes viable here in the US. A more likely step for the US would be one of the competing versions of a national sales tax that would then be supported by streamlined models such as the Streamlined Sales Tax Project.