Shift from direct to indirect taxation, increase of VAT rates and an increase of tax authority scrutiny are methods of government to balance their budgets. From an economic point of view the question is what the impact will be on the economy in the downturn. Increase of prices and often the same or even lower available budgets of consumers will result in less spending. The effectiveness of indirect tax revenue is – based on literature – also seen in the US.
We understand that a several prominent commentators, politicians past and present, ex-chair of the Federal Reserve Alan Greenspan among them, have suggested that the introduction of a VAT or GST may be the “least worst” option open to the US government to raising revenue and to combat the deficit. We have gathered macroeconomic data and described the regressive nature of VAT.
Watch the findings here:
The conclusion drawn in this executive summary:
- “As a consumption-based tax, an add-on VAT would be shifted forward to consumers through higher consumer prices. As a result, private consumption would fall. By increasing consumer prices, the VAT also reduces real or inflation-adjusted wages, which would cause labor supply to fall as well.
- An add-on VAT would have particularly adverse effects on the retail industry. There would be an especially pronounced reduction in retail spending because nearly all retail goods would be subject to double-digit VAT rates, while many other consumer purchases would be exempt under a narrow-based VAT. In addition, some consumers would evade the tax – experience in other countries suggests 12 percent non-compliance with the VAT – driving up the VAT rate.
- Moreover, an add-on VAT leaves the economy considerably worse off than a similarly-sized reduction in government spending on income transfers. With an add-on VAT, GDP would initially be lower and the economy would lose jobs; by comparison, GDP and employment would increase with a reduction in spending. Although lower deficits and debt would have positive long-run economic effects for the economy, most middle income Americans who are working age or older at the time of enactment of the VAT would be worse off.
- Perhaps the most troubling aspect of a deficit-reducing VAT is that, if enacted in the near future, its negative effects on GDP, consumer spending, and employment would occur in the face of the current economic climate of weak economic growth, high unemployment, and low consumer confidence. The near-term drop in output, loss of jobs, and sharp decline in consumer spending described by this report would raise additional economic worries, rather than shoring up the weak economy. With the CBO projecting unemployment to not fall below 7 percent until 2013, the initial reduction in employment from a VAT, estimated to be roughly equivalent to 850,000 jobs, would make full economic recovery much more difficult.”
National Retail Organization - executive summary
This reference site lists and links articles, Op/Ed’s, video and books that explain and advocate a Value Added Tax for the United States.
Facilitating A Discussion
We are aware that drawing conclusions based on one report might be dangerous. It is our intention to facilitate a discussion.
- Do you agree with the conclusion?
- Are there any contra arguments that should be taken into consideration?
What does your gut feeling say?
Are These Macroeconomic Effects Findings Also Applicable For Countries That Recently Raised Their VAT Rates?
Based on the title of the Blog the first focus is whether a VAT system would work in the US. However, we see in countries that have a VAT system a shift from direct to indirect tax and increase of VAT rates are a trend.
- Are the finding (to what extent) re macroeconomic effects applicable for the countries that recently raised their VAT rate?
- What is the impact on the economy in the downturn?
- To stimulate the economy, would a decrease of VAT rates make more sense?
In our next Blog we will discuss the impact of a VAT system on companies and the Tax Administration. Effectiveness is the big advantage of Indirect Tax, however how efficient is such an introduction for companies that have to change systems, processes and train their people. From a Tax Administration point of view more transactions means more monitoring. One of the major concerns in Europe is VAT fraud.
Richard Cornelisse is CEO of the KEY Group and worked previously as Big4 Partner in the Tax Performance Advisory and Indirect Tax Practice and blogs on Tax Function Effectiveness and Tax Control Framework developments.