Richard Cornelisse

Would Europe’s Value Added Tax Work For The United States?

In Macroeconomic effects of VAT, US VAT introduction on 01/03/2012 at 12:49 pm

By Richard Cornelisse and Kelvin Hulsebos

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:

Movie About Macroeconomic Effects Re Introducing US VAT System

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.

    1. Do you agree with the conclusion?
    2. 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.

    1. Are the finding (to what extent) re macroeconomic effects applicable for the countries that recently raised their VAT rate?
    2. What is the impact on the economy in the downturn?
    3. To stimulate the economy, would a decrease of VAT rates make more sense?
Next Blog

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.

Tax Management Consultancy welcomes your opinion on any of the issues raised, so feel free to join in the discussion on LinkedIn | Twitter | Facebook.

  1. I disagree with some of your assumptions in what a US VAT might look like and the consequences of the same. For example, you state that “nearly all retail goods would be subject to double-digit VAT rates”. Firstly, there is no eveidence to suggest that this would be the case. If the US was to align its indirect tax rates (i.e. state sales tax plus federal VAT) with its NAFTA partners Canada and Mexico, this is more likely to call for a VAT rate around the 7% mark and most of the estimates that have been considered have used this rate or one close to in order to illustrate likely revenue gains. Secondly, especially considering VAT’s regressive qualities, there is no need for “nearly all” retail goods to be taxed at the standard rate. It is likely that reduced and zero rates would apply alongside exemptions, just as in the vast majority of VAT countries. Also, if a 7% rate was introduced, I would bet that the supply chain would absorb 3-4% of this increase, so the likely retail increase would, in reality, probably only be in the 3-4% range, which would not exactly help retail sales but would not be disastrous either. Finally, if a VAT was to be introduced to the US, it would almost certainly be in conjunction with reductions in other taxes (in order to “sell” it to a tax-resistant general public). This would, of course, have further important ramifications within the wider US tax system.

  2. Most of the arguments stated are either that reducing the deficit will be painful whatever method is chosen, or that spending reductions are better than tax increases. The question should be is VAT better than income tax at the margin? If the answer is yes then it can either be additional to reduce the deficit or instead of part of the existing income tax take. Which is a separate question.

  3. […] our Blog of March 1 “Would Europe’s Value Added Tax Work for the United States“  we quoted the executive summary of the National Retail Organization.  The report was on […]

  4. I think, in broad terms, the introduction of a VAT would be of overall benefit to the US economy. However, introducing a VAT alone will not solve the USA’s financial problems. To achieve maximum effect I believe that a VAT should be introduced as part of a much wider reform package that would have to take into account State and Federal fiscal relations. For a start, introducing a VAT would be meaningless without a fundamental reform of State based Sales and Use taxes. I know previous attempts at harmonising S&U have been unsuccessful but given the precarious economic situation I think the individual State and Federal Governments should work together to introduce a harmonised broad-based VAT at a rate of something like 10% with the States retaining their current level of taxation at about 8% and the Federal Government 2%. Whether this is just dreaming or not I do not know but I think the time has come for some mature debate in this area. The VAT/GST has been in my own country Australia for 12 years now and it largely works very well although I do not think our model of GST distribution (which is a Federal Tax) to the States will work well in the USA. There are enough arguments between 6 Australian States let alone what it would be like between 50 much more independent American states!

  5. Yes it would/could work in the US and others hold that opinion.

    At what cost to the economy is a dimension that is debateable.

  6. […] “Would Europe’s Value Added Tax Work for the United States“, […]

  7. How about using a VAT to replace all US income-investment,and payroll taxes? This in my opinion would benefit the US economy tremendously.But if a US VAT were to be added on top of our current bloated tax code without abolishing other taxes,any benefit would be negated.My plan would abolish all income-payroll-estate and excise taxes,and end all tax loopholes,subsidies.Lower the corporate top tax rate to a flat 15 percent.Abolish all US import duties.After all of that simply replace and implement a 10 percent VAT on all goods(of course the vat would be paid by foreign exporters at our border on all imported goods to keep em honest).What do you think could it work to increase US prosperity? Or do you have a better tax plan for the US like maybe the “Fair Tax” which I also prefer to our current outdated tax code.

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