The value-added tax

Is it a reasonable alternative to raise federal revenue ? The value-added (VAT) is viewed widely as a panacea for much-needed deficit reduction and revenue generation in the United States. The popular argument is the VAT is a relatively painless tax, since consumers may not know the amount of they actually are paying. The VAT also is viewed as * A that does not affect business profits. * A tremendous revenue raiser with relatively low rates. * A self-enforcing collection process. * An encouragement to save. * A textbook answer to the nation's balance-of-payments problem. In addition to raising revenue, policy also must satisfy a nation's social, economic and political aims. The pros and cons of a VAT can be debated at length in these terms. In his landmark work, The Wealth of Nations, Adam Smith outlined five characteristics of a tax: equity, neutrality, certainty, economy and simplicity (see the sidebar on page 47 for more complete definitions). For a to be good it should meet one or more of Smith's five characteristics or be desirable in terms of one of the three aims listed above. Should the United States adopt a VAT? Within the framework of these eight characteristics and aims, this article will examine this question to determine if a VAT is a logical solution to the nation's economic and budget woes. COMPUTING THE VAT As the name implies, a VAT is a on the value added at each stage of a product's production, distribution or retail sale. In its most common form, it simply is the on a company's sales minus the paid on the company's purchases. This is the credit (invoice) method of computing the VAT. (See the exhibit on page 48, for a Treasury Department description of three methods of computing VAT.) The subtraction method VAT creates fewer administrative burdens for both government and taxpayers since information to compute it already is available on businesses' federal income returns. This method, however, would be difficult to administer if Congress created many different rates and exempted or zero-rated goods or businesses. Under the addition method, a company's VAT base is primarily untaxed inputs (wages, salaries, depreciation, profit and interest). The base is simply multiplied by the rate. Most countries do not consider this method as an alternative; the European Community (E C) requires use of the invoice method. Given the need for flexibility in administering any tax, some experts consider the credit method the best for the United States. There are three methods of treating VAT paid on capital purchases: * Consumption method. Gross purchases are added to all other inputs. * Income method. The VAT paid is amortized. * Gross product method. No deduction is permitted for VAT paid. The consumption method is most common and also considered best for the United States. VAT-HISTORY AND CURRENT STATUS The VAT is a multistage tax; the retail sales is a single-stage tax. Many European countries have had one of these taxes for many years. Even before the first VAT (in France in 1954) European countries had a turnover tax on each stage of a product's production. In the late 1960s, other countries joined the VAT movement: Denmark, 1967; Germany, 1968; and the Netherlands, Belgium and Sweden, 1969. Today all 12 members have a VAT as part of their system. The Organization for Economic Coordination and Development (OECD) includes 17 European countries, Japan, Turkey, New Zealand, Australia, Canada and the United States. Of these 23 nations, at least 19 use a form of VAT. The latest countries to join the ranks were Japan in 1989 and Canada in 1990. The credit method currently is used by 18 of the 19 OECD nations that have a VAT. In the United States, the VAT has been discussed at the national level since President Richard Nixon's Task Force on Business Taxation proposed a VAT as a corporate income alternative. …