The best of both: where the VAT and tax integration converge.

• Author: Christian, Ernest S., Jr.

The Best of Both: Where the VAT and Tax Integration Converge

Introduction

Up to a point, the patterns of modern tax reform in the United States and Canada have been similar -- lowering marginal rates and broadening the tax base. With the Goods and Services Tax (GST), Canada is, perhaps, about to take another major step: adoption of a fairly traditional value-added tax (VAT) that is effectively adjusted at the border for imports and exports. While that will not be easy in Canada, it would be much more difficult in the United States. Even in Canada, where there is a considerable tradition of indirect taxes, it has been necessary to vary the traditional VAT pattern somewhat.

In the United States, where tax history has been different and political biases run strongly against anything that even appears to be a tax on consumers, we probably cannot follow the traditional VAT pattern at all. Instead, we must find some other formulation of an indirect tax, consistent with our own history and politics, that can be adjusted at the border for imports and exports.

The strong emphasis at the outset on border tax adjustments, which usually are permitted for indirect taxes but not for direct taxes, highlights an important point. The dominant reason for adopting a VAT, as such, is to adjust the tax for imports and exports. The other consequences of such a tax can be achieved by other means.

To suggest that the distinction under the GATT between indirect and direct taxes is largely a matter of form highlights another important point. It may be possible to achieve indirect tax status and border tax adjustments, without adopting a multi-stage sales tax.

Therefore, in the United States, we may be able to gain the traditional advantages of a VAT without having to suffer the political disadvantages of adopting a tax on consumers as such. By borrowing certain key ingredients from the VAT and melding them into our existing U.S. tax structure, we may also be able to go even further, and gain the major additional advantage of a fully integrated corporate and individual tax system.

Just as the United States stands nearly alone in relying on direct taxes on net income that cannot be adjusted at the border, it also stands nearly alone with a nonintegrated corporate income tax that greatly increases the cost of capital and distorts the preference for debt over equity -- a matter that has been much in the news in recent days.

Treasury Secretary Nicholas Brady has emphasized his intention to integrate the corporate tax and has directed his staff to develop a detailed set of options for public discussion and potential enactment. Many believe that the Administration will seriously pursue tax integration. The principal barrier is a potentially large revenue cost.

While Treasury officials openly advocate tax integration, no one in the Administration will even talk about a VAT or any other additional tax. For the same and other reasons, almost no one in the U.S. business community will actually advocate enactment of a VAT at this time. Despite the obvious advantages of border tax adjustments and the philosophical desire to shift the tax burden away from savings and investment, when it gets down to reality, there are just as many negatives as positives. With a half dozen exceptions, members of Congress shudder at the idea of telling their constituents that they voted for any new tax, especially one on consumers. It may be good for Canada and elsewhere, but a multi-stage sales tax VAT is not in the cards for the United States.

Instead, we may borrow the good parts from a VAT, leave the rest behind, and move forward with historic tax reform by fully integrating the corporate and individual taxes in the United States. Assume, for example, that the gross profit tax base found in the VAT were extracted and substituted for the present U.S...