VAT extends global reach: why don't we have VAT in the U.S.?

• Author: Levin-Epstein, Michael
• Position: Value-added tax - Cover story

Question: What do more than 160 countries have that the United States does not?

Answer: A value-added tax (VAT)

VAT is a broad-based consumption tax, chargeable at every stage of the supply chain, up to the retail stage, that generally allows the recovery of input tax for businesses and results in the effective taxation of the added value at each stage.

Why doesn't the United States have a VAT even though so many other countries do? Karen Christie, principal in the U.S. VAT practice at Ernst & Young LLP in New York City, points to several reasons, including the perception that a VAT potentially would have a disproportionate impact on low- and moderate-income households, as well as the concern that an additional revenue source ultimately could lead to greater spending and governmental expansion. Also, the increase in the tax administrative burden for U.S. companies cannot be overlooked.

From a federal perspective, Christie explains, fiscal policymakers are concerned that a VAT will be enacted not as a replacement tax but as an add-on tax to raise additional revenues. "This leaves the potential that the VAT could become a cash cow or money pump, whereby increases in the VAT rate over time raise additional revenue and lead to an increase in the size and scope of government," she explains.

Some are concerned that a VAT, which is fundamentally a tax on household consumption, is a regressive tax, affecting the low-income segment of the population more because they consume a higher proportion of their income compared with high-income households, according to Christie. "Adjustments in the VAT base to exclude items consumed more heavily by low- and moderate-income taxpayers could undermine the economic benefits of a VAT by requiring a higher tax rate to raise the same revenue on the narrower tax base, and could also add to the complexity of the VAT, which, in turn, increases the tax administrative burden even more," Christie asserts.

States State Their Case

Another reason the United States does not have a federal VAT: resistance from the states. Forty-five states, the District of Columbia, Puerto Rico, and several U.S. territories levy a sales tax, Christie notes. "A VAT at the federal level would be similar to state sales taxes. States would likely strongly resist any federal attempt to usurp their sales tax authority, because they rely on sales tax revenue," she says.

States would also likely be forced to keep their rates within a narrow range. Because the VAT rate would probably begin relatively high, it may leave states little room to lower their sales tax rate to increase their competitiveness with other states.

On the other hand, she explains, from a state taxation perspective, the landscape might be in store for change. Puerto Rico has been seriously considering the introduction of a VAT system: A VAT bill has been put forward by Puerto Rico's governor as a key part of the administrations current tax reform package. Although the first presentation of the package was defeated April 30 in the Puerto Rico House of Representatives by a margin of 22-28, the package may be presented again for a vote. If eventually adopted, the VAT in Puerto Rico would replace its sales tax, help reduce residents' individual and corporate income taxes, and help address the territory's deficit. "If a VAT was enacted in Puerto Rico, it could well become a testing ground for a VAT at the state level, potentially serving as a catalyst for the consideration of VAT in other states," she says.

On a global level...