Why the flap over a VAT?

• Author: Van Leuven, Mary
• Position: Value-added tax

There has been considerable discussion in Washington over the past several months about tax reform and deficit reduction. In late 2010, two bipartisan commissions offered their plans for reforming the Internal Revenue Code and bringing the federal budget into a more sustainable position. The congressionally created National Commission on Fiscal Responsibility and Reform proposed the elimination of nearly all individual and corporate tax expenditures, along with significant expenditure reductions, as a means of repairing the budget imbalance, bringing greater neutrality to the Code, and substantially reducing personal and corporate tax rates.

The Debt Reduction Task Force of the Bipartisan Policy Center--cochaired by former senator Pete Domenici and Alice Rivlin, a former director of both the Congressional Budget Office (CBO) and the Office of Management and Budget--made a number of similar proposals, but also recommended that the federal government adopt a 6.5% value-added tax (VAT), which it termed a debt reduction sales tax, to address the longer-term fiscal picture, including the need to reduce the federal debt and deal with the health and retirement obligations of an aging population (Bipartisan Policy Center Debt Reduction Task Force, Restoring America's Future, p. 39 (November 2010)).

Concerns about the near- and long-term fiscal prospects for the federal budget have led a number of other observers to suggest that the United States adopt a VAT at the federal level. The general position of the VAT proponents is that the long-term costs of meeting the Medicare and Social Security obligations of a rapidly aging population, coupled with the need to reduce the federal debt and reform the income tax, require an additional federal revenue source. Given that the United States is the only major developed country in the world without a broad-based national consumption tax, proponents believe that a VAT similar to that used by over 150 countries around the globe should be adopted.

If the federal government were to adopt a VAT, it would need to address a number of issues regarding the structure and operation of the tax as well as how it might be integrated with existing state and local retail sales taxes. This item provides a brief overview of some of those issues, without taking a position either for or against the need or desirability of the federal government adopting a VAT. To provide some context for the VAT discussion, it begins with a brief overview of the near-term and long-term fiscal position of the federal government and then discusses the considerations involved in structuring a hypothetical U.S. federal VAT.

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