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The Benefits of a Value Added Tax
A Value Added Tax is a consumption levy imposed at each stage of production in a supply chain. The tax is ultimately paid by the consumer, either at the register (that widget will be $20 plus a $4 VAT please) or the VAT will be embedded into the price of the product (the widget costs $24, VAT included). Companies are responsible for keeping track of the VAT, but they act basically as tax collectors -- it doesn't come out of their pockets.
The VAT has been around for nearly 60 years. In theory, the biggest benefit of a value-added tax is that it can lower the types of other taxes people and businesses pay. Indeed, Columbia University Tax Law Professor Michael Graetz has proposed a VAT he says could remove 150 million Americans from the tax rolls. In other countries, VAT takes the place of things like social security taxes that are used to pay pension benefits for the elderly.
In reality, countries with VAT tend to have higher overall tax burdens, although they also tend to provide more services.
Many economists believe it has the lowest impact of all taxes on economic growth. The Organization for Economic Cooperation and Development, in fact, recently made that declaration, which has fueled a shift in Europe and elsewhere away from corporate income taxes to VAT. Hungary, for example, had a VAT rate of 27 percent in 2012, the highest in the Euro Zone.
And because so many companies have so much experience working with VATs in other countries, it's viewed as relatively manageable to administer. However there are risks for companies because they can be on the hook for remittance errors. Also, it can be a pain in the neck reimbursement periods from the government aren't efficient. And fraud is a problem too.
Pros and Cons
Almost every country in the world has a VAT or GST. The standout exception is the United States. It's also true that the these other countries with VAT generally have lower business INCOME taxes. The United States on April 1 will have the highest statutory corporate income tax in the world. It's also the only country in the world with both a corporate tax rate above 25% and a policy of taxing business income no matter where it is earned in the world. So in an oversimplified example, if Widget Co. earns $100 in the US and $100 in Europe, it pays tax in the U.S. on $200 (although it gets to subtract any taxes paid abroad from its U.S. tax bill). In most other countries, tax stops at border, so if Widget Co. earned $100 in its home country of Ireland and $100 in the U.S., it would pay tax in Ireland on just the $100.
There are two chief criticisms of a VAT:
1) It is regressive, meaning the burden of paying it falls heaviest on those with the lowest incomes.
2) It is a money machine and easily dialed to reach revenue needs without being very noticeable. This means the size of government can grow easier.
The VAT has always been regarded with suspicion in the United States. Indeed, while there's no formal proposal to implement one, the United States Senate in 2010 voted against its implementation 85-13 based on fears the Obama administration might seek one.
Former U.S Treasury Secretary and White House Economics Adviser Lawrence Summers tells this (admittedly partisan) joke in the U.S.: Democrats hate a VAT because it hurts the poor. Republicans hate it because it means bigger government. (He pauses). When Republicans realize it hurts the poor and Democrats realize it grows government, then we'll get a VAT.
One final piece of trivia about the VAT: It is said that every ruling political party that authorized implmentation of a VAT in the past has been voted out of office in the next election. I'm still tracking down the veracity of that.