Abstract
This paper reviews issues related to the introduction of a value-added tax in the United States. In particular, the paper distinguishes between European-styled value-added taxes that are levied similarly to sales taxes, and value-added taxes that are levied through the business and personal income tax systems. The costs and benefits of such taxes, including their potential yield, are then discussed.
I. Introduction
Over the past several decades, numerous proposals have been made for a value-added tax (VAT) in the United States. The impetus for these proposals has been in large part the view that a VAT is less distortionary than existing income or sales taxes. More recently, VATs have been proposed as a means of achieving deficit reduction, or as a possible means of financing the costs of health care reform. This note briefly reviews various proposals for value-added taxation at the state and federal levels, and discusses the possible costs and benefits, as well as the likely yield, of a VAT.
In summary, the main advantage of a value-added tax as compared to other forms of taxation is that taxing consumption can be less distortionary than taxing labor or other income. As a result, most estimates suggest that the use of a VAT to reduce the fiscal deficit could raise potential output in the longer term. The disadvantages of a VAT are the significant administrative costs that would be incurred in implementing the tax, and its regressivity.
II. Value-Added Taxes 1/
Value-added taxes (VATs) are distinct from sales and excise taxes in that VATs are levied on the value added at each level of production. By taxing only firms’ value added the VAT can help avoid the cascading that may occur when a sales or excise tax is applied at multiple stages of production. A VAT is often termed a consumption tax since the value added by a firm is also the difference between the firm’s receipts and its cost of purchased inputs, which may be viewed as the firm’s net consumption of inputs. Similarly, from a macroeconomic perspective the base of a VAT that properly accounts for purchases of capital is private sector consumption.
A VAT can be levied in different ways. The most common approach among OECD countries is the credit method (often termed a European-style VAT), which requires firms to calculate and report their VAT liability as the VAT rate times their sales. Against this amount, firms deduct a credit equal to the amount of VAT that was paid on their inputs at earlier stages of production. This approach is usually implemented by the credit-invoice method, in which firms are required to produce invoices for all sales showing the amount of VAT paid. 2/ Alternate methods include the subtraction method, which requires firms to apply the VAT rate to the difference between sales and taxable inputs, and the addition method, which requires calculation of value added on the basis of total input costs including wages and salaries.
Special treatment to different sectors or products can be provided under a VAT either through exemptions or through differential rates. In the former case, industries producing specific products can be exempted from the VAT on their sales, but exempt firms would not be able to receive a credit for VAT paid on their inputs. This type of treatment is often accorded to businesses below a certain size threshold, on the assumption that the costs of administering the VAT for such firms would exceed the yield from the tax. 1/ If the exemption is provided to retailers, the tax paid on their sales is effectively reduced. However, if the exemption is provided at an earlier stage of production, exemptions can have the effect of increasing the total amount of tax paid since purchasers of exempted goods would not be able to obtain a credit for VAT paid by the exempt sector.
Tax concessions also can be provided in the form of differential rates. Firms receiving such a concession apply a lower VAT rate on their sales but are able to credit the full amount of VAT paid on inputs. This avoids the cascading effect that can result from exemptions. At the extreme, the concessional rate can be set at zero--i.e., firms are “zero-rated.” Such treatment is sometimes accorded to producers of capital goods as a means of promoting investment. 2/ Exports also are usually zero rated.
An alternative form of a VAT is the so-called direct consumption tax. In this case, rather than taxing consumption at the point of sale, the tax is administered through the income tax system, and is applied by measuring consumption over a period as the difference between income and savings. Proposals for such a tax usually include two components--a business and a wage tax. 1/
For example, the business portion of the direct consumption tax would be administered through the corporate/business income tax system and would involve a flat rate levied on gross business receipts less purchases of intermediate, capital, and labor inputs (i.e., similar to a subtractive VAT). The wage tax portion of the tax would be levied on individuals’ wage income, which would have been deducted from the business tax base, and would be administered through the personal income tax system. Thus, these types of taxes are said to be equivalent to a consumption tax since the basis is private sector income less investment, which in turn is equal to private sector consumption. The advantage of these proposals is that they would utilize the existing tax administration, and they would provide greater scope for including a degree of progressivity in the VAT system. For example, specific proposals have assumed that the wage income tax would contain an allowance for family size and filing status, or that the wage income tax would have a progressive rate structure.
III. Past and Current U.S. VAT Proposals
Calls for a VAT tax at the federal level date as far back as the proposal by T.S. Adams in 1921. 1/ More recently, a VAT was recommended in 1972 as a source of revenue for providing relief on residential property taxes. The proposed Tax Restructuring Act of 1979 also contained a proposal for a European-style VAT with multiple rates between 10 and 15 percent. In 1985, a 0.8 percent VAT (to be levied at the manufacturing stage) was proposed to raise revenue for the “Superfund” but failed in part because of concerns that administrative costs would exceed projected revenues. 2/ Also in 1985, Senator Roth proposed a Business Transfer Tax (BTT), which was a subtractive method VAT requiring firms to calculate their value added by subtracting the costs of taxed inputs from sales. In 1987, a European-style VAT with a single rate of 10 percent was included in a proposed omnibus trade bill introduced by Senator Hollings.
Congressman Armey has recently proposed a “flat tax” modeled on the direct consumption tax initially described by Hall and Rabushka (1985). It would involve a roughly 17 percent tax rate applied to business income less capital, labor, and intermediate goods expenses. A similar rate would apply to labor income after a deduction of $13,100 for single persons or $26,200 to a married couple. The returns to savings, including capital gains, would not be taxable at the personal level.
Two Senate proposals for direct consumption taxes were prepared in 1994, one sponsored by Senators Boren and Danforth and the other by Senators Domenici and Nunn. 1/ Both propose to eliminate corporate income taxes in favor of a consumption levy in a revenue-neutral fashion. Although the two measures contain significant differences, both plans would require businesses to subtract all purchases of goods and services from gross income and pay a tax of approximately 10 percent on the difference. 2/ As a result, durable goods such as capital equipment and inventories would no longer be depreciated over several years but rather would be written off in the year of purchase. Businesses would not be able to deduct interest costs or the costs of imports, while revenues from the sale of exports would be exempt. Unlike the Boren-Danforth bill, the Domenici-Nunn proposal would amend the personal income tax system. In particular, it would redefine taxable income as the difference between income and saving--i.e., consumption--and would levy tax at rates ranging from 14 to 36 percent.
Several proposals for VATs have been made at the state and local levels, but only Louisiana and Michigan have adopted VAT-style taxes (see Appendix I for a discussion of the Michigan experience). As early as 1932, the Brookings Institution suggested a VAT for Alabama and Iowa. In 1966, the Temporary Commission on City Finances proposed that New York City replace all nonproperty business taxes with a value-added tax. A VAT also was proposed in 1967 to the Governor of California by the Citizen’s Advisory Tax-Structure Task Force as a replacement for all local taxes on personal and business property and a means of reducing the state corporate income tax. The West Virginia legislature nearly enacted a VAT in 1967, and passed VAT legislation in 1970 that was vetoed by the Governor. Legislation proposing a VAT also was introduced in the Oregon state assembly in 1969 and 1971, but was not approved. More recently, several legislative committees in Hawaii have recommended that Hawaii’s general excise-tax system be replaced with a VAT.
IV. The Costs and Benefits of a Consumption Tax
1. Economic effects
An often-cited benefit of VATs is that they are less distortionary than other forms of taxation. In particular, other types of indirect taxes (such as sales taxes) tend to distort relative prices because of cascading. For example, if a sales or excise tax is levied at different levels of production it will fall disproportionately on those goods with multiple stages of production since the tax will be compounded at each level. As a result, consumption can be distorted away from products with many stages of domestic production and toward imports. As the VAT is levied on value added at each stage of production, in principle the effective tax rate will be uniform for all domestically produced goods. 1/
In addition, a VAT is often considered to be less distortionary in an intertemporal sense, as compared to an income tax. This is because income taxes are generally applied both to labor income and to the returns to saving. As a result, income taxes are prone to an intertemporal form of cascading since the tax is levied twice, both when labor income is earned and again when the income is saved and earns a return. Depending on a number of factors, including consumer preferences, it can be argued that an income tax will tend to reduce the incentives to supply labor and to save, and therefore will tend to reduce aggregate output. 1/
Ballard, Scholz, and Shoven (1987) examine the costs of these distortions for the United States by simulating the effect of using a 6 1/2 percent VAT to substitute for a portion of personal income tax receipts. Their results suggest that the effect would be to increase GDP by 1 percent. However, a CBO study (1992) suggests that these estimates may be overstated because they assume that the VAT is adopted at a uniform rate and over a broad base, and because the estimates assumed a relatively high elasticity of saving with respect to after-tax interest rates.
The CBO (1992) also performed simulations examining the effect on saving of a shift from income taxes to a VAT. Their simulations suggested that replacing income tax revenue by a 6 percent VAT would increase the saving rate by 1/2 percentage point and increase output by 1 1/2 percent in the long run. 1/ The CBO report cautioned, however, that their simulations could overstate the effect on saving since they assumed a relatively large effect on the savings behavior of older preretirement consumers.
Moreover, the simulations above assume that the VAT replaces another type of tax. Some authors have argued that if a VAT were introduced as a means of reducing the deficit it could have substantial short-run costs in terms of output. For example, Prakken (1986) simulates the effect of the introduction of a VAT in the context of a large-scale macroeconomic model. These simulations confirm that the longer term effect of a VAT would be to increase saving and potential output, but suggest that aggregate output would tend to decline in the short run. More specifically, a VAT might cause a larger reduction in current consumption than would an increase in personal income taxes because the latter would tend to lower the after-tax yield on saving. Short-run costs also tend to be compounded by the fact that a VAT would initially raise prices by the amount of the tax, reducing disposable income, real money balances, and real wages. However, these short-run costs could be reduced if the monetary authorities accommodated the first-round effects of a VAT on prices.
By contrast, models that assume that households are forward-looking when formulating expectations of inflation and wealth would tend to suggest: a lesser near-term output loss from tax increases. For example, simulations using the IMF’s multicountry simulation model (MULTIMOD) indicate that a VAT would have a smaller adverse output effect in the short run. Bartolini, Razin, and Symanski (1994) compare the adoption by the United States of a wage tax, a VAT, and a capital income tax that each yield revenue equal to 2 percent of GDP. Their results (see tabulation below) suggest that the short-run output loss from a deficit-reducing tax increase would be relatively small, and that the longer term benefits from a VAT would be significant. By contrast, increases in wage or capital taxes yielding a roughly equivalent amount would cause a greater loss of output in the short run and would lower longer run output.
Change in Real GDP 1/
(Percent deviations from baseline)
Change in Real GDP 1/
(Percent deviations from baseline)
| Year | Long Run |
|||||||
|---|---|---|---|---|---|---|---|---|
| 1 | 2 | 3 | 4 | 5 | 6 | 10 | ||
| VAT | -0.6 | -0.7 | -0.5 | -0.3 | -0.1 | -- | 0.3 | 0.7 |
| Wage tax | -0.7 | -0.7 | -0.8 | -0.8 | -0.8 | -0.8 | -0.8 | -0.6 |
| Capital tax | -1.6 | -1.5 | -0.8 | -0.6 | -0.7 | -1.0 | -2.2 | -4.0 |
Change in Real GDP 1/
(Percent deviations from baseline)
| Year | Long Run |
|||||||
|---|---|---|---|---|---|---|---|---|
| 1 | 2 | 3 | 4 | 5 | 6 | 10 | ||
| VAT | -0.6 | -0.7 | -0.5 | -0.3 | -0.1 | -- | 0.3 | 0.7 |
| Wage tax | -0.7 | -0.7 | -0.8 | -0.8 | -0.8 | -0.8 | -0.8 | -0.6 |
| Capital tax | -1.6 | -1.5 | -0.8 | -0.6 | -0.7 | -1.0 | -2.2 | -4.0 |
2. Administrative costs
A criticism of VATs is that the administrative costs of introducing a new form of taxation would be excessive. This criticism is argued to be stronger in the case of the United States owing to the fact that a VAT would not replace an existing federal indirect tax and would, therefore, require an additional administrative network, unless it were implemented through the income tax system.
The administrative costs of VATs in other OECD countries are estimated to range from 0.02 percent of GDP (Sweden) to 0.08 percent of GDP (Belgium and Ireland), and seem to depend to a large degree on the number of traders registered. 1/ The U.S. General Accounting Office (GAO) has estimated that the costs of a broad-based, single-rate VAT, with an exemption for businesses with gross receipts of less than $100,000, would be $1.2 billion in FY 1995 (roughly 0.02 percent of GDP), i.e., at the lower end of the above range of estimates. 2/ While significant administrative economies of scale might accrue to a VAT in the United States over those in other smaller countries, the GAO’s estimates may also reflect the assumption of a relatively simple VAT structure, high compliance rates, and a high taxpayer threshold. An offsetting consideration could be that a federal VAT could enable harmonization with existing state sales taxes, providing scope for reducing the overall tax administration burden.
A VAT also would impose compliance costs on registered firms. The CBO (1992) reports the results of a U.K. study, which suggest that compliance costs could be as high as 2 percent of taxable sales for businesses with annual sales of up to $30,000, but fall to 1/2 percent at levels of sales of about $100,000, and fall below 0.05 percent for firms with sales in excess of $1.5 million. A recent study of the Canadian value-added tax suggests that compliance costs averaged less than 1/2 percent of business revenues for firms with revenues above $50,000. 3/
3. Federal-state issues
There do not appear to be significant legal proscriptions against the federal government adopting a VAT, despite the fact that to date general sales taxes have typically been the domain of the states. However, difficulties might be encountered in administering a federal VAT in conjunction with the states’ retail sales tax systems. While the option would exist for the states to continue running their own separate sales tax systems, Tait (1988) notes that this would impose a heavy burden on firms who would need to comply with two separate systems, and would mean that administrative costs would be duplicated at the state and federal levels. The preferred approach would be for the states to forgo their own retail sales tax regimes in favor of a share of VAT revenues. However, merging state and federal taxes would likely mean some loss of control by the states over decisions regarding the tax base and the VAT rate. 1/ These types of issues have contributed to substantial difficulties in harmonizing the Canadian federal VAT with provincial sales tax systems, and have been argued to have contributed to higher-than-expected private sector compliance costs, as well as VAT evasion.
4. Equity issues
An important criticism of VATs is that they are regressive compared with income taxes or direct consumption taxes. In particular, assuming that low-income households consume a greater proportion of income than higher income households, the introduction of a single-rate, broad-based VAT would impose a greater tax burden on low-income households as a share of income. For example, the CBO simulated the effect of a 3 1/2 percent broad-based VAT, and estimated that the average household’s VAT burden would be 2.2 percent of household income. 1/ However, the burden on family income ranged from 4.8 percent for households in the lowest quintile to 1 1/2 percent for the highest quintile. Conversely, an income surtax that raised the same revenue was estimated to impose a 0.2 percent burden for the lowest quintile, rising to 3 percent for the highest quintile.
A VAT is regressive when tax paid as a share of annual income is used to gauge equity, but is less so when alternate measures of equity are used. For example, when lifetime burdens are considered, the VAT is estimated to be almost neutral vis-à-vis income taxation for low- and middle-income households since they tend to consume virtually their entire incomes over their lifetimes. Caspersen and Metcalf (1993) simulate the lifetime burden of a 5 percent VAT and estimate that regressivity measured on a lifetime-income basis would be considerably less than when measured on the basis of annual income. For example, on the basis of annual income the burden would range from 6.6 percent to 3.2 percent from the lowest to the highest income decile, while on the basis of lifetime income, the burden would range from 5 percent to 3.7 percent. The authors also suggest that the VAT’s regressivity is reduced further if measured on the basis of lifetime consumption.
A number of options exist to mitigate the regressivity of VATs. For example, goods that account for a disproportionately high percentage of the consumption of lower income households can be zero-rated or exempted from VAT. Similarly, a multiple-rate VAT could be adopted that applies a lower VAT rate to necessities. The option also exists to utilize existing or new tax and transfer programs to mitigate the effect of the VAT on the poor. 1/ However, the first two options would come at the cost of reducing the intended efficiency of the VAT. An alternative, which can minimize the need for a new administrative system and which permits rates to be set to achieve a degree of progressivity, is to introduce the value-added tax through the income tax system in the form of a direct consumption tax.
V. VAT yields
The yield from a VAT will depend on the tax rate as well as the comprehensiveness of the tax base. In the absence of any exemptions, the VAT base would simply equal the amount of domestic personal consumption. For example, in 1993 U.S. personal consumption was $4.4 trillion, or roughly 70 percent of GDP. Thus, assuming 100 percent compliance, no exemptions, and ignoring the possible effect of introducing a VAT on other tax receipts, each percentage point of a VAT would yield 0.7 percent of GDP.
However, in most cases exemptions reduce the tax base considerably. For example, the CBO (1992) notes that even for the broadest of consumption taxes the tax base (and yield) would be reduced by about 25 percent owing to administrative and enforcement issues. In particular, the tax base would likely be reduced by the exemption of religious and charitable organizations, as well as state and local governments and utilities. Small businesses also likely would be exempt owing to the administrative costs that they and the fiscal authorities would need to bear. In addition, difficulties are presented by the treatment of housing and housing services, as well as the treatment of financial services.
With regard to the treatment of housing, the VAT’s neutrality could be preserved by simply taxing the construction cost of new homes and exempting rental costs, since taxing both would imply double taxation. However, this would imply a windfall for existing homeowners. The alternative of only taxing rental payments, however, would leave owner-occupied housing untaxed. Most European countries and Canada exempt long-term rental payments but the treatment of new housing varies across countries. 1/ The difficulty with regard to taxing financial services is the uncertainties that arise in measuring value added. For example, banks cover their costs by imposing spreads between deposit and lending rates rather than in the form of explicit fees. These measurement problems are compounded in the case of cross border financial transactions, and these problems have led many countries to exempt financial services from the VAT. 1/
The tabulation below summarizes a number of recent estimates of the likely yield of a 1 percent VAT in the United States. These assume a consumption-based VAT (i.e., the VAT is not applied to capital inputs) applying the destination principle (i.e., the VAT is paid on imports and exports are zero-rated). The first row of the tabulation contains estimates published by the CBO, in which a broadly defined base excludes purchases of residential housing, rental housing, and religious and welfare activities. The CBO’s narrowly defined base also excludes medical care, food consumed at home, financial services, and private education, as well as a number of smaller items. The Congressional Research Service (CRS) also prepared estimates of two possible VAT bases on the basis of existing practices of VATs in other OECD countries. The CRS’s broad base excludes the rental value of housing, services provided without payment by financial intermediaries, religious and welfare activities, net tourism expenditures in the United States, private education and research, and a major proportion of health, life, and auto insurance payments. The CRS’s narrow base excludes, in addition, food consumed at home, new housing expenditure, medical care, and a number of smaller items. The CRS also prepared estimates updating studies of VAT yields by McClure (1987) and Musgrave (1984).
Estimated Revenue from a 1 Percent Value-Added Tax 1/
Estimated Revenue from a 1 Percent Value-Added Tax 1/
| Base as Percent of Consumption |
Gross Receipts | Nat- Receipts | ||||
|---|---|---|---|---|---|---|
| Source | Type of Base | Billions of 1995 Dollars |
Percent of GDP |
Billions of 1995 Dollars |
Percent of GDP |
|
| CBO | Broad | 88 | … | … | 33 | 0.5 |
| Narrow | 46 | … | … | 18 | 0.2 | |
| CRS | Bread | 77 | 37 | 0.5 | 28 | 0.4 |
| Narrow | 47 | 22 | 0.3 | 17 | 0.2 | |
| McClure 2/ | Broad | 76 | 37 | 0.5 | 27 | 0.4 |
| Narrow | 45 | 21 | 0.3 | 16 | 0.2 | |
| Musgrave 2/ | Broad | 74 | 35 | 0.5 | 27 | 0.4 |
| Narrow | 38 | 18 | 0.3 | 14 | 0.2 | |
Estimated Revenue from a 1 Percent Value-Added Tax 1/
| Base as Percent of Consumption |
Gross Receipts | Nat- Receipts | ||||
|---|---|---|---|---|---|---|
| Source | Type of Base | Billions of 1995 Dollars |
Percent of GDP |
Billions of 1995 Dollars |
Percent of GDP |
|
| CBO | Broad | 88 | … | … | 33 | 0.5 |
| Narrow | 46 | … | … | 18 | 0.2 | |
| CRS | Bread | 77 | 37 | 0.5 | 28 | 0.4 |
| Narrow | 47 | 22 | 0.3 | 17 | 0.2 | |
| McClure 2/ | Broad | 76 | 37 | 0.5 | 27 | 0.4 |
| Narrow | 45 | 21 | 0.3 | 16 | 0.2 | |
| Musgrave 2/ | Broad | 74 | 35 | 0.5 | 27 | 0.4 |
| Narrow | 38 | 18 | 0.3 | 14 | 0.2 | |
All the estimates above are similar in that they generally predict that a broadly defined base would generate roughly 1/2 percent of GDP for each percentage point of VAT, while a narrowly defined base would yield roughly 1/4 percent of GDP. This ratio is roughly consistent with the experience of many OECD countries with VATs. Chart 1 plots the standard VAT rates in 16 OECD countries against the yield as a percent of GDP. The results would suggest that a 10 percent VAT would yield roughly 4 percent of GDP.
UNITED STATES
VAT Yields in Selected OECD Countries
(In percent)
The estimates reported in the above tabulation depend on a number of important assumptions. First, it is assumed that the introduction of a VAT would reduce other fiscal revenues by roughly 25 percent of gross VAT receipts. In particular, the VAT would tend to have the effect of reducing individual and corporate income. Second, the degree to which taxpayers would comply with the VAT is difficult to gauge. The estimates reported above are based on a relatively high compliance rate of roughly 95 percent. This is justified by the strong incentive under a credit-invoice VAT to ensure that suppliers have paid their VAT so that purchasers of inputs can claim their credit. However, the experience of some OECD countries has shown that this system can break down, especially if the VAT base is not sufficiently broad. Third, the estimates assume that all exclusions from the tax base were achieved by zero ratings, i.e., that producers are able to claim as a credit the VAT paid on inputs. However, in most OECD countries, exemptions are just as common as zero ratings. In this case, producers are unable to claim credits for VAT paid on inputs and total VAT revenue would tend to be larger than in the case of a zero rating. 1/
References
Advisory Commission on Intergovernmental Relations, The Value-Added Tax and Alternative Sources of Federal Revenue (Washington: Government Printing Office, 1973).
Atkinson, A. B. and J. R. Stiglitz, Lectures on Public Economics (Maidenhead, U.K.: McGraw-Hill, 1980).
Ballard, Charles L., Scholz, John K., and Shoven, John B., “The Value-Added Tax: A General Equilibrium Look at Its Efficiency and Incidence,” in Martin Feldstein, ed., The Effects of Taxation on Capital Accumulation, (Chicago: University of Chicago Press, 1987)
Bartolini, Leonardo, Assaf Razin, and Steven Symansky, “G-7 Fiscal Restructuring in the 1970s: Macroeconomic Effects,” Working Paper, International Monetary Fund (Washington, June 1994), forthcoming.
Bickley, James M., “Value-Added Taxes: Concepts, Policy Issues, and OECD Experiences,” U.S. Library of Congress, Congressional Research Service, Report No. 94-41E (January 1994).
Bickley, James M., “Value-Added Tax: Revenue Estimates for FY 95,” U.S. Library of Congress, Congressional Research Service, Report No. 93-687 E, (July 1993).
Bickley, James M., “Value-Added Tax: Should It be Calculated by the Credit-Invoice Method or Subtraction Method?” U.S. Library of Congress, Congressional Research Service, Report No. 92-504 E, (June 1992).
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Bickley, James M., “Value-Added Tax Contrasted with a National Sales Tax,” U.S. Library of Congress, Congressional Research Service, Report No. IB92069, (November 1993).
Bradford, David F., “On the Incidence of Consumption Taxes,” in Charles E. Walker and Mark A. Bloomfield, eds., The Consumption Tax: A Better Alternative?, (Cambridge, Massachusetts: Ballinger Publishing Company, 1987), pp. 244–253.
Brazer, Harvey E., ed., Michigan’s Fiscal and Economic Structure (Ann Arbor, Michigan: The University of Michigan Press, 1982).
Caspersen, Erik and Gilbert Metcalf, “Is a Value-Added Tax Progressive? Annual Versus Lifetime Incidence Measures,” NBER Working Paper No. 4387 (June 1993).
Congressional Budget Office, Effects of Adopting a Value-Added Tax (Washington: Government; Printing Office, 1992).
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Hall, Robert E. and Rabushka, Alvin, The Flat Tax, (Stanford: Hoover Institution Press, 1985), pp.40–68.
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Mackenzie, G. A, “Estimating the Base of the Value-Added Tax (VAT) in Developing Countries: The Problem of Exemptions,” Working Paper, International Monetary Fund (Washington), No. 91/21 (February 1991).
McClure, Charles E., The Value-Added Tax: Key to Deficit Reduction (Washington: American Enterprise Institute, 1987).
Musgrave, Richard, A. and Peggy B. Musgrave, Public Finances in Theory and Practice, 4th Edition (New York: McGraw-Hill, 1984).
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Smith, Dan, James B. Webber, and Carol M. Cerf, What You Should Know About the Value-Added Tax (Homewood, Illinois: Dow Jones-Irwin, 1973).
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APPENDIX I: The Michigan Experience with VATs
In 1953 Michigan adopted a modified VAT calculated on a subtraction basis, termed the Business Activity Tax (BAT), The BAT was repealed in 1967, in favor of a corporate income tax, but a VAT was reintroduced in 1975 in an effort to stabilize revenues and promote investment. The new tax--the Single Business Tax (SBT)--differed from the BAT in that it was calculated on an additive basis, and was levied at a rate of 2.35 percent. However, the SBT’s exclusions, adjustments, reductions, and credits mean that it falls short of true value-added tax, and that there are major differences in effective rates between economic sectors. Nonetheless, SBT revenues have reached roughly $1 billion and the tax has become the state’s second largest revenue source. Moreover, unlike the corporate income tax it replaced, SBT receipts have proven to be less volatile in the face of cyclical fluctuations in the automobile sector. 1/
The Michigan experience suggests a number of important features of VATs. First, an additive VAT procedure has the advantage of being more easily applied across the board to the business sector than a subtractive VAT, but the additive approach reduces flexibility to provide for special exemptions and lower rates on certain goods, and for the tax to promote goals such as the stimulation of exports. Second, the adoption of the BAT and the SBT did not appear to reduce Michigan’s attractiveness to high-technology and high-profit industries, or to have placed Michigan at a disadvantage in competing with other states. Lastly, compared with the corporate income tax, the adoption of the SBT appeared to have widened the tax base from profitable manufacturing, banking, and utility corporations to include service and professional partnerships.
This paper was written while Mr. Shah was working in the Western Hemisphere Department of the IMF. The views expressed are the authors’ and do not necessarily represent those of the IMF.
This section borrows heavily from Bickley (1994) and the Congressional Budget Office (1992).
See Bickley (1992) or the Congressional Budget Office for a further discussion.
See, for example, the discuss ion In Tait (1991), pp. 13-14.
In order to avoid multiple rates, the same effect can be achieved by reducing the taxable base of some activities. Smith et al. (1973) cite as an example Sweden’s treatment of certain services and capital purchases. Note that different types of VATs have been proposed that treat capital differently. An income VAT provides for the credit of VAT paid on capital to be amortized over the life of the asset, while a gross product VAT provides for no credit on purchases of capital goods.
Such proposals include those by Hall and Rabushka (1985) and Bradford (1987). For a discussion of this alternative, see the Congressional Budget Office (1992), pp. 75-79.
For a discussion of the history of VATs in the United States, see Smith, Weber, and Cerf (1973), Lindholm (1980), and the Advisory Commission on Intergovernmental Relations (1973).
The Superfund was designated for the clean-up of industrial waste and pollution.
The Danforth-Boren proposal was introduced as legislation in June 1994; the Domenici-Nunn proposal was introduced in 1995.
In the Domenici-Nunn proposal, wage costs would not be deducted from the business tax base.
This, of course, will not be the case if multiple VAT rates or exemptions are in effect.
See Atkinson and Stiglitz, Lecture 3, (1980), for a discussion of this issue. The authors make the point that a tax on consumption and bequests is equivalent to a proportional wage tax that exempts the return to saving. This equivalence, however, does not hold if taxes are levied on the return to saving or if there are constraints over individuals’ ability to borrow and lend.
See also Gravelle (1988) for similar results.
Adapted from Bartolini, Razin, and Symansky (1994), Table 3.
See, for example, the data included in OECD (1988).
Bickley (1993), p. 9. The CBO (1994) estimates that the administrative costs of a VAT would be more than $1 billion (see p. 338).
Differing rates would create incentives for tax arbitrage across state lines. Tait notes that this problem could be addressed by adopting a subtractive method of VAT calculation, possibly administered through the business income tax system.
Congressional Budget Office (1992), pp. 31-47; household income was defined before taxes.
For example, the Goods and Services Tax in Canada exempted a number of basic consumer items and provided an income tax credit to low-income households.
See CBO (1992), pp. 29-30 for a discussion.
In order to avoid placing domestic providers of financial services on an adverse international footing, many countries zero-rate the export of financial services, allowing financial institutions to receive a credit for taxes paid on inputs. See Tait (1988), Chapter 5, for a discussion of these issues.
Sources were CBO (1994) and James Bickley (July, 1993). The CBO figures were adapted by prorating the CBO’s estimates of the longer term yield of a 5 percent VAT.
As updated by the CRS.
See Mackenzie (1991) for a discussion of this issue.
Corporate income tax revenues initially rose during a period of strong auto sales, which led to the introduction of new state government programs. However, as car sales slumped, corporate tax receipts fell sharply, forcing cutbacks in state programs and searches for additional revenues.