Value Added Tax (VAT), National Sales Tax (NST), Flat Tax, Transaction Tax

Dissatisfaction with the federal tax system has led to a debate about U.S. tax reform, including proposals for a national consumption tax. One type of proposed consumption tax is a value-added tax (VAT), widely used around the world. A VAT is levied on the difference between a business’s sales and its purchases of goods and services. Typically, a business calculates the tax due on its sales, subtracts a credit for taxes paid on its purchases, and remits the difference to the government.

While the economic and distributional effects of a U.S. VAT type tax have been studied, GAO was asked to identify the lessons learned from other countries’ experiences in administering a VAT. This report describes (1) how VAT design choices, such as exemptions and enforcement mechanisms, have affected compliance, administrative costs, and compliance burden; (2) how countries with federal systems administer a VAT; and (3) how countries that recently transitioned to a VAT implemented the new tax. GAO selected five countries to study–Australia, Canada, France, New Zealand, and the United Kingdom–that provided a range of VAT designs from relatively simple to more complex with multiple exemptions and tax rates. The study countries also included some with federal systems and some that recently implemented a VAT. GAO does not make any recommendations in this report.

Like other tax systems, even a simple VAT–one that exempts few goods or services–has compliance risks and, largely as a consequence, generates administrative costs and compliance burden. For example, all of the study countries reported that they devoted significant enforcement resources to addressing compliance. Businesses whose taxable purchases exceed their taxable sales are entitled to a refund under a VAT, which makes VATs vulnerable to fraudsters creating phony invoices in order to falsely claim refunds. Also, similar to other taxes, adding complexity through exemptions of some goods or services and reduced tax rates generally decreases revenue and increases compliance risks because of the incentive to misclassify purchases and sales. Such complexity also increases the record-keeping burden on businesses and increases the government resources devoted to enforcement.

Canada’s experience administering a national VAT along with a variety of provincial VATs and sales taxes demonstrates that multiple arrangements in a federal system are feasible, but increase administrative costs and compliance challenges for both the governments and businesses. Businesses, particularly retailers, in provinces with a sales tax face greater compliance burdens than those in other provinces because they are subject to dual reporting, filing, and remittance requirements.

Australia, Canada, and New Zealand, all with relatively new VATs, built on preexisting consumption tax administrative structures to implement the new tax. Nevertheless, they devoted considerable resources to educate, assist, and register businesses and implementation took from 15 to 24 months. Both Australia and Canada provided monetary assistance to qualifying small businesses to help meet new bookkeeping and reporting requirements. Despite their efforts, Australia and Canada had some difficulty getting businesses to register for the VAT by the implementation date.

Value-Added Taxes: Lessons Learned from Other Countries on Compliance Risks, Administrative Costs, Compliance Burden, and Transition, Government Accountability Office, Report GAO-08-566, April 4, 2008 (67-page PDFPDF)

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[O]ur “center-right” leadership is failing us in merely saying “no” to all tax proposals, and gambling on the ability to drag this cycle of stupidity around one more time.

The solution is to make the case for a massive overhaul of the tax system, and transition the system from one that relies on income (corporate and individual and Soc. Sec.) taxation to one that relies on taxing consumption (VAT, National Sales Tax, or FairTax). This is a wonderful opportunity for a party of ideas (Republicans, before they succumbed to corrupt Hastertism) and a vibrant think tank community (before they began to resemble an echo chamber of conservo-libertarian apparatchiks promoting stale doctrine) to lay the ground work for a 3rd and 4th “American Century.”

There are even more new ideas (and political and economic benefits) to go along with this new (and superior) tax policy.

Why aren’t we talking about increasingly popular ideas like constitutional spending caps? Why aren’t we lauding the replacement of the the bureaucratic entitlement state with a yearly stipend for every American (see Fair Tax rebate or Charles Murray)?

Instead of fighting against a welfare state that most Americans still support (Soc. Sec., “health care reform,” and public education), why aren’t we framing our ideas as the “individualization” of government assistance through retirement accounts, health savings accounts, and scholarships and education savings accounts?

Swapping a VAT for failing income tax is good policy, by Bruno Behrend, Chicago Boyz, July 27th, 2010

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Most proposals for fundamental tax reform involve the concept of replacing our current income tax system with some form of a consumption tax, usually with a single or “flat tax” rate. Other proposals would significantly broaden the income tax base and lower tax rates. Proponents of these tax revisions often maintain that they would simplify the tax system, make the government less intrusive, and create an environment more conducive to saving. Critics express concern about the distributional consequences and transitional costs of a dramatic change in the tax system.

Most observers believe that the problems and complexities of our current tax system are not primarily related to the number of tax rates but rather stem from difficulties associated with measuring the tax base. For those fundamental tax reform proposals involving shifting to a consumption tax, one or more of the following four major types of broad-based consumption taxes are included in these congressional tax proposals: the value-added tax (VAT), the retail sales tax, the consumed-income tax, and the flat tax based on a proposal formulated by Robert E. Hall and Alvin Rabushka of the Hoover Institution.

Tax Reform: An Overview of Proposals in the 111th Congress, CRS Report for Congress R40414, March 19, 2010 (18-page PDFPDF)

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A firm’s value added for a product is the increase in the value of that product caused by the application of the firm’s factors of production. A [value added tax] VAT on a product would be levied at all stages of production of that product. A firm’s net VAT liability is usually calculated by using the credit method. According to this method, a firm determines its gross tax liability by multiplying its sales by the VAT rate. Then the firm computes its net VAT liability by subtracting VAT paid on purchases from other firms from the firm’s gross VAT liability.

The three types of VAT differ in their tax treatment of purchases of capital (plant and equipment). A consumption VAT treats a firm’s purchases of plant and equipment the same way as any other purchase by a firm. All developed nations with VAT have the consumption type. The other two types of VATs are the income VAT and the gross product VAT. Under the income VAT, the VAT paid on the purchases of capital inputs is amortized (credited against the firm’s VAT liability) over the expected lives of the capital inputs. Under the gross product VAT, no deduction for the VAT on purchases of capital inputs is allowed against the firm’s VAT liability. A [national sales tax] NST would be a federal consumption tax collected only at the retail level by vendors. Both a VAT and a NST are assumed to be ultimately paid by consumers. For FY2000, a broad-based VAT or NST would have raised net revenue of approximately $37.8 billion for each 1% levied.

The operating differences between a consumption VAT and a NST have important policy implications. The administrative cost of a VAT would exceed that of aNST because a VAT would require more information to be reported and audited. An opportunity exists for a NST to be collected jointly with state sales taxes, but a federal VAT offers no readily available joint collection possibilities. A consumption VAT with the credit method more easily excludes inputs from double taxation than does a NST. A consumption VAT would be easier to enforce than a NST. It is in the self-interest of a firm to have accurate purchase invoices so that it can obtain full credit for prior VAT paid. Tax authorities can double check the accuracy of the VAT remitted by any firm because data are collected from producers at all levels of production. A VAT could have a broader tax base than a NST because a VAT is easier to enforce. A VAT could have a higher tax rate than a NST because a VAT is more difficult to evade. A VAT would require more time to implement than a NST because a VAT is more complicated, covers more firms, and is a new tax method. A VAT may be less visible to consumers than a NST. A VAT is levied at all stages of production, and policymakers have the option of not requiring the amount of VAT to be shown on retail sales receipts.

A Value-Added Tax Contrasted With a National Sales Tax, CRS Issue Brief for Congress IB92069, October 9, 2003 (9-page PDFPDF)

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