From the Tax Foundation Archives: The Pros and Cons of a Value Added Tax (VAT)

Updated on May 23, 2022

Washington is embroiled in a fierce discussion about the future of the United States tax system. Ways and Means Chairman Kevin Brady’s “Better Way” tax reform strategy calls for a destination-based cash-flow tax (DBCFT) and border adjustability.

The arguments for and against the GOP tax plan are identical to those made in the 1970s when Washington was considering a value-added tax (VAT) on goods and services.

“A Value-Added Tax for the United States?” was issued by the Tax Foundation in 1979 as a valuable primer on the VAT’s many facets. According to this research, there is a strong case for and a strong case against a sales tax (VAT). In the current debate over the DBCFT and border adjustability, many of same arguments are being used.

Research shows that there is general agreement on the benefits and drawbacks of the VAT, a broad-based federal levy on consumption.

Claimed advantages for the VAT are that it would:

Be based on consumer demand and hence provide a steady source of income;
Make sure you’re “neutral,” because it will be applied to all kinds of businesses.
Businesses should be given more incentives to keep costs down;
Savings should be encouraged, not discouraged.
Are capable of generating substantial money at a low tax rate.
Ensure that it’s easy to use;
Streamline exports, provided certain conditions are met;
Aid in the creation of a more equitable tax system.

Set against these positive characteristics are the alleged drawbacks. It is contended that the VAT would:

Be regressive; \sLead to excessive spending;\sLack a countercyclical balance;

Be damaging to new and marginal business activity;

Create administrative complexities;

Set off inflationary tendencies;

Be a “hidden tax”;

Conflict with the prevailing arrangement of state and local sales taxes;

Be unable, in many situations, to establish effective incentives for exports.