How Could We Improve the Federal Tax System?

Updated on June 2, 2022

Q.

What is a VAT?

A.

The value-added tax (VAT) is the world’s most common form of consumption tax, in place in more than 160 countries, including every economically advanced nation except the United States.

It is the difference between what a business sells and what it buys from other businesses. “Value added” It’s the total of everything a company makes, including salaries, benefits, interest, and everything else.

As an example, let’s say a farmer grows wheat and sells it to a baker at $40 per pound. In exchange for $100, the baker sells the finished bread to customers. To put it another way, the baker’s value added is $60. The farmer’s value added is $40 if there are no costs associated with the production process. The retail sale price of the product, in this example $100, is equal to the value contributed at each step of manufacturing.

While income taxes can be difficult to administer, the VAT, unlike income taxes, does not affect family or corporate investment decisions. The Organization for Economic Cooperation and Development’s (OECD) third-largest revenue source after income and payroll taxes collected 5.8 percent of GDP on average in 2015.

Further Reading

Gale, William G. 2020. “Raising Revenue with a Progressive Value-Added Tax.” In Tackling the Tax Code: Efficient and Equitable Ways to Raise Revenue, 43 – 88. Washington, DC: Brookings Hamilton Project.

Tax Analysts. 2011. The VAT Reader: What a Federal Consumption Tax Would Mean for America. Falls Church, VA: Tax Analysts.

Toder, Eric, and Joseph Rosenberg. 2010. “Effects of Imposing a Value-Added Tax to Replace Payroll Taxes or Corporate Taxes.” Washington, DC: Urban-Brookings Tax Policy Center.

Toder, Eric, Jim Nunns, and Joseph Rosenberg. 2012. “Using a VAT to Reform the Income Tax.” Washington, DC: Urban-Brookings Tax Policy Center.