The value-added tax brings in billions for other countries, but the U.S. doesn’t have one

Updated on June 26, 2022

KEY POINTS

Taxes on goods and services at each stage of the supply chain are known as value-added taxes, or VAT.
Other nations in the Organization for Economic Co-operation and Development (OECD) rely on VATs as their third-largest source of revenue.
Despite this, tax policy experts claim that VATs are not widely supported in the United States.

"Taxes" engraved at IRS headquarters in Washington, D.C.

Many members of Congress are concerned about the state of the nation’s crumbling roads, bridges, and other facilities.

The way to pay for it is still a point of contention among lawmakers.

Taxes on the wealthy, including income and capital gains tax rises, as well as estate tax reform and stronger IRS enforcement, have been proposed by Vice President Joe Biden.

Biden’s tax proposals have been criticized by other policymakers, including the White House, who reject increasing gas taxation as an alternative.

But a value-added tax, or VAT, which is a levy on goods and services at each stage of the supply chain, has been left out of negotiations.

As co-director of Urban-Brookings Tax Policy Center, William Gale says the US is the only large country without a value-added tax.

More from Personal Finance:
Many wealthy Americans escape big income tax bills. Here’s how they do it
Advisors look to lessen toll of Biden’s retroactive capital gains tax hike
How Biden’s tax plan may spark more charitable giving

How VAT works

Each stage of the production process is taxed separately, unlike retail sales taxes, which only collect a single tax at the end.

Consider the case of a farmer who raises $100 worth of wheat and sells it to a baker. The baker must pay $120 in VAT and the farmer must send $20 to the government for each transaction. When a baker charges $5 for a loaf of bread, they add an additional $1 to the price because VAT is added.

With their tax return, bakeries are able to claim a credit of $20 for any value added tax (VAT) paid to farmers. The consumer, on the other hand, does not receive any credit for the VAT they paid.

An economics expert at Columbia University says that the VAT system generates a “self-reporting mechanism” where each company registers the activities of another, leading to higher levels of compliance.

A ‘workhorse’ for other tax systems

Daniel Bunn, vice president for worldwide programs at the Revenue Foundation, cited another factor for the success of VATs: the stability of the tax base.

According to him, the government’s tax collection will not be subject to large fluctuations over the course of a year.

It’s possible the epidemic was the exception rather than the rule in this particular case.

Consumption tax revenue does not fluctuate as much as personal income, even during a pandemic.

After personal income taxes and levies for social security-type programs, VATs are the third largest source of revenue for other members of the Organization for Economic Co-operation and Development (OECD).

Gale remarked, “It’s been a mainstay of the European tax regimes.”

Furthermore, he argues that VATs have been successful in emerging markets because they are simpler to administer and enforce than income taxes.

However, the implementation of VATs comes with its own set of difficulties.

According to Kopczuk, several countries do not charge VAT on needs including food, medicine, and other necessities. Inconsistencies among the products that are exempt may cause problems for some businesses.

There are instances of tax evasion as well, particularly for cross-border purchases where a tax credit for VAT paid outside of one’s home country is received by the purchaser.

There have been cases when corporations have created fake invoices to claim VAT credits for purchases that never occurred, he added.

“For example, in China, it’s a significant concern,” Kopczuk said.

As a result of these problems, VATs generate a lot of revenue, he stated.