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

Updated on June 2, 2022

KEY POINTS

In the supply chain, goods and services are subject to VAT, or value-added tax.
Other member countries of the Organization for Economic Cooperation and Development rely heavily on VATs as a revenue source.
But tax policy experts in the United States say VATs aren’t popular with legislators.

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

Washington, DC’s IRS building has the word “Taxes” carved into its facade.
Reuters’ Andrew Kelly explains.
There are a number of lawmakers in Congress who believe that the country’s infrastructure is in need of repair.

It’s still up in the air as to how the government will pay for it.

Former Vice President Joe Biden has called for more taxes on the rich, including increases in income and capital gains taxes, estate tax reform, and more IRS enforcement.

Biden’s tax proposals have been criticised 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.

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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.

We can use the example of a farmer selling $100 worth of wheat to a baker as an example. The baker pays $120 and the farmer pays $20 to the government if there is a 20% VAT on the sale. When a baker charges $5 for a loaf of bread, they add an additional $1 to the price because VAT is added.

It is expected that the baker will repay the $1 VAT on bread and seek a $20 credit for VAT they paid to farmers as part of their tax return filing. However, the VAT paid by the consumer is not refunded.

According to Wojciech Kopczuk, an economics professor at Columbia University, the VAT system generates a “self-reporting mechanism” where one entity logs the activity of another.

A ‘workhorse’ for other tax systems

As Daniel Bunn, vice president of global programmes at the Revenue Foundation, points out, VATs are successful because of the relatively stable tax base they provide.

A steady flow of taxes to the government, he predicted, would be unlikely.

It is possible that the epidemic was an exception.

While income can fluctuate considerably during a pandemic, “your consumption tax revenue does not,” Bunn added.

According to a Brookings Institution and Urban-Brookings Tax Policy Center research, VATs are the third-largest revenue source for other member countries of the Organization for Economic Co-operation and Development (OECD).

The European tax systems have relied on it for years, according to Gale.

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