The Value-Added Tax Is Wrong for the United States

Updated on June 26, 2022

Abstract:

Some proponents of a value-added tax (VAT) argue that the United States should implement a VAT in order to close the nation’s historic budget deficits. They’ve got it all wrong. Even while VATs have a few advantages over the current tax law, adding the VAT to current federal taxes as proponents propose would not realize these advantages and would instead lower the economy, as opposed to the other way around. Overspending by Congress, not a lack of taxation, is the underlying reason of the large government debt.

Except for the United States, every industrialized nation imposes a VAT as a major source of tax revenue. The Domenici–Rivlin Debt Reduction Task Force has released the latest request for the United States to implement a VAT in order to manage its mounting debt problem. To lower the deficit to more manageable levels, some believe that Congress must raise taxes significantly. [2] As a result of its great potential for revenue generation and the fact that the United States is the only developed country without a VAT, the VAT is seen as the logical solution.

VAT supporters often point to the country’s economic benefits as a basis for implementing it. The VAT offers some advantages over other tax systems, but only if all other federal taxes are replaced by the VAT. Its comparative advantages would vanish if Congress merely implemented a VAT on top of other federal levies. Taxes would rise significantly, the current tax system’s many faults would be perpetuated, and new obstacles would be introduced. Even if a VAT were to completely replace the current tax structure, the country would face numerous difficulties.

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What Is the VAT?

Businesses are taxed on the value they add at every stage of the production process when they levy a VAT. It can be applied to both produced items and services. Income tax, on the other hand, does not include purchases, unlike the more familiar income tax, which only taxes incomes and returns on savings. A consumption tax like the VAT would reflect the state and local sales taxes that most Americans pay on a regular basis. Consumers, on the other hand, would see no difference between a VAT and a national sales tax. The final price of items would be raised by about the same amount if a VAT and a sales tax were both intended to raise the same amount of money.

A VAT credit invoice. If a company uses the credit-invoice technique, which is the most often used way for collecting VAT, it must pay VAT on its input purchases and collect it on all sales, regardless of whether those sales are to another business or to a final consumer. The government’s revenue department then gets the invoices from the business’s suppliers. The VAT paid by the company to its suppliers is shown on the invoices. A refund is issued to a business if the revenue agency verifies that the business paid the correct amount of VAT on its sales and that the invoiced matches the supplier’s records. It is simple for the revenue agency to ensure that businesses are paying the correct amount of VAT by relying on the filings made by enterprises.

The business pays no taxes if it can pass the tax on to its customers, which is the case in the majority of cases. Tax collector: It only collects VAT on its sales and pays back the difference between what it collects and what it pays for its own supplies. Like the sales tax, the tax burden goes up the supply chain until it reaches the consumer. Using the credit-invoice system of VAT, the manufacture of a shirt is depicted in Chart 1.

How the Value-Added Tax Works

A bill of exchange More efficient revenue collection is made possible by the lower administrative burden of VAT on revenue agencies. Revenue collection is more effective because of the approach used. Sales tax is only collected when the product is purchased by the end user. To put it another way, customers who purchase anything like a pair of shoes or a television pay the item’s retail price plus the additional sales tax, which is a percentage of that retail price. Since the sales tax “pyramids” inside product costs and raises prices covertly, businesses don’t pay it on the items they buy. According to reasonable tax policy, businesses should be totally free from paying sales taxes in many circumstances, but this is not the case in practice.

Customers and sellers can work together more readily to avoid the sales tax because it is collected just once in the production process. An audit by a revenue body is the only way to ensure that the vendor is collecting the tax. Because firms collect and pay VAT at each stage of the production process under a credit-invoice VAT system, the tax is more difficult to evade.

Subtraction-Method VAT.

The subtraction-method VAT, which is similar to the credit-invoice VAT, is another feasible option for levying VAT. There are advantages and disadvantages to each technique, but the credit-invoice method has been adopted by the majority of countries that levy a VAT. Only Japan uses the subtraction approach among the approximately 150 countries that impose a VAT. [3]

As with business income taxes in the United States and most other countries, a VAT calculated using the subtraction approach works similarly. Subtracting sales from expenses yields the taxable base used by businesses (gross income). Labor costs are not deductible in a subtraction-method VAT, whereas they are deductible in a business income tax. Labor’s contribution to the output of the firm is a significant portion of its worth. All purchases from other companies are instantly deducted under the VAT subtraction technique (no depreciation system), but interest expenses are not deductible. This is a significant distinction.

Taxes are collected in two different ways: via credit-invoice VAT or via subtraction-method VAT. Businesses would pay VAT on their taxable base, which is computed by totaling their gross receipts and subtracting the cost of inputs purchased from other enterprises, under the subtraction-method VAT.

Because firms still pay tax on the difference between the sales of their items and the costs of their inputs, a VAT calculated using the subtraction approach would have the same economic impacts as a VAT calculated using the credit method. In practice, however, the VAT deduction approach conceals the fact that products and services are subject to a tax. Unlike credit-invoice VATs, subtraction-method VATs do not require, and in some circumstances restrict, the presentation of the tax on sales receipts, making the tax opaque to the taxpayers.

In light of today’s economic climate and the repercussions of previous tax policy decisions, the credit-invoice approach is preferred by the majority of countries over the subtraction method. For example, while it resembles a traditional income tax in many ways, the subtraction-method VAT could be a better tax system than a simple income tax, but it would be a bad idea to introduce it as a new tax. It is not uncommon for countries that have enacted a credit-invoice VAT to have already implemented some form of national consumption tax. Replacement of a bewildering assortment of minor sales taxes with an operational, comprehensive national retail sales tax in the form of a VAT would be a smart idea in the search for additional money.

Furthermore, tax avoidance is an issue that affects all governments. A credit-invoice VAT does not eliminate tax evasion, but the tax is less vulnerable to it than other taxes because of the paper trail provided by the credit-invoice VAT. With high tax rates, the challenge of dodging the VAT increases significantly..

Addition-Method VAT.

The method of adding No country in the world imposes VAT. The addition method is the polar opposite of the subtraction approach, as its name implies. Similar to subtracting, it is applied once in the production process and its cost is completely obscured from individual taxpayers. Businesses, on the other hand, do not remove the costs of their inputs from their sales when calculating their tax base for VAT purposes. The costs of labor, the costs of purchased goods and services, and even profits are examples of possible inputs. [4]

A theoretical VAT application, the addition approach, is not employed in practice. However, even though it is theoretically identical to other forms of tax, the addition approach introduces issues that the other ways do not. Because of their specific circumstances, some businesses, such as those that employ a large number of workers, will have to pay more in taxes. It’s hardly surprising that these companies would go to the government for relief in the shape of industry-specific carve-outs. Once one company gets an exemption, the pressure grows to extend similar exemptions for other industries. The VAT’s ability to have a minimum impact on the market is soon undermined when specific industries are given preferential status. As a result of these exemptions, unlike other forms of VAT, the addition-method VAT would be a significant economic burden. [5]

VAT Strengths

Some of the VAT’s best qualities are shown below. Because it eliminates savings and investment from the tax base, it is the most essential. Saving and investing are essential for economic growth since capital is needed to expand corporate operations.. They’re a go-to resource for budding business owners. Jobs and economic growth are generated by both of these activities. By making it more expensive for firms to get capital, taxing people’s savings and investments is a lose-lose situation for everyone. As a result, less money is being saved and invested, which in turn results in fewer new employment being created. The VAT is a superior alternative to other taxes that tax savings and investments because it only taxes consumption.

The VAT’s “border flexibility” is another favorable element. Exports are either exempt from VAT or refunded in full in all countries that use VAT. The same applies to all countries that impose VAT on their exports. There are two advantages to this. No matter where they come from, all items sold within the nation of origin pay the same amount of border-adjusted VAT. Because all goods sold anywhere in the world bear the same tax rate, border-adjusted VAT gives exports a level playing field with domestically produced goods. In contrast, because it is not refundable like a VAT, a business income tax raises the relative price of exported items. Similarly, enterprises that pay individual income tax rather than business income tax have their taxes rolled into the price of their goods. There is no feasible way to reduce the total cost of the commodity by the amount of the higher price owing to income tax. In order to compete in global markets, a company has to raise the price of its product when it exports it.

Individuals and firms’ behavior is altered by all taxes, resulting in a distortion in the market. When it comes to taxes, the least amount of influence is exerted on individual and business decision making. Because it has little impact on company and individual decisions, a VAT with good structural foundations is competitive with other taxes. As a result, the prices of all goods and services in an economy will rise in proportionally if this characteristic is not universally applied. This prevents any product or service from gaining an unfair competitive edge. This VAT’s relative advantage vanishes quickly the moment a single product or industry wins an exemption for its goods or services. Since all goods are taxed at the same rate no matter where they are made, border adjustments help maintain VAT’s neutrality.

Tax enforcement costs are relatively modest, which adds to the VAT’s overall advantages. Due to its simplicity and businesses’ need to submit invoices to obtain their refunds, enforcing VAT costs less than enforcing other taxes.

VAT Flaws

The VAT has some advantages over other taxes, but it is not without its problems. There are a number of issues with the VAT from the get-go.

Hidden Tax.

The major problem with the VAT is that, unless specifically stated, taxpayers have no idea how much VAT they have paid. In the first graph, Consumers in this case are simply aware of the shirt’s $22.00 price tag. The customer is unaware that the purchase includes a 10% ($2.00) VAT because it is not written on the sales receipt. Transparency in taxation is an important value, and most countries’ VATs blatantly disregard it.

On sales receipts, state and municipal sales taxes are clearly marked so that consumers may see the difference between the price before and after the tax. Sales receipts often do not include a VAT, even though it would raise the final cost of products and services the same way.

Taxpayers are unlikely to save their receipts, even if they indicate the VAT, so that they can add up their VAT for the year. Because it hides the tax burden and the true cost of government services from taxpayers, the VAT is a favorite of politicians everywhere. As a result, taxpayers may want more government services because they incorrectly believe that the prices are cheaper than they are. When it comes to deciding how much government to have, citizens and taxpayers should have as much information as possible to help them make an educated decision.

Taxing Services.

Services are becoming an increasingly important part of American business, but the VAT is having trouble levying taxes on those services. Since no physical property is exchanged in a service transaction, it is difficult to collect taxes on the transaction. This is true for all consumption taxes, including state and local taxes on sales. Because of this, many states and municipalities in the United States choose not to impose a sales tax on the vast majority of goods and services.

Most service providers buy inputs from suppliers at a lower cost than the cost of their services. Patients pay doctors a lot of money, yet doctors have modest input costs compared to, say, automakers. To build an automobile, automakers need to buy expensive inputs like steel. A doctor’s office just needs to be outfitted once in order for them to perform services. Legal and financial service providers are also affected by this trend, as are other service providers. As a result, service providers have a higher value added (price of service less cost of inputs) and a higher VAT due as a percentage of gross receipts than typical manufacturing enterprises. As a result, service providers and their clients are more likely to work together to escape VAT by conducting business in cash. For those who prefer to avoid paying taxes, the service provider has the option of underreporting sales and keeping the money they save. Tax evasion cannot be shown in either situation without on-site surveillance and inspections.

Exempting services from a VAT would imply raising the VAT rate far higher to collect the expected revenue, which is another big problem with the VAT.

State Sales Taxes. 

A sales tax is imposed in 46 states. State sales taxes are analogous to a federal value-added tax. Because states rely on sales tax revenue, they are likely to reject any federal move to usurp their jurisdiction. There is a possibility that a federal VAT would oblige the various states to apply their sales taxes to the same range of items. States would lose the flexibility to set their own sales taxes in accordance with their preferences and the particular economic circumstances of each state. Rates in states would have to fall within a specific range. In order to remain competitive with other states, governments would have to cut their sales tax rates if the VAT rate starts off relatively high. Another problem is that sales tax avoidance would be increased by a federal VAT, which would reduce state tax revenues greatly.

Underground Economy.

The VAT isn’t the only tax that isn’t 100% enforceable. The ease with which the VAT can be enforced is not a categorical statement. Unlike other taxes, the VAT has a paper trail that can be easily audited. However, there are bound to be others who will find a way around a VAT. In fact, a VAT would serve to amplify the growth of the unregulated black market. Customers and businesses would be more likely to cooperate in the fight against VAT evasion if they could save up to 20% or more on every purchase. They could avoid paying VAT by exchanging products or services for cash. Authorities would have a tough time proving abuse if they used one of these strategies, which would leave no paper trace.

This is based on Europe’s experience with the illegal economy. Europe has a lot of informal transactions and people purchase and sell on the black market. The practice of evading VAT is widely accepted. The VAT evasion strategies of many citizens have become so ingrained in their daily routines that they don’t even realize they are avoiding taxation. [6] If the United States implements a VAT, this type of behavior will swiftly become the norm.

Fraud. 

A bill of exchange Due to the extensive paper trail, VAT has a built-in self-enforcement mechanism, although fraud would still be a problem. Undercover activity is distinct from outright fraud. In contrast to an underground economy, it consists of enterprises attempting to obtain larger returns from the government than they are entitled to. VATs are always vulnerable to frauds that let businesses to claim higher refunds than they are entitled to, regardless of how skillfully they are structured. Businesses that are only set up to produce fake tax invoices and claim refunds for nonrefundable expenditures are among the most common examples of VAT fraud. [7]

Despite having a long history of VAT administration, European countries are nevertheless plagued by significant amounts of VAT fraud. Uncollected VAT costs the EU member states almost $107 billion a year. To put it another way, this translates to a tax gap of 13%[8], which is a significant noncompliance rate for a consumption tax.

Criminals who use VAT to their advantage will always be a threat to tax authorities. It is a huge incentive for crooks to stay one step ahead of law enforcement by misusing the VAT. According to the EU’s cap-and-trade program, carbon dioxide emission permits are a cornerstone of the EU’s efforts to fight VAT-related fraud and abuse.

Carousel fraud, for example, is the creation of a bogus firm to purchase a carbon-emitting permit from a corporation in another nation. Upon selling the permission to another company in its country, the fictitious firm immediately takes the VAT collected from the company purchasing the permit and vanishes. Any conveniently transportable good can be used in this approach.

Over the last 18 months, fraud concerning carbon emission permits cost the EU members a total of $7.4 billion.

[9] The carbon emission permits scam is the most recent example of VAT fraud, but it is far from the last. Once authorities crack down on this form of fraud, tax evaders will soon switch to a new plan.

Economic Drag from Exemptions.

Regressiveness of the VAT is a commonly held misconception. They claim that because the poor spend a larger percentage of their income on necessities, they should be required to pay a higher percentage of their income in VAT. It is reasonable to compare the amount of tax paid in relation to the amount of income earned, but it is also reasonable to compare tax paid in relation to consumption in the case of a VAT. Because all taxpayers would pay the same amount of tax as a percentage of their consumption, a VAT is proportionate. Tax policymakers should be aware of this disparity, because otherwise any VAT law would likely exempt basic necessities like food and housing, which generally account for a larger share of low-income consumers’ consumption expenditures.

The VAT has the advantage of having less of an impact on individual and business decision-making. However, the benefits of a VAT quickly fade away if certain goods and services receive preferential treatment because some businesses—or, more precisely, the goods and services they produce—enjoy preferential tax treatment..

Exemptions from the VAT allow businesses to charge lower prices than their competitors, who would otherwise have to pay the tax. As a result, businesses that do not have to pay VAT would see a rise in profit margins, luring more investment to the VAT-free sector. Since the distribution of resources would be misallocated, less value would be produced from the nation’s resources as a result of the VAT if exemptions were allowed.

More Power to Government and Lawmakers.

In order to exert more control over the economy, the government must spend more money and deploy tax and regulation measures. Private persons and corporations are demanding greater access to decision-makers in response to the government’s expansion of authority. Businesses will look to the government for VAT relief because of the substantial advantages they stand to earn from securing an exemption for their product. Allowing the government to pick winners and losers in a competitive economy will make firms more dependent on obtaining government favors than than offering the goods and services that the public wants to buy. As a result, government becomes more powerful and firms and industries with strong lobbies become more powerful. If this continues, it will only enhance the public’s distrust in a government that has become increasingly dependent on its wealthy backers.

Government-Growing Tax

A VAT has the potential to generate enormous sums of money. Some economists believe that a VAT that is large enough to cover all of the nation’s existing and future deficits is necessary in the current budgetary climate. [10] Some examples: The “deficit reduction sales tax” proposed by the Domenici–Rivlin Task Force is in fact a VAT. To bridge the current budget imbalance, a VAT rate of 15% to 20%[11] would be required, which is in line with VAT rates in other economically developed countries. A VAT of at least 15% is required by the EU, and in some countries it is as high as 25%. [12]

It is estimated that a VAT of 15% will bring in 6% of GDP (GDP). This would result in an additional $1.2 trillion in taxes in 2019. In 2019, a VAT of 20% would raise taxes by little about $1.7 trillion, or 8% of GDP. [13] The federal tax burden would rise between 33% and 44% if this tax hike were implemented.

Any time Congress needs more money from the taxpayers to fund new programs, they can simply raise the VAT rate. Government expansion would become less unpleasant if tiny increases in the VAT rate could raise considerable quantities of money. By the end of the decade, even a 1% increase would generate an additional $80 billion in revenue.

Members of Congress will almost probably succumb to the allure of taxing themselves even more if the VAT succeeds. These findings are corroborated by studies conducted in other developed countries. According to data in Table 1, 29 of the 30 member nations of the Organization for Economic Cooperation and Development have put in place VATs. The only exception is still the United States. Twenty of the 29 countries that have implemented VATs have increased their rates by at least 1 percentage point over the past few years. With a 10 percentage point jump from 15% to 25%, Denmark leads the way in the group. The 20 countries have all hiked their VAT rates by 4.5 percentage points on average.

VAT Rates Typically Rise After Implementation

Permanently Slower Economic Growth

For a variety of reasons, a VAT would permanently stifle U.S. economic progress.

If the VAT is implemented, it will divert trillions of dollars a year from private hands to the public sector. In the long run, future generations would have a poorer quality of living than they would have had a VAT in place if fewer resources were available in the private sector. The government’s political decision to allocate VAT income has resulted in a reduced standard of living for the people. It is possible that if these resources were left in private hands, they would be allocated according to market forces. Market-based allocation is often more efficient than politicized allocation because political decisions do not address the highest-value use of resources while market-based allocation takes into account these issues and thus performs a better job of allocating resources.

Second, by reducing the incentives for people to work, the VAT would have a negative impact on the economy. Proponents of the VAT frequently point out that unlike the income tax, the VAT does not penalize saving. Nevertheless, they fail to mention how much the VAT, like the income tax, inhibits employment. This well-established fact may not be visible at first glance, but it becomes clear when you examine why individuals go to work in the first place.

Economically, people labor for a variety of reasons, but the most important one is that they need to earn money to pay for necessities like food, clothing, shelter, and healthcare. Depending on an individual’s qualities and market opportunities, they can demand a salary commensurate with their ability to create economic value. Given that wage, the individual can then pick what task to accomplish, how long to work, and how much leisure time to take, based on how much money he or she can earn by giving up a specific amount of free time or leisure time. Labor-leisure tradeoff without taxation encapsulates this. It’s a generalization and oversimplification of the complexities of the market, but it does a good job of capturing the essence of the debate.

As a result of government taxes on wages like payroll taxes, workers’ after-tax wages are reduced, which lowers the “price of leisure,” or the return to work. Workers’ motivation to work a certain number of hours decreases as a result of such a fee. Because of this, workers have less post-tax income to spend or save, reducing their purchasing power.

The worker’s after-tax income would remain the same if the government imposed a VAT in place of a payroll tax, but the VAT would raise prices, diminishing the worker’s purchasing power. Workers’ purchasing power has decreased, which has reduced the genuine worth of their pay. What counts to the worker is how much money he or she may earn in exchange for a specific quantity of labour.. Payroll taxes, which reduce after-tax wages, and VAT, which raises consumer costs, both disadvantage workers in the same way, decreasing their desire to work. The VAT is akin to a payroll tax in terms of economics. Work effort, as well as output and earnings, are both reduced in both cases.

Six VAT Myths

With all of the various federal taxes that Americans already pay, imposing a VAT on top of all of the advantages of the VAT would be counterproductive. Tax reform isn’t a top priority in Congress right now, even though the economy could be better off if the VAT replaced all of the current income tax laws[14]. A VAT would most likely be considered by Congress as a way to raise additional money in order to balance the deficit. Adding on top of the income tax’s inefficiencies the specific inefficiencies of a VAT would make the burden on the economy and taxpayers considerably higher.

The VAT is defended by six prevalent fallacies. In most cases, the confusion stems from a misunderstanding of the distinction between an additional VAT and a VAT that replaces all current income taxes.

Myth #1: A VAT would increase the savings rate.

Because it would boost the prices of everything we buy, a VAT would, according to some, encourage saving. Americans would save money if they followed this line of reasoning, which would lead them to purchase fewer goods and services.

When costs go up, savings go up, but this isn’t the case when taxes are implemented. It is not because of low costs that Americans have a low savings rate; rather, the existing tax structure penalizes investors by taxing their investment returns through capital gains, dividends, and interest. Adding a VAT would have no effect on this situation. Savings will be discouraged as long as capital gains and income are taxed under the current system.

According to the existing state of affairs, adding a VAT to the current tax system would result in a long-term decrease in savings and a permanent loss of both wealth and growth. A VAT might result in a 15% to 20% increase in the cost of consumer products and services. Families would have to save less and even tap into their savings in order to maintain as much of their present consumption as feasible in the wake of the VAT.

Myth #2: A VAT would increase investment.

In light of the fact that some believe that a VAT will boost savings, others believe that it will boost investment. A VAT is once again being compared to an additional tax on top of what is already in existence, when in fact the two are very different concepts. The short-term impact on investment would be negative if Congress enacted a VAT, since households would be forced to reduce their savings and take money out of their retirement accounts in order to maintain their existing consumption levels.

Myth #3: A VAT would encourage economic growth.

Tax increases are rarely argued to promote economic growth by economists. There are others who believe taxes on consumption, rather than income, are better for the economy. Working, saving, and investing are crucial to economic growth, but the highly progressive structure of the income tax and the double taxation of capital income and capital gains discourage these activities.

The disincentives to labor, save, and invest would remain even if Congress imposed a VAT on top of the current system. Instead of encouraging more labor and savings, this would actually make things more difficult for people. For a long time, the savings rate would be lower if the VAT were implemented. A tax on labor is an economic counterpart of a tax on the VAT, which will discourage people from working even more.

Myth #4: VAT promotes exports.

With its border tax adjustment system, some argue that the VAT would make American products more competitive in worldwide markets because the VAT rebates exports while imposing import taxes. This is not true. The competitiveness of US exports would be unaffected by a VAT. Once again, proponents of a VAT as a replacement for the income tax are mistaking the benefits of a VAT as an add-on tax for the actual costs. Even if border tax adjustments make the VAT international neutral, the drawbacks of the income tax, which does not have similar border tax adjustments, are still detrimental to the competitiveness of the United States.

Myth #5: VAT allows for lower income taxes.

The VAT is seen by some supporters as a way to reduce the country’s enormous deficits. There is limited room for lowering income taxes if the deficit is not reduced through expenditure cuts, therefore Congress will have to rely on income tax and VAT revenues to bring the deficit under control. A VAT would certainly contain some small and temporary tax cuts in order to get support from the American people as well as some members of Congress. It is possible, however, that Congress might levy an income tax at its prior levels or even higher as long as the 16th Amendment remains in place.

This is how it’s been in Europe so far. Despite the governments’ claims to the contrary, income taxes have risen after VATs were adopted. [16] It is conceivable that the combination of a VAT and an income tax in the United States would lead to comparable increases in income tax as successive Congresses seek additional money. As a result, tax rates would rise even further, slowing the economy’s growth even further.

If the 16th Amendment is removed, the VAT or any other national consumption tax would be permissible.

Myth #6: VAT would close the deficit.

Tax income and credit markets are used to the maximum extent possible.[17] Congress is on a course to exceed the limits of credit markets. No evidence suggests that Congress will suddenly become fiscally disciplined after the introduction of VAT. Tax money would be used to fund new programs, and borrowing would likely continue at a high rate. As long as the United States’ debt-to-GDP ratio continues to rise, giving Congress more money from the taxpayers would only make the current fiscal crisis even worse.

How this could happen is illustrated by the Greek crisis. As a result of its persistent and unsustainable overspending, credit markets have stopped lending it at fair rates. In the near future, the credit market may discontinue financing to other fiscally unstable nations that impose large VATs, such as Portugal (21%), Italy (20%), and Ireland (12%). (21.5 percent). Only through cutting back on expenditures can a budget imbalance be eliminated. Tax increases are almost always followed by an increase in spending.

An Unnecessary Tax

Deficits now and in the future endanger the economy of the United States, prompting some to advocate a VAT as a means of reducing the deficit. Overspending by Congress, rather than a lack of tax income, is to blame for the looming deficits. Federal tax revenues will still surpass their historical level of 18 percent of GDP if Congress extends for all taxpayers the 2001 and 2003 relief and fixes the alternative minimum tax (AMT) so that it does not impact middle-income families. As a result of Obama’s budget, government expenditure will grow to 24% GDP by the end of this decade, which is significantly higher than the historical average of 20%. In the future decades, entitlement spending will continue to rise at an unchecked rate. In order to balance the deficit, higher tax rates will be necessary unless Congress restrains expenditure. Nevertheless, as many European countries are learning, even the VAT isn’t going to fix their problems. They need to substantially reorganize their welfare and entitlement programs.

Instead of heeding the siren calls for a VAT, Congress should address the country’s budget issues head-on. The disparity will never be closed by raising taxes. Instead, the federal government’s spending must be reduced to no more than 20% of GDP. As a result, the annual budget deficit would be smaller and more manageable. Debt-to-GDP would level off, and the risk of a lending freeze or interest rate hikes on credit markets receded. A VAT is not required for any of these stages.