The Value Added Tax

The Value Added Tax (VAT) generates a substantial share of tax revenues in the European Union countries and in most developed economies throughout the world. Table 1 shows that for the European Union as a whole, the VAT raises about 30 percent of total tax revenues and is the largest single source of tax revenues in the EU. All EU countries have a VAT as a condition of membership, and the VAT has spread to most developed economies and to many less developed economies around the world. The United States is unusual in not having a VAT, which is one reason the possible adoption of a VAT in the United States has been a longstanding issue of US tax policy. The issue is coming further to the forefront of policy debate in 2010 because of the substantial budget deficits that are forecast as far out as forecasts are made. Thus, it is reasonable to ask whether a VAT, which is so common throughout the world, might be a desirable policy option for the United States.

Table 1

Sources of Tax Revenues in the European Union, 2008

Source: www.eapn.ie/eapn/policy/policy-areas/resources-on-taxation/sources-of-t…

As shown, the VAT is more than just an additional revenue source in the EU: it is the largest single source of tax revenues there. Thus, one should be skeptical that an EU-style VAT could simply be grafted onto the current US tax code. A VAT of that magnitude would require a major overhaul of the entire tax structure, and, indeed, when the VAT was introduced into Europe that is what happened. Another alternative would be to have a smaller VAT added to the current tax code as a revenue enhancer. A problem with that is that there are major administrative and compliance costs that go along with a VAT, and it may not be worthwhile to incur those major costs in exchange for a smaller flow of revenue.

Looking around the world, VAT rates vary substantially among countries. Iceland has the highest VAT rate at 25.5 percent, while Canada is at the bottom of the list with a VAT rate of 5 percent. Table 2 gives standard VAT rates for various countries. While there is a substantial variation, VAT rates most commonly fall in the 17-25 percent range. The EU requires members to maintain a standard VAT rate of at least 15 percent. Denmark, Norway, and Sweden all have 25 percent VAT rates, while the rate in France is 19.6 percent and in Germany is 19 percent. Australia has a 10 percent VAT rate, and Switzerland’s rate is 7.6 percent.

Table 2

Value Added Tax Rates for Various Countries

Source: www.nationmaster.com/graph/tax_val_add_tax_sta_rat-value-added-tax-stan…

The rates shown in Table 2 are “standard” rates, and most countries with VATs have reduced rates of various amounts for certain categories of goods. Belgium, for example, with a standard rate of 21 percent, also has rates of 12, 6, and 0 percent for some goods. France, in addition to its standard rate of 19.6 percent, has 5.5 and 2.1 percent rates. The United Kingdom has rates of 5 and 0 percent in addition to its 17.5 percent standard rate. The UK’s standard rate of 17.5 percent took effect January 1; prior to 2010 the rate was 15 percent. Once a VAT is in place, it is relatively easy to raise the rate to generate more revenue.

One can see from this brief introduction that the VAT is responsible for a substantial share of tax revenues in most countries where it is used, and that typical rates are above 17 percent. When applied to the United States, then, one would want to consider whether the nation would be inclined toward a major tax reform, as occurred in Europe when the EU adopted the VAT, or whether a VAT could be scaled down and applied in the US, perhaps using Canada as the closest example.