Value-Added Tax: “The Least-Worst Solution”?


By Dave Carpenter, AP Personal Finance Writer

It's popular around the world. You probably paid it on your last European vacation. But how many Americans understand or even know about the value-added tax?

The answer at the moment is surely "not too many." That will change dramatically, however, if the Obama administration ever puts it forward as a serious option for generating badly needed revenue.

Former Federal Reserve Chairman Alan Greenspan said earlier this month that he believed the government will eventually impose some kind of value-added tax, or VAT. While that's far from certain or imminent, the VAT debate is starting to intensify.

Here are some questions and answers about the value-added tax.

Q: What exactly is a value-added tax?

A: It's essentially a national sales tax, although technically not quite the same. It's a tax assessed on the transfer of goods and services, from production to delivery. Consumers are not taxed directly but the higher costs are passed along to them, which means they bear the burden for higher prices.

Q: How does it work?

A: In the kind of value-added tax that's in place in Europe and is being looked at in Washington, a tax is levied on the value added to a product at every stage of the manufacturing cycle. It's collected from each party in the production chain — manufacturer, wholesaler, retailer. Each pays taxes on the amount by which its gross receipts exceed what it paid for the product.
While that may sound complicated, even opponents acknowledge that it is a relatively easy tax to enforce, administer, comply with and raise revenue from. Since transactions must be recorded, the tax is hard to evade, too.

Q: Where is it already in use?

A: More than 130 nations have a value-added tax of some sort, with rates ranging from approximately 4% to at least 25%. It is particularly common in the European Union, where countries use it to pay for national health insurance.

Q: Why are we hearing about it now?

A: The change in administrations and the growing need for money have brought VAT into the tax reform debate.
The government is spending much more than it's taking in even without taking into account the proposed expansion of the health care system, putting pressure on Congress to come up with a new source of revenue.

Some lawmakers have been talking about it, though it remains on a back burner.

Q: Does a VAT tend to hit low-, middle- or upper-income people the hardest?

A: It affects everyone but it is a regressive tax, meaning it imposes a greater burden, percentage-wise, on the poor than the rich. That's because people with lower incomes tend to spend most of their incomes on goods and services.

Q: Wouldn't that run counter to the administration's promise to apply tax increases only to the rich?

A: Yes it would. The White House says it's unlikely to be used as a way to pay for health care reform. But officials haven't ruled it out for down the road, and Greenspan and some policy experts think it may be inevitable.

Q: Who supports it and why?

A: A number of economists, academics and influential officials say it's the most efficient and simplest way to raise the large amounts of revenue that will be needed to keep the government out of crisis.

Greenspan, while not exactly endorsing it, called it "the least-worst solution" and said it is "the only thing that raises revenue in significant quantities without significantly impacting the economy." Former Fed Chairman Paul Volcker, chairman of a task force that President Barack Obama assigned to study the tax system, also has expressed at least tentative support for a VAT.

VAT advocates say it could be made progressive by combining it with health care reform and using the revenue to pay for health insurance for all Americans, taking a cue from the Europeans who use the proceeds to support a generous social safety net.

Q: What do opponents say?

A: Many liberals don't like it because it's regressive, while conservatives dislike it as an extra layer of taxes on top of existing income taxes.

The right-leaning Heritage Foundation is open to possibly having it replace the current income-tax structure but dislikes it as a "revenue grab" to help pay for health and pay down the massive deficit, according to Curtis Dubay, a senior tax policy analyst at the right-leaning organization.

A VAT is "very appealing" to anyone who thinks the solution to the revenue crisis is for the government to come up with large new revenue sources, said Tom Giovanetti, president of the Institute for Policy Innovation, a conservative think tank in Lewisville, Texas.
"On the other hand, we think that would be very destructive to just get on a permanent track now where we're going to have essentially European-level taxes," he said. "There's a reason why European countries have had systematic, long-term unemployment rates above 10%."

Q: What form, and rate, might a U.S. value-added tax take here?

A: Both are wide open.

House Democrats who cite it as an option to pay for expanded health care have talked about a VAT rate of 1.5% or more, with housing, education, financial services and medical care potentially exempt. Dubay says he can't see it gaining the necessary political support unless clothing, food, medicine and housing are exempted.

Liberal policy expert Len Burman, who until recently was co-director of the Tax Policy Center, a joint project of the Urban Institute and the Brookings Institution, has proposed a 25% VAT that could pay for health care reform and balance the budget. Under the plan, millions of families would be exempt from income taxes and the top income tax rate would be cut to 25%.

That overhaul may be too ambitious in this fractious political environment.

Q: So how likely is a VAT to be adopted?

A: It's unlikely in the short term and anyone's guess beyond that.

It could become a big issue after midterm elections in 2010 if rising deficits increase the urgency for new revenue and the Obama administration gets behind it.

Burman, who has worked closely with Democratic lawmakers, suspects there's already a consensus in both the House and the Senate, with a significant number of Republicans among them, that a VAT is needed. But that doesn't mean it has real political support.

"The number who are willing to say so in public, you can probably count on one or two hands," said Burman, now a professor at Syracuse University's Center for Policy Research. "So I wouldn't bet a lot of money on a VAT happening any time in the next few years."

Copyright 2009 The Associated Press.  All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at

Show Comments

Back to Top