What a Value-Added Tax Means

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Uncle Sam has a tax problem — and he’s looking at one European idea to help solve it.

No doubt, “it” is a big problem. The current national public debt is about $12.8 trillion, or about $41,760 to each of the nation’s 308 million citizens. The U.S. Congressional Budget Office pegs that debt to grow to about $20 trillion by 2020.

Paying that debt down likely means more taxes, and one new tax idea that is gaining momentum in Washington, D.C., is the value-added tax, more commonly known as the VAT.

Nothing is set in stone yet, but the White House is giving the value-added tax some serious thought. More formally, the CBO right now is looking into the feasibility of such a tax, and what it might mean to government revenues, businesses and, of course, U.S. taxpayers.

So what is the value-added tax, and what would it mean to American taxpayers?

The tax, created by a French economist back in 1954, is essentially a sales tax on steroids. Unlike the Fair Tax, which is imposed only at the point of transaction, the value-added tax is a sales tax imposed throughout every layer of production that leads to a consumer transaction.

That process starts at the raw materials provider, goes to the product manufacturer, goes through the retailer and winds up in the customer’s hands. Think of a new car transaction: The steel producer sells to the auto manufacturer, who sends a new car off the production line to an auto dealer, where it winds up on the showroom floor. Ultimately, a consumer buys the new car. Each transaction in the chain is assigned a "value added" by the government, and is taxed accordingly.

VAT levels vary from country to country, but the value-added tax in France stands at 20% right now, and in Germany, it’s 19%.

The whispering in Washington points to a significantly lower value-added tax of about 5%-7% as a starting point. According to the CBO, if the U.S government charged a 7% VAT on every consumer transaction then it could raise about $1 trillion in revenue. But another study — this one by the Washington-based Tax Policy Center, says that a 5% VAT would bring in about $260 billion if implemented by 2012.  Already, there are doubts among economists that food and clothing would be included in a value-added tax. If that’s the case, then the government would need the value-added tax to go higher than 5%-7%, no matter whose numbers you believe.

Now that we’ve got the numbers out of the way, how would a VAT impact you?

For starters, it would likely result in higher taxes, and here’s why. Whatever happens with a VAT, it would not replace the current federal tax system — it would only augment it under the guise of a “national sales tax.” Consumers who live in states that have sales taxes already know the drill. On top of federal, state and even county and city taxes, a VAT would add a federal sales tax to the list.

Here are some other impactors from a VAT:

It will raise the price of everyday goods. One thing is for sure — producers, manufacturers and retailers will take any extra taxes and factor them into the price of their goods. That means the American consumer will likely be the one holding the bill in the end, in the form of higher consumer prices as well as the VAT tax.

More government revenue. A VAT would surely bring in more money to U.S. Treasury coffers, and not just because it’s another tax on consumers. Think of foreign travelers who visit the U.S. Anything they buy while stateside would fall under the VAT umbrella, meaning that the U.S. government would get a slice of foreign tourist purchases, and that could result in billions of dollars. Of course, some foreign travelers could cross the U.S. off the list of preferred travel destinations, since it would cost more to come here.

It could help the rich. No self-respecting tax advocate would admit it, but a VAT would help the wealthy more than the poor. On the surface, a VAT is designed to raise taxes pretty much equally across the board. But “pretty much” is a loaded term — in favor of the loaded. The Tax Policy Center estimates the VAT breakdown as follows:

“A VAT would raise taxes roughly equally across-the-board — with one exception. The tax is a boon to high-income taxpayers, who make much of their money from VAT-free savings and investments. On average, the 5 percent VAT would reduce after-tax income by about 2.7 percent. The lowest earners would face an income loss of 2.8 percent while middle- and upper-middle class taxpayers would lose about 2.9 percent. But the highest earning 1 percent would see their after-tax incomes fall by only 2.1 percent.”

Lack of transparency. With a pure sales tax, the tax owed is printed right there on the receipt. But under a VAT, consumers would likely find it difficult to know how much they are being taxed, since value is added to the consumer transaction at several checkpoints. Since every level of production feels the pinch, it’s hard for consumers to know what exactly it is they are being taxed. In Europe, this lack of transparency has proven problematic, as various governments have rigged the system by hiding new taxes in the VAT for popular social programs, relying on the VAT’s complicated structure to hide the dirty deed.

One thing is for sure; the VAT process is very much a dynamic one, with new theories, opinions and studies seemingly coming out every week. But these are the facts so far, and as new ones come out, MainStreet will keep you posted on the details.

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

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