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Congressional Research Service: Should the United States Levy a Value-Added Tax for Deficit Reduction?

Author: James Bickley, Specialist in Public Finance, Congressional Research Service
January 21, 2011

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Due to an increasing U.S. Federal government deficit many groups now argue for the institution of a national value-added tax (VAT) to increase government revenue. James M. Bickley of the Congressional Research Service examines the plausibility of enacting such a plan.

Long-term fiscal problems, which were exacerbated by the recession that ended in June 2009, resulted in widespread concern about the need to formulate a fiscal solution to the high budget deficits and growing national debt. The levying of a value-added tax (VAT), a broad-based consumption tax, has been discussed as one of many options to assist in resolving U.S. fiscal problems. A VAT was not included in the report of the National Commission on Fiscal Responsibility and Reform but was included in the report of the Debt Reduction Task Force of the Bipartisan Policy Center.

A VAT is imposed at all levels of production on the differences between firms' sales and their purchases from all other firms. For 2011, a broad-based VAT in the United States would raise net revenue of approximately $55 billion for each 1% levied. Most other developed nations rely more on broad-based consumption taxes for revenue than does the United States. A VAT is shifted onto consumers; consequently, it is regressive because lower-income households spend a greater proportion of their incomes on consumption than higher-income households. This regression, however, could be reduced or even eliminated by any of three methods: a refundable credit against income tax liability for VAT paid, allocation of some of VAT revenue for welfare spending, or selective exclusion of some goods from taxation.

From an economic perspective, a major revenue source is better the greater its neutrality—that is, the less the tax alters economic decisions. Conceptually, a VAT on all consumption expenditures,with a single rate that is constant over time, would be relatively neutral compared to other major revenue sources. A VAT would not alter choices among goods, and it would not affect the relative prices of present and future consumption. But a VAT cannot be levied on leisure; consequently, a VAT would affect households' decisions concerning work versus leisure. For a firm, the VAT would not affect decisions concerning method of financing (debt or equity), choice among inputs (unless some suppliers are exempt or zero-rated), type of business organization (corporation, partnership, or sole proprietorship), goods to produce, or domestic versus foreign investment.

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