The growth in national debt has been accompanied by an increase in discussion of new taxes. One of the latest ideas getting attention is the value-added tax, or VAT.

The VAT is basically a national sales tax and is common in most other countries. France, for example, derives half its revenue from the VAT.

Although it looks like a sales tax, there is a key difference. The VAT is applied throughout the production and sales cycle as value is added to the product. Original producers charge a tax to manufacturers, who charge retailers, who charge consumers. Each tax can be deducted from the next tax, which is supposed to reduce the impact on the consumer. It is important not only because it spreads the tax throughout the production and sales system, but also because it  helps keep the end sales tax below 10 percent, which is considered the limit of consumer acceptance. Above that, according to economic theory, more people figure out ways to evade the tax.

This is generally how the VAT works in European countries, where it adds 10 percent to 20 percent to purchases, although not all at once. The taxes also can be assessed differently, so, for example, food could be taxed at a lower rate than other goods.

Some like the VAT because it taxes consumption rather than income. Some argue that an income tax penalizes achievement because it taxes wage growth and investment. But others argue that consumption taxes penalize lower-wage earners because consumption eats up more of their income. So the tax would be a larger proportion of their spending. Income taxes are generally considered progressive, and consumption taxes are regressive.

People across the political spectrum are considering the tax, partly because it can be used to replace other taxes, such as corporate taxes, that are considered more onerous. Besides general opposition to consumption taxes and, of course, to taxes in total, a key argument against the VAT is that it does not address the problem of overspending. Many people say that rather than figuring out how to fund growing government, government should figure out how to stop growing. Others say this is unrealistic, given the inevitable increase in Medicare and Social Security alone, and that a more equitable way to pay for government spending should be devised.

The VAT tax is likely to get more attention over the coming months, because Congress and the Obama administration have been asking for studies on its impact as a basis for future policy.

This entry was posted on Sunday, May 2nd, 2010 at 9:46 am and is filed under Tax Advice. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.