Will The Growing US Deficit Necessitate a VAT? — Rationale & Implications

I posted an announcement last week that KPMG would sponsor a webcast conducted by The Tax Governance Institute yesterday afternoon titled Will the US Adopt a Value-added Tax (VAT)? For those Spend Matters' readers who were unable to listen in, this post is a recap of the 90 minute webcast, the issues surrounding a VAT option, how it might work and its impact on US companies. The presentation was a stellar discussion that included the following panelists:

Harry L. (Hank) Gutman, Moderator and Principal in Charge, Federal Tax Legislative and Regulatory Services, Washington National Tax, KPMG LLP; Director of the Tax Governance Institute
Richard M. Bird, Professor Emeritus and Associate of the International Institute of Business, Rotman School of Management, and Senior Fellow, Institute for Municipal Finance and Governance, Munk Centre for International Affairs, the University of Toronto
William Gale, The Arjay and Frances Miller Chair in Federal Economic Policy, in the Economic Studies Program at the Brookings Institution
Walter Hellerstein, The Francis Shackelford Professor of Taxation at the University of Georgia Law School
Harley Duncan, Managing Director, KPMG LLP, Washington, DC and Former Executive Director of the Federation of Tax Administrators

Let's begin with some background data. The over-riding and inescapable premise of the discussion -- on which all panelists agreed -- was that according to the Congressional Budget Office (OCB):

  • The FY 09 US deficit is 10% of GDP (1.4 trillion dollars) and is projected to grow (based on current law remaining in effect for 10 years) to 83% of GDP by 2019.
  • Unemployment will average 10.2 % in 2010
  • Real GDP growth will be approximately 2.8% in 2010
  • The CPI will increase 1.6% for 2009 and 1.1% in 2010

Giving rise to the consensus that the US has very serious revenue problems regardless of current law vs. new proposed legislation and that the above numbers are considered low and do not represent future reality.

Upon indicating that the US ranks 5th in the world when it comes to overall taxation (28% of GDP all in) compared with the top 4 countries at 35-50%, Mr.Gutman paraphrased Sen. Daniel Patrick Moynahan (for whom he once worked) as having said "Everyone is entitled to the facts but no one is entitled to their own facts". Which led to the question: "What about reducing spend?" The answer was straight forward and simple indicating that the overwhelming bulk of the US annual budget consists of net interest on the deficit (currently 800 billion dollars), defense, social security, medicare and medicaid where cuts, if tenable, would barely make a dent in reducing the deficit (which was not to say that spending should not be scrutinized, reduced and held in check). It is also interesting to note that of the 28% of GDP US tax revenue, federal taxes comprise 18-20% with state and local taxes at 9.5-11.0 %.

Mr. Gale then discussed our Fiscal Gap -- which Wikipedia defines as "a measure proposed by economists Alan Auerbach and Lawrence Kotlikoff, [that] measures the difference between government spending and revenues over the very long term, typically as a percentage of Gross Domestic Product" -- that is presently $1.3 trillion/year and said that while we must reduce spending and raise taxes we can't get another 5% of GDP from existing taxes (the amount needed) without severely damaging the economy. And on a humorous note it was said: "The taxes we have are really bad and we don't have enough of them".

Given the above background information, along with the fact that the US is among the few countries in the world without a VAT -- 145 countries have a VAT and most that don't are underdeveloped -- the panelists seemed unanimous in believing that the US will ultimately need to implement one as a far more equitable, transparent and enforceable instrument vs. expanding existing tax structures.

So what would a US VAT look like? Wikipedia's definition is the most concise: "Value added tax (VAT), or goods and services tax (GST) is a consumption tax (CT) levied on any value that is added to a product. In contrast to sales tax, VAT is neutral with respect to the number of passages that there are between the producer and the final consumer". According to the panelists it would be a very broad based tax on all goods and services that would role forward as the tax is added at every step of the supply chain as goods and services receive inputs and is then credited back to each element of production until it is finally paid by the end consumer. This Credit Invoice Method is most common among countries in Europe where the VAT system is mature -- and from which we could benefit regarding implementation and systems. The panel was repeatedly clear that VAT does not tax business inputs, just individual consumption.

While the panelists did not directly discuss the administrative/accounting impact on businesses and corporations, it's safe to project that it would be substantial and that given accepted managerial accounting principles, would add overhead cost and therefore result in increased prices. The only solace here is that there would be competitive incentive to administer the process as efficiently as possible and all competing vendors/producers would be subjected to the task.

The discussion concluded with a case study of the Canadian VAT system that was not especially relevant -- Canada introduced VAT as an excise tax substitute rather than a deficit reduction instrument -- except that the Canadian implementation experience was very interesting with reference to provincial embracement. The provinces balked at first -- as the US states certainly would -- but ultimately embraced the efficiency of the tax to the point of "harmonizing" their own systems with the federal VAT and sharing, rather than duplicating, the costs of administration.

And finally, VAT is regressive -- in taxing all goods and services including food and clothing it would disproportionately impact the nation's poor. A problem that the panelists believe can and should be addressed outside of the VAT process with possible income tax credits that have, in other countries, produced an increase in income tax filings. Other topics addressed included conceptual problems with notoriously difficult to tax financial services institutions as well as how it would be best to not administer a VAT system through existing bureaucracies like the IRS but to implement an entirely new structure so that the tax would be expressly applied to the national debt.

My conclusion is that while a US VAT may not be imminent -- President Obama has promised to not sign any new taxation for people earning less than $250,000/yr and Republicans will not vote for any new taxes what-so-ever -- it seems to be the most viable and simple (relatively speaking) tax instrument to address the dire deficit debacle which cannot continue to be ignored. At the risk of over simplifying the concept, it appears to me that VAT resembles the game of hot potato -- except that it ultimately lands on the US consumer to take the heat and US companies to do the accounting.

William Busch

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