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Chris Walsh
Chris Walsh

VAT in the USA

Value-added tax and national sales tax regimes analyzed.

December 10, 2009
by Chris Walsh

The global economic crisis has two diametrically opposed aspects, as things stand today. The first of these has created the current focus on economic stimulus; of getting consumers to consume; of encouraging lenders to lend; and of re-energizing the banking, manufacturing, wholesaling and retailing sectors. In other words, the emphasis is on getting markets back to a reasonable level of their former functionality. These strategies are now being addressed more seriously.

The situation has never been so dire for the national debt. Additionally, it has been estimated that the U.S. will issue somewhere between $2.7 trillion and $4.2 trillion of debt over the next two years. With the federal deficit already racing towards $2 trillion and with many more billions likely to be paid out in funding to U.S. businesses and in stimulus packages before the crisis is over, how will we ever extract ourselves from the deepening debt hole that threatens to drain the economy for generations to come? Even before the current set of circumstances evolved, it was being forecast that spending on Social Security, Medicare and Medicaid alone would overwhelm the entire federal budget within the next 35 years to 40 years.

To address these problems, the limited options open to government include drastically cutting forecast spending, raising taxes or a mixture of both approaches. The Obama administration has already undertaken to review entitlement provisions and has set a goal of halving the federal deficit before the end of the current administration but, in the absence of an unlikely root and branch cutting of benefits for baby boomers and beyond, this is unlikely to come close to solving the long-term problem.

Indirect Taxation

It is also worth mentioning that there is a clear identifiable trend around the world for governments to move away from direct taxes, which effectively penalize employment, savings and earnings, in favor of certain indirect taxes that impact spending, consumption and the environment. Although such taxes are sometimes referred to as “regressive” (in that they can impact the poorer segments of society more severely than the wealthier ones), the degree of regression can largely be controlled by governments targeting particular types of expenditure. There is also a perception of innate fairness about indirect taxes, in that individual citizens are not compelled to pay them because it is to some extent their own choice whether they buy certain goods and services and thereby incur the tax.

For governments, the benefits of moving towards indirect taxes have been highlighted in the current economic environment. Direct taxes such as Income Tax are intrinsically unstable sources of revenue, as they rely on taxpayers making profits in the first instance. As we are seeing in the present crisis, the profitability of American companies this year is likely to be marginal and the result of that will be a sharp decrease in Income Tax revenues. As an example, in June 2009 California announced that its tax revenues had decreased by 39 percent for personal income tax and 52 percent for corporate income tax. In contrast, state sales-tax yields had only fallen by 7.5 percent. This illustrates that, although sales taxes are adversely affected by economic downturns as consumers tighten their purse strings, they are far more stable than direct taxes because people still have to purchase goods and services, even during a recession.

National Sales Tax

If increasing corporate direct taxes are not a viable option, then what other tax types could raise sufficient revenue to make a meaningful dent in the deficit? Realistically, a national sales tax (NST), similar to the VAT that prevails in almost every other country, is one of the few tax systems that could make a real difference over a relatively short period of time. Although raising taxes is never a popular move, it may be useful to add some broader global context here.

The average rate of state sales tax in the U.S. is around eight percent, which compares very favorably with most other developed countries in the world. Comparable rates of VAT (or local equivalents) include 15 percent in Canada Mexico and the U.K.; 19.6 percent in France; 19 percent in Germany and 17 percent in China. The average European Union (EU) rate hovers around 20 percent and global rates average out at about 16 percent. So there is a significant gap between the consumption taxes paid in the U.S. and those paid in most other parts of the world and it is this gap that could be narrowed through the introduction of NST and justified on the dual bases of the U.S. being so far out of line with the rest of the world and the critical need to fund the country’s long term economic health. The added benefits of introducing an NST would include the ability to reduce income tax rates (thus making the U.S. more competitive on the world stage) and to potentially eliminate some other taxes completely, thereby streamlining the entire tax system. It is this “trade-off” between increasing indirect taxes and reducing direct taxes that could make such a proposal salable to an otherwise financially stressed American public.

To read more on the potential impact NST can have on U.S. businesses, read the full article on the LexisNexis Tax Law Center.

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Chris Walsh is chief international indirect tax officer at Vertex comments on the uses for business-networking sites with regards to tax. To read more articles by Chris Walsh and other Vertex Tax Experts, visit the Vertex Web site.

*Note: The content of this article advances the outlook and opinions of the author, Chris Walsh. The author does not advance this article's content to represent in any way the views of the AICPA Corporate Taxation Insider, AICPA or Vertex, Inc. This article was previously published on the LexisNexis Tax Law Center.