Designing a Federal VAT: Summary and Recommendations
Reuven S. Avi-Yonah
University of Michigan Law School
June 18, 2009
U of Michigan Law & Economics, Olin Working Paper No. 09-013
U of Michigan Public Law Working Paper No. 155
For the past thirty-five years, the debate on fundamental tax reform in the United States has centered on whether some type of consumption tax would replace all or part of the federal income tax. In my opinion, this debate has now been decided. Given recent budgetary developments and the impending eligibility of the baby boom generation for Social Security and Medicare, we cannot dispense with the revenue from the corporate and individual income tax. Moreover, we will need huge amounts of additional revenue, and most informed observers believe that the only plausible source for such revenues is a federal Value Added Tax (VAT) enacted in addition to, and not as a replacement of, the federal income tax.
When a federal consumption tax is considered as an addition to, and not as a replacement of, the existing income tax, it becomes clear that a lot of the discussion of consumption taxes in the preceding US debate has been misguided. Consumption tax advocates typically began by asking how the income tax should be modified to reach only consumption. As a result, consumption tax proposals centered on features that derive from the income tax, such as progressivity and entity-based taxation. The resulting proposals bore little resemblance to existing VATs around the world. They were designed in large part to look more like income taxes and therefore perhaps be more politically acceptable.
Once this central complication is abandoned, it becomes clear that the US should not reinvent the wheel. For example, most earlier consumption tax proposals were subtraction based (i.e., based on inclusions and deductions, like the income tax) rather than credit-invoice based (i.e., based on transactions). Almost all existing VATs, however, are credit-invoice based, for good reasons (explored below in Itai Grinberg’s article). Another example is that many consumption tax proposals (like David Bradford’s X-Tax and the Flat Tax) are origin based, while all VATs are destination based. This feature stems in part from the need to make a subtraction-method consumption tax WTO compatible. But as Keen and Hellerstein explain in this volume, destination based taxes are clearly superior, and once the US tax is a “normal” credit-invoice VAT, it can be destination based as well. Finally, if progressivity issues are addressed by the income tax, then the consumption tax can be applied at a single rate, like most modern VATs.
Number of Pages in PDF File: 15
Keywords: Value Added Tax, tax reform
JEL Classification: H25
Date posted: June 18, 2009 ; Last revised: July 9, 2009