Order Code IB92069
Issue Brief for Congress
Received through the CRS Web
A Value-Added Tax Contrasted
With a National Sales Tax
Updated March 19, 2003
James M. Bickley
Government and Finance Division
Congressional Research Service ˜ The Library of Congress

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CONTENTS
SUMMARY
MOST RECENT DEVELOPMENTS
BACKGROUND AND ANALYSIS
Concept of a Value-Added Tax
A National Sales Tax
Policy Implications
Administrative Costs
Joint Tax Collection
Avoiding Double Taxation of Intermediate Goods and Services
Enforcement
Broadness of Tax Base
Maximum Tax Rate
Time Required to Implement
Visibility
LEGISLATION
FOR ADDITIONAL READING
CRS Products

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IB92069
03-19-03
A Value-Added Tax Contrasted with a National Sales Tax
SUMMARY
Proposals to replace all or part of the
NST would be a federal consumption tax
income tax, proposals for national health care,
collected only at the retail level by vendors.
and a proposal to finance America’s war effort
Both a VAT and a NST are assumed to be
have sparked congressional interest in the
ultimately paid by consumers. For FY2000, a
possibility of a broad-based consumption tax
broad-based VAT or NST would have raised
as a new source of revenue. Both a
net revenue of approximately $37.8 billion for
value-added tax (VAT) and a national sales
each 1% levied.
tax (NST) have been considered by some
Members of Congress.
The operating differences between a
consumption VAT and a NST have important
A firm’s value added for a product is the
policy implications. The administrative cost
increase in the value of that product caused by
of a VAT would exceed that of a NST because
the application of the firm’s factors of produc-
a VAT would require more information to be
tion. A VAT on a product would be levied at
reported and audited. An opportunity exists
all stages of production of that product. A
for a NST to be collected jointly with state
firm’s net VAT liability is usually calculated
sales taxes, but a federal VAT offers no
by using the credit method. According to this
readily available joint collection possibilities.
method, a firm determines its gross tax liabil-
A consumption VAT with the credit method
ity by multiplying its sales by the VAT rate.
more easily excludes inputs from double
Then the firm computes its net VAT liability
taxation than does a NST. A consumption
by subtracting VAT paid on purchases from
VAT would be easier to enforce than a NST.
other firms from the firm’s gross VAT liabil-
It is in the self-interest of a firm to have accu-
ity.
rate purchase invoices so that it can obtain full
credit for prior VAT paid. Tax authorities can
The three types of VAT differ in their tax
double check the accuracy of the VAT remit-
treatment of purchases of capital (plant and
ted by any firm because data are collected
equipment). A consumption VAT treats a
from producers at all levels of production. A
firm’s purchases of plant and equipment the
VAT could have a broader tax base than a
same way as any other purchase by a firm. All
NST because a VAT is easier to enforce. A
developed nations with VAT have the con-
VAT could have a higher tax rate than a NST
sumption type. The other two types of VATs
because a VAT is more difficult to evade. A
are the income VAT and the gross product
VAT would require more time to implement
VAT. Under the income VAT, the VAT paid
than a NST because a VAT is more compli-
on the purchases of capital inputs is amortized
cated, covers more firms, and is a new tax
(credited against the firm’s VAT liability)
method. A VAT may be less visible to con-
over the expected lives of the capital inputs.
sumers than a NST. A VAT is levied at all
Under the gross product VAT, no deduction
stages of production, and policymakers have
for the VAT on purchases of capital inputs is
the option of not requiring the amount of VAT
allowed against the firm’s VAT liability. A
to be shown on retail sales receipts.
Congressional Research Service ˜ The Library of Congress

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IB92069
03-19-03
MOST RECENT DEVELOPMENTS
On March 5, 2003, House Majority Leader Tom DeLay stated that House Republicans
have “already started work” on reforming the tax code. He said that major tax reform was
a long-term project and expressed a preference for a national sales tax.
BACKGROUND AND ANALYSIS
Proposals to replace all or part of the income tax, proposals for national health care, and
a proposal to finance America’s war effort have sparked congressional interest in the
possibility of a broad-based consumption tax as a new source of revenue. A value-added tax
(VAT) or a national sales tax (NST) have been frequently discussed as possible new tax
sources. Both the VAT and the NST are taxes on the consumption of goods and services and
are conceptually similar. Yet, these taxes also have significant differences. This issue brief
discusses some of the potential policy implications associated with these differences.
Concept of a Value-Added Tax
The value added of a firm is the difference between a firm’s sales and a firm’s purchases
from all other firms. In other words, a firm’s value added is simply the amount of value that
a firm contributes to a good or service by applying its factors of production (land, labor,
capital, and entrepreneurial ability). A value-added tax would be a tax, levied at each stage
of production, on a firm’s net value added. The credit method is usually used to collect the
VAT. Under the credit method, a firm would calculate the VAT on its sales. Next, a firm
would compute its VAT liability by subtracting the VAT paid on its inputs from the VAT
on its sales, and would then remit the difference to the federal government to cover its tax
liability.
There are three types of VATs which differ in their tax treatment of purchases of capital
inputs (plant and equipment). The consumption-type VAT treats capital purchases the same
way as the purchase of any other input, i.e., it is equivalent to expensing. The other two
types of VATs are the income VAT and the gross product VAT. Under the income VAT,
the VAT paid on the purchases of capital inputs is amortized (credit against the firm’s VAT
liability) over the expected lives of the capital inputs. Under the gross product VAT, no
deduction for the VAT on purchases of capital inputs is allowed against the firm’s VAT
liability. The consumption VAT is the only type of VAT that is used in developed nations
and has been proposed for the United States; consequently, the consumption VAT is
contrasted with the NST in this issue brief.
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IB92069
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A National Sales Tax
A national sales tax (NST) would be a federal consumption tax collected only at the
retail level by vendors. The NST would equal a set percentage of the retail price of taxable
goods and services. Retail vendors would collect the NST and remit tax revenue to the
federal government.
The retail price of a good or service equals the sum of value added at all stages of
production. Consequently, a value-added tax and a national sales tax with the same tax rate
and tax base would yield the same amount of revenue. The operating assumption of
policymakers and economists is that both taxes are fully shifted forward onto consumers; that
is, the price to the consumer increases by the (full) amount of the tax. For FY2000, a
broad-based VAT would have raised net revenue of approximately $37.8 billion for each 1%
levied.
Policy Implications
The operating differences between a VAT and a NST have many important policy
implications, including the following eight factors: administrative cost, joint tax collections,
avoiding double taxation of intermediate goods and services, enforcement, broadness of tax
base, maximum tax rate, time required to implement, and visibility.
Administrative Costs
Under a VAT, all firms would have to report tax information and collect taxes. Under
a NST, firms without retail sales would not report or collect taxes. But the substantial
majority of all firms would collect the NST since they have some retail sales. Under a VAT
with a credit method of collection, each firm must keep invoices on all sales and purchases
from other firms, and these invoices would be subject to audit by tax authorities. Hence, the
value-added tax would require more information to be reported and audited than a national
sales tax, and, consequently, a VAT could be expected to be more expensive to administer
than a NST.
Joint Tax Collection
Since 45 states and the District of Columbia have general sales taxes, an opportunity
exists for a NST to be collected jointly with state sales taxes. A federal VAT could not be
jointly collected with state sales taxes. States could convert their sales taxes to a VAT with
the federal tax base, but this is unlikely since it would require that the states establish an
entirely new tax system. Consequently, no administrative costs saving would be expected
from a VAT; therefore, the collection costs of a VAT can be expected to be higher than a
NST.
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IB92069
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Avoiding Double Taxation of Intermediate Goods and Services
Double taxation occurs if an input is taxed at the time of purchase and then a tax is
levied on the same input again when it becomes part of the output of the firm. A
consumption VAT, with the credit method of tax computation, easily excludes inputs from
taxation. The exclusion of inputs from a NST would be more difficult. Usually, firms
buying inputs would have to provide sellers with exemption certificates before making their
purchases. At the state level, procedures to exempt input purchases from state retail sales
taxes have worked imperfectly. It is therefore reasonable to expect that excluding inputs
from taxation would be more difficult with a NST than with a VAT.
Enforcement
With a VAT, a firm would have a financial interest in ensuring that amounts of VAT
paid on input purchases are accurately reported on its purchase invoices since the firm could
receive credits against its VAT liability. In addition, the VAT would provide the tax
authorities with an opportunity to cross-check the amount of VAT collected because data are
gathered from producers at different stages of production. Some enforcement problems do
exist with a VAT. For example, firms at different stages of production could collude to
falsify invoices. But the NST lacks both the self-enforcing procedure and the cross-checking
opportunity of the VAT. Hence, better compliance is expected from a VAT than with a NST.
Broadness of Tax Base
Because of the potential for better enforcement of a VAT, it may be possible to levy a
VAT on more goods and services than a NST. This view is supported by the fact that VATs
of European nations, on the average, are levied on more goods and services than most state
sales taxes in the United States.
Maximum Tax Rate
Both the self-enforcing procedure and the cross-checking opportunity of a VAT would
increase the probability of a tax evader being apprehended. Thus, for a given tax rate, a VAT
is expected to have better voluntary compliance than a NST. In general, as a tax rate rises,
the financial gains from tax evasion increase relative to the punishment if apprehended.
Consequently, it is expected that as a consumption tax rate is increased, the level of tax
evasion would rise. Since voluntary compliance with a VAT is expected to be better than
with a NST, the tax rate for a VAT may be raised to a higher level than for a NST before a
problem with tax evasion occurs.
Time Required to Implement
The VAT would take more time to implement than a NST. The VAT is more
complicated and would cover more firms than a NST. Also, business executives are not
familiar with this form of taxation, so the U.S. government would have to conduct an
educational campaign.
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Visibility
The value-added tax may be less visible to consumers than a national sales tax.
Policymakers and economists assume that 100% of both the VAT and the NST are passed
onto consumers. But the perceptions of many consumers may be different about a VAT.
Many consumers may believe that a VAT tax would at least partially fall on firms because
the VAT is collected at each stage of production. Since the NST is levied only at the retail
level, consumers may more readily believe that they would pay the entire tax. Furthermore,
policymakers have the option as to whether the amount of a VAT should be stated on retail
sales receipts. The amount of a NST would be explicitly stated on sales receipts.
The lower visibility of the VAT relative to the NST may be either desirable or
undesirable depending on one’s political ideology. It can be argued that taxes should be
visible so that the costs of taxation may be compared with the benefits of government
spending. Conversely, it can be argued that people generally do not like the idea of paying
taxes; consequently, to finance public sector responsibilities, it is better to have taxes seem
as painless as possible.
LEGISLATION
H.R. 25 (Linder)
To promote freedom, fairness, and economic opportunity by repealing the income tax
and other taxes, abolishing the Internal Revenue Service, and enacting a national sales tax
to be administered primarily by the states. Introduced January 7, 2003; referred to the House
Committee on Ways and Means.
H.R. 269 (English)
Simplified USA Tax Act of 2003. Replaces the individual income tax, the corporate
income tax, and the estate and gift taxes with a border-adjustable business tax (subtraction-
method VAT) and a progressive consumed-income tax. Individuals may utilize the
equivalent of universal Roth IRAs to encourage savings. Introduced January 8, 2003;
referred to the House Committee on Ways and Means.
H.R. 278 (Graves)
Date Certain Tax Code Replacement Act. Establishes within the legislative branch a
National Commission on Tax Reform and Simplification that shall review and submit to
Congress a report on (1) the present structure and provisions of the Internal Revenue Code;
(2) whether tax systems imposed under the laws of other countries could provide more
efficient, simple, and fair methods of funding the revenue requirements of the government;
(3) whether the income tax should be replaced with a tax imposed in a different manner or
on a different base; and (4) whether the Internal Revenue Code can be simplified, absent
wholesale restructuring or replacement. Authorizes appropriations for the Commission. Any
new federal tax system would require approval by Congress no later than July 4, 2007. If a
new federal tax system is not approved by July 4, 2007, then Congress would be required to
vote to reauthorize the Internal Revenue Code of 1986. Introduced January 8, 2003; referred
to the House Committee on Ways and Means.
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IB92069
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S. 112 (Hollings)
War Financing Act of 2003. A bill to amend the Internal Revenue Code of 1986 to
impose a value added tax and to use the receipts from the tax to fund America’s war effort.
Introduced January 9, 2003; referred to the Senate Committee on Finance.
FOR ADDITIONAL READING
CRS Products
CRS Report RL30351. Consumption Taxes and the Level and Composition of Saving, by
Steven Maguire.
CRS Report 98-248. A Federal Tax on Consumed Income: Background and Analysis, by
Gregg A. Esenwein.
CRS Report 98-529. Flat Tax: An Overview of the Hall- Rabushka Proposal, by James M.
Bickley.
CRS Report 95-1141. The Flat Tax and Other Proposals: Who Will Bear the Tax Burden?
by Jane G. Gravelle.
CRS Report 96-315. The Flat Tax and Other Reform Proposals: Overview of the Issues,
by Gregg A. Esenwein and Jane G. Gravelle.
CRS Issue Brief IB95060. Flat Tax Proposals and Fundamental Tax Reform, by James M.
Bickley.
CRS Report 98-901. Short-Run Macroeconomic Effects of Fundamental Tax Reform, by
Thomas G. Woodward and Jane G. Gravelle.
CRS Issue Brief IB91078. Value-Added Tax as a New Revenue Source, by James M.
Bickley.
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