Should the United States Levy a Value-Added Tax for Deficit Reduction?

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Should the United States Levy a Value-Added
Tax for Deficit Reduction?
James M. Bickley
Specialist in Public Finance
March 22, 2011
Congressional Research Service
7-5700
www.crs.gov
R41602
CRS Report for Congress
P
repared for Members and Committees of Congress

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Summary
Long-term fiscal problems, which were exacerbated by the recession that ended in June 2009,
resulted in widespread concern about the need to formulate a fiscal solution to the high budget
deficits and growing national debt. The levying of a value-added tax (VAT), a broad-based
consumption tax, has been discussed as one of many options to assist in resolving U.S. fiscal
problems. A VAT was not included in the report of the National Commission on Fiscal
Responsibility and Reform but was included in the report of the Debt Reduction Task Force of the
Bipartisan Policy Center.
A VAT is imposed at all levels of production on the differences between firms’ sales and their
purchases from all other firms. For 2011, a broad-based VAT in the United States would raise net
revenue of approximately $45 billion to $55 billion for each 1% levied. Most other developed
nations rely more on broad-based consumption taxes for revenue than does the United States. A
VAT is shifted onto consumers; consequently, it is regressive because lower-income households
spend a greater proportion of their incomes on consumption than higher-income households. This
regression, however, could be reduced or even eliminated by any of three methods: a refundable
credit against income tax liability for VAT paid, allocation of some of VAT revenue for increased
welfare spending, or selective exclusion of some goods from taxation.
From an economic perspective, a major revenue source is better the greater its neutrality—that is,
the less the tax alters economic decisions. Conceptually, a VAT on all consumption expenditures,
with a single rate that is constant over time, would be relatively neutral compared to other major
revenue sources. A VAT would not alter choices among goods, and it would not affect the relative
prices of present and future consumption. But a VAT cannot be levied on leisure; consequently, a
VAT would affect households’ decisions concerning work versus leisure. For a firm, the VAT
would not affect decisions concerning method of financing (debt or equity), choice among inputs
(unless some suppliers are exempt or zero-rated), type of business organization (corporation,
partnership, or sole proprietorship), goods to produce, or domestic versus foreign investment.
The imposition of a VAT would cause a one-time increase in this country’s price level. But a VAT
would not necessarily affect this country’s future rate of inflation if the Federal Reserve offset the
contractionary effects of a VAT with a more expansionary monetary policy. If the United States
continued its policy of flexible exchange rates, then the imposition of a VAT would not
significantly affect the U.S. balance-of-trade. There is no conclusive evidence that a VAT would
substantially change the rate of national saving more than another type of major tax increase. The
administrative costs of a VAT would be significant but relatively low if measured as a percentage
of revenue yield. In comparison to other broad-based consumption taxes, VATs have produced
relatively good compliance rates. A significant gross receipts threshold for registration could
reduce the costs of administration and compliance. Data suggest that 15 to 24 months would be
required to implement a VAT. Whether or not a federal VAT would encroach on the primary
source of state revenue, the sales tax, is subject to debate. A federal-state VAT could be collected
jointly, but a state would lose some of its fiscal discretion.
The prevailing view of tax professionals is that an optimal VAT would have the following
characteristics: a broad base, a single rate, the credit-invoice method of collection, the destination
principle, and a significant sales threshold for registration.
This report will be updated as issues develop, legislation is introduced, or as otherwise warranted.
Congressional Research Service

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Contents
Introduction ................................................................................................................................ 1
Concept of a Value-Added Tax .................................................................................................... 3
Methods of Calculating VAT ................................................................................................. 4
Exemption Versus Zero-Rating.............................................................................................. 5
Exemption ...................................................................................................................... 5
Zero-Rating .................................................................................................................... 6
Revenue Yield............................................................................................................................. 7
Revenue Performance ................................................................................................................. 7
International Comparison of Composition of Taxes ..................................................................... 8
VAT Rates in Other Countries ..................................................................................................... 9
Equity ......................................................................................................................................... 9
Ability-to-Pay ....................................................................................................................... 9
Time Period ........................................................................................................................ 10
Vertical Equity .................................................................................................................... 10
Policy Options to Alleviate Regressivity.............................................................................. 11
Exclusions and Multiple Rates ...................................................................................... 11
Tax Credits ................................................................................................................... 12
Earmarking of VAT Revenues ....................................................................................... 12
Horizontal Equity................................................................................................................ 13
Neutrality.................................................................................................................................. 13
Inflation .................................................................................................................................... 14
Balance-of-Trade ...................................................................................................................... 15
National Saving ........................................................................................................................ 16
Administrative Costs................................................................................................................. 17
Compliance............................................................................................................................... 18
VAT Registration Thresholds..................................................................................................... 19
Time Required for VAT Implementation .................................................................................... 20
Intergovernmental Relations...................................................................................................... 20
Encroachment on a State Tax Source ................................................................................... 20
Joint Collection................................................................................................................... 21
Size of Government .................................................................................................................. 22
Conclusions .............................................................................................................................. 22

Tables
Table A-1. Credit-Invoice Method ............................................................................................. 24
Table A-2. Subtraction Method.................................................................................................. 24
Table B-1. OECD VAT Revenue Ratios, 1996-2000 .................................................................. 25
Table C-1. Data on General Consumption Taxes in OECD......................................................... 26
Congressional Research Service

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Table C-2. VAT/GST Rates in OECD Member Countries........................................................... 27
Table C-3. Annual Turnover Concessions for VAT/GST Registration and Collection 2010 ......... 30
Table D-1. Standard VAT Rates by Country ............................................................................... 33

Appendixes
Appendix A. Credit-Invoice, Subtraction, and Addition Methods............................................... 24
Appendix B. VAT Revenue Ratios in OECD.............................................................................. 25
Appendix C. General Consumption Taxes in OECD Countries .................................................. 26
Appendix D. VAT Rates by Country .......................................................................................... 33

Contacts
Author Contact Information ...................................................................................................... 37

Congressional Research Service

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Introduction
A value-added tax (VAT) is a broad-based consumption tax. During the 111th Congress, proposals
to levy some form of a value-added tax (VAT) were debated. Bills were introduced to replace the
U.S. income tax system with a flat tax, a modified VAT.1 Before the passage of the Patient
Protection and Affordable Care Act, a bill was introduced to levy a VAT to finance national health
insurance.2
Long-term fiscal problems, which were exacerbated by the recession that ended in June 2009,
resulted in widespread concern about the need to formulate a fiscal solution to the high budget
deficits and growing national debt. The Congressional Budget Office (CBO) published reports
with extensive data documenting the severe long-term fiscal problems.3 Budget documents issued
by the Office of Management and Budget (OMB) also quantified the long-term fiscal difficulties.
Representatives of some think tanks, international organizations, and academic institutions
examined the VAT as part of a possible solution. The mass media also discussed the levying of a
VAT for deficit reduction.4
On June 11, 2009, Senator Jim DeMint introduced S. 1240, Roadmap for America’s Future Act of
2009, and on January 27, 2010, Representative Paul D. Ryan introduced H.R. 4529, Roadmap for
America’s Future Act of 2010. These similar bills were designed to be comprehensive plans to
address America’s long-term economic and fiscal problems. Both bills included a value-added tax
as a replacement for the corporate income tax.
On January 25, 2010, the Bipartisan Policy Center established a “Debt Reduction Task Force” led
by former Senate Budget Chairman Pete Domenici and former OMB and CBO Director Alice
Rivlin. The press release stated that “the Domenici-Rivlin Task Force will develop a
comprehensive, balanced, and politically-viable package of spending reductions and revenue
increases for expedited consideration by Congress and the Administration.”5
On February 18, 2010, President Barack Obama issued an executive order establishing the
National Commission on Fiscal Responsibility and Reform (the “Commission”). The executive
order stated that “no later than December 1, 2010, the Commission shall vote on the approval of a
final report.” President Obama selected the co-chairs of the Commission: Erskine B. Bowles,

1 The combined individual and business taxes proposed by the typical flat tax can be viewed as a modified value-added
tax (VAT). The individual wage tax would be imposed on wages (and salaries) and pension receipts. Part or all of an
individual’s wage and pension income would be tax-free, depending on marital status and number of dependents. The
business tax would be a modified subtraction-method VAT with wages (and salaries) and pension contributions
subtracted from the VAT base, in contrast to the usual VAT practice. For a comprehensive analysis of the flat tax, see
CRS Report 98-529, Flat Tax: An Overview of the Hall-Rabushka Proposal, by James M. Bickley.
2 On January 6, 2009, Representative John D. Dingell introduced H.R. 15, National Health Insurance Act, which would
have levied a VAT to finance national health insurance.
3 For example, see U.S. Congressional Budget Office, The Long-Term Budget Outlook, June 2010, 74 p.
4 For example, see Lori Montgomery, “Once Considered Unthinkable, U.S. Sales Tax Gets Fresh Look,” The
Washington Post, May 27, 2009, p. A15, and George F. Will, “Higher Taxes, Anyone?,” Sunday Opinion, The
Washington Post, July 12, 2009, p. A15, and more recently, Seth McLaughlin, “VAT Back as Proposal to Solve
Revenue Ills,” Washington Times, vol. 28, no 238, pp. A1, A9.
5 Bipartisan Policy Center, “Bipartisan Policy Center Launches Debt Reduction Task Force,” Press Release, January
25, 2010, p. 1.
Congressional Research Service
1

Should the United States Levy a Value-Added Tax for Deficit Reduction?

former President Bill Clinton’s chief of staff, and former U.S. Senator Alan K. Simpson. Alice
Rivlin and Representative Paul Ryan were also selected as members of the Commission.
On Tuesday, April 6, 2010, Paul Volcker, economic adviser to President Obama, reportedly said
that
a VAT was not as toxic an idea as it has been, and that both a VAT and some kind of tax on
energy need to be on the table. If at the end of the day we need to raise taxes, we should raise
taxes.6
In reaction to Volcker’s comments, three nonbinding resolutions were introduced by Republican
Members of the House of Representatives that expressed opposition to the imposition of a value-
added tax. Furthermore, Senator John McCain introduced S.Amdt. 3724 to H.R. 4851, which
expressed the sense of the Senate that the value-added tax (VAT) is “a massive tax increase that
will cripple families on fixed income and only further push back America’s economic recovery;
and the Senate opposes a value-added tax.” This amendment passed by a vote of 85 to 13 and is
Section 11 in P.L. 111-157, Continuing Extension Act of 2010.
On May 20, 2010, 154 Members of the House sent a letter to the National Commission on Fiscal
Responsibility and Reform.7 This letter stated the following:
we urge the Commission to focus on spending reductions, not tax increases. We must avoid
the mistake Europe made when it tried to pay for bigger government with new taxes—
namely the Value Added Tax (VAT).8
On November 10, 2010, the co-chairs of President Obama’s Fiscal Commission issued their
proposal.9 On December 1, 2010, the full Fiscal Commission issued its report, which was very
similar to the co-chairs’ proposal.10 On December 3, 2010, the members of the Commission cast
11 votes for and six votes against the report, which was not enough positive votes to approve the
report. Neither report recommended the levying of a value-added tax.
On November 17, 2010, the Bipartisan Policy Center’s Debt Reduction Task Force issued its final
report titled Restoring America’s Future. One of the recommendations was the levying of a value-
added tax, which it referred to as a “Debt Reduction Sales Tax” or DRST.11 The DRST would be
set at a rate of 3% in 2012 and 6.5% from 2013 onward.12 Approximately 75% of personal
consumption expenditures would be subject to the DRST.13 The DRST would generate estimated
new revenue of $3.048 trillion from 2012-2020, $8.764 trillion from 2012-2030, and $17.333
trillion from 2012-2040.14

6 “Volcker on the VAT,” The Wall Street Journal, WSJ.com, April 8, 2010, p. 1.
7 Congressional letter to co-chairs of National Commission on Fiscal Responsibility and Reform, May 20, 2010, 12 p.
8 Ibid., p. 1.
9 National Commission on Fiscal Responsibility and Reform, Co-Chairs’ Proposal, November 2010, 50 p.
10 National Commission on Fiscal Responsibility and Reform, The Moment of Truth, December 2010, 64 p.
11 Bipartisan Policy Center’s Debt Reduction Task Force, Restoring America’s Future, November 17, 2010, pp. 40-43.
12 Ibid., p. 41.
13 Ibid., p. 42.
14 Ibid., p. 32.
Congressional Research Service
2

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Arguably, the primary reason for congressional interest in the VAT is its high potential revenue
yield.15 For 2011, the Urban-Brookings Tax Policy Center estimates that a 5% broad-based VAT
would yield $277.2 billion ($55.44 billion per 1%).16 This estimate assumes a 15% non-
compliance rate; a 25% revenue offset from lower income and payroll taxes; and a VAT base that
excludes education expenditures, rent, housing, and religious and charitable services.17 This
assumed tax base is more comprehensive than the actual VAT base in most developed nations.18
CBO estimated that a broad-based VAT as an add-on revenue source would yield $240 billion in
FY2014 ($48 billion per 1%).19
Because their value is difficult to measure, certain items—such as financial services, existing
housing services, primary and secondary education, and other services provided by
government agencies and non-profit organizations for a nominal or no fee—would be
excluded from the base. (Existing housing services encompass the monetary rents paid by
tenants and rents imputed to owners who reside in their own homes.)20
CBO would also exclude government-reimbursed expenditures for health care from the VAT
base.21
Other aspects of a VAT that often raise interest or concern include revenue performance,
international comparison of composition of taxes, VAT rates, equity, neutrality, inflation, balance-
of-trade, national saving, administrative costs, compliance, VAT registration thresholds, time
required for VAT implementation, intergovernmental relations, and size of government.
This report considers the experiences of the 29 nations with VATs in the 30-member Organization
for Economic Cooperation and Development (OECD), relevant to the feasibility and operation of
a possible U.S. VAT. Currently, the OECD consists of 22 European nations, Turkey, the United
States, Canada, Australia, New Zealand, Japan, Mexico, and South Korea. In order to examine
different aspects of a VAT, it is important to understand the concept of a value-added tax, the
different methods of calculating VATs, exemption, and zero-rating.
Concept of a Value-Added Tax
A value-added tax is a broad-based consumption tax, levied at each stage of production, on the
value added by each firm at that stage of production. The value added of a firm is the difference
between a firm’s sales and a firm’s purchases of inputs from other firms. In other words, a firm’s
value added is simply the amount of value a firm contributes to a good or service by applying its

15 The revenue for a VAT would vary depending on the tax base. For a discussion of this issue, see CRS Report
RS22720, Taxable Base of the Value-Added Tax, by James M. Bickley.
16 Urban-Brooking Tax Policy Center, “5 Percent Broad Based Value Added Tax (VAT) Impact on Tax Revenue
($ billions), 2010-19,” November 12, 2009, p. 1.
17 Ibid.
18 For further information, see CRS Report RS22720, Taxable Base of the Value-Added Tax, by James M. Bickley.
19 U.S. Congressional Budget Office, Reducing the Deficit: Spending and Revenue Options, March 2011, pp. 189-190.
20 Ibid., p. 189.
21 Ibid.
Congressional Research Service
3

Should the United States Levy a Value-Added Tax for Deficit Reduction?

factors of production (land, labor, capital, and entrepreneurial ability).22 Another method of
calculating a firm’s value added is to total the firm’s payments to its factors of production.
Methods of Calculating VAT
There are three alternative methods of calculating VAT: the credit-invoice method, the subtraction
method, and the addition method.23 Under the credit-invoice method, a firm would be required to
show VAT separately on all sales invoices.24 Each sale would be marked up by the amount of the
VAT. A sales invoice for a seller is a purchase invoice for a buyer. A firm would calculate the VAT
to be remitted to the government by a three-step process. First, the firm would aggregate VAT
shown on its sales invoices. Second, the firm would aggregate VAT shown on its purchase
invoices. Finally, aggregate VAT on purchase invoices would be subtracted from aggregate VAT
shown on sales invoices, and the difference remitted to the government.
Under the subtraction method, the firm calculates its value added by subtracting its cost of taxed
inputs from its sales. Next, the firm determines its VAT liability by multiplying its value added by
the VAT rate. Most flat tax proposals are modified subtraction method VATs. Under the addition
method, the firm calculates its value added by adding all payments for untaxed inputs (e.g., wages
and profits). Next, the firm multiplies its value added by the VAT rate to calculate VAT to be
remitted to the government.25
The credit-invoice method is used by 28 of 29 OECD nations with VATs. Tax economists differ in
their classifications of the Japanese VAT. Both the credit-invoice and the subtraction methods
have been discussed for the United States. The prevailing view of tax economists is that the
credit-invoice method is superior.26 This method requires registered firms to maintain detailed
records that are cross indexed with supporting documentation. A VAT shown on the sales invoice
of one firm is the same as the VAT shown on the purchase order of another firm. Hence, the
credit-invoice method allows tax auditors to cross check the records of firms. Also, each firm has
a vested interest in insuring that the VAT shown on its purchase orders is not understated so the
firm can receive full credit against VAT liability for VAT previously paid. Thus, the credit-invoice
method would seem to be easier to enforce. Also, the credit-invoice method is probably the only
feasible method if there are to be multiple tax rates.
Supporters of the subtraction method maintain that it would have low compliance costs because
all necessary data could be obtained from records kept by a firm for other purposes. The
subtraction method does not require invoices.27 Still, a firm would have to make calculations

22 These factors of production have specific meanings to an economist. Labor consists of all employees hired by the
firm. Land consists of all natural resources including raw land, water, and mineral wealth. Capital is anything used in
the production process that has been made by man. The entrepreneur is the decision maker who operates the firm.
23 Numerical examples of the credit-invoice method and the subtraction method of calculating VAT are shown in
Appendix A.
24 An exception is the final retail stage where policymakers have the option of including or excluding the VAT from the
retail sales slip.
25 No developed national uses the addition method; consequently, if receives no further discussion in this report.
26 For a comparison of the credit-invoice method and the subtraction method as a partial replacement VAT, see Itai
Grinberg, “Where Credit is Due: Advantages of the Credit-Invoice Method for a Partial Replacement VAT, presented
at the American Tax Policy Institute Conference, Washington, DC, February 18, 2009, 41 p.
27 Ibid., p. 9.
Congressional Research Service
4

Should the United States Levy a Value-Added Tax for Deficit Reduction?

based on these data. For example, deductible expenses would have to be separated from
nondeductible expenses, and some data expressed on an accrual basis would have to be converted
to a cash flow basis.
The credit-invoice method would have substantial compliance costs because the amount of VAT
would have to be shown on every sales invoice (and, conversely, on every purchase invoice). On
the plus side, however, the credit-invoice method would yield an additional data base to firms.
Some firms might find these additional data useful in decision making. For example, records of
purchase invoices and sales invoices may improve some firms’ control over their inventories.
Compliance costs of the credit-invoice method might be partially offset by the value of the VAT
data base to firms, but this value has never been quantified.
The credit-invoice method would have greater administrative costs than the subtraction method
because of its requirements for additional data, computations, and record-keeping. Although there
are data on the administrative costs of a VAT calculated by the credit-invoice method, empirical
data are not available on the subtraction method; consequently, a quantitative comparison of cost
currently is not feasible. The subtraction method would not work administratively if many goods
are exempt or if multiple tax rates are levied. As will be explained in a subsequent section on the
balance of trade, under the destination principle, a VAT using the credit-invoice method is border
adjustable, but a standard subtraction method VAT is origin based and thus not border adjustable.
Unless specified otherwise, this report will assume that the credit-invoice method is used.
Exemption Versus Zero-Rating
Two alternative special treatments of a product or a business are exemption and zero-rating.
Exemption
A VAT may exempt either a product or a business from taxation.28 An exempt business would not
collect VAT on its sales and would not receive credit for VAT paid on its purchases of inputs. An
exempt business would not register with tax authorities, and, consequently, would not be part of
the VAT system. Hence, an exempt business would not have the usual VAT compliance costs and
would not impose administrative costs on the government (except verification of its exemption).
An exempt business’s costs, however, include any tax paid on inputs, because it receives no credit
for previously paid taxes. A business might be exempt because it only produces an exempt
product. Also a business might be exempt because its total sales fell below some threshold. A
business that sells both exempt and non-exempt products would be required to allocate its tax
payments between the two kinds of sales.
Exemption breaks the VAT chain and, consequently, causes problems. First, if exemption occurs
as some intermediate stage, the value added prior to the exempt stage is effectively taxed more
than once; that is, cascading of the VAT occurs.29 Second, the exemption of inputs will induce

28 For a current examination of exemptions, see Walter Hellerstein and Harley Duncan, “VAT Exemptions: Principles
and Practice,” Tax Notes, August 30, 2010, pp. 989-999.
29 Liam Ebrill, Michael Keen, Jean-Paul Bodin, and Victoria Summers, The Modern VAT, International Monetary
Fund, Washington, DC, 2001, p. 85.
Congressional Research Service
5

Should the United States Levy a Value-Added Tax for Deficit Reduction?

producers to substitute away from those inputs; that is, input choices are distorted.30 Third,
businesses have an incentive to self-supply rather than purchase an exempt input.31 Fourth,
exemptions may create pressures for additional exemptions.32 For example, in some countries, the
exemption of basic foodstuffs has created pressure for the exemption of agricultural inputs.33
Some goods and services are usually exempt because they are difficult to tax.34 Other products are
exempt on equity grounds. Products and services that are usually exempt are in the following
categories: free public sector services, education, health, financial services, and real estate.35 Free
public services are usually exempt because “it is hard to tax output that is given away.”36 The
standard practice is “to exempt basic education services, and to tax ... more specialist training
provided on a commercial basis.”37 Usually basic health services are exempted including
professional services of registered doctors and dentists and the supply of prescription drugs.38
Financial services are usually exempt because “it is difficult to distinguish between the provisions
of a service (consumption) and return on investment.”39 “The United Kingdom estimated the
exemption of financial services and insurance reduced net VAT revenues collected by
approximately 5 percent for 2006.”40
Many real estate services are self-supplied and have no observable market value.41 For example,
services enjoyed from owner occupation are exempt for VAT. “To avoid distorting the choice
between house ownership and renting, the commercial leasing of residential property is
commonly also exempt.”42
Zero-Rating
A business or product could be zero-rated. A zero-rated business would not collect VAT on its
sales but would receive credit for VAT paid on its inputs. This is equivalent to the business being
charged a zero tax rate. A zero-rated business would be a registered taxpayer and, consequently,
would involve the usual compliance and administrative costs. A zero-rated business, however,
would receive a refund of any VAT paid on its inputs; therefore, its costs would not include VAT
paid at earlier stages. The producer of a zero-rate product would neither pay VAT on the inputs
used to produce that product nor charge VAT on the sale of that product.

30 Ibid., p. 86.
31 Ibid., pp. 86-87.
32 Ibid., p. 89.
33 Ibid.
34 Ibid.
35 Ibid., pp. 91-99.
36 Ibid., p. 92
37 Ibid., p. 93.
38 Ibid., p. 94.
39 U.S. Government Accountability Office, Value-Added Taxes: Lessons Learned from Other Countries on Compliance
Risks, Administrative Costs, Compliance Burden, and Transition, Report no. GAO-08-566, pp. 23-24.
40 Ibid., p. 24.
41 Ebrill et al., p. 98.
42 Ibid.
Congressional Research Service
6

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Revenue Yield
In estimating a VAT’s revenue yield, economists and public officials use the operating assumption
that a VAT would be fully shifted to final consumers in the form of higher prices of goods. A VAT
(or any other major tax increase) would have a contractionary effect on the economy unless offset
by other economic policies. Consequently, a revenue estimate is generally made under the
assumption that the Federal Reserve would use an expansionary monetary policy to neutralize the
contractionary effects of a VAT. Also, a revenue estimate does not take into account the possible
shifts in consumption patterns that might be expected if some items are taxed and others are
excluded from taxation.
There are three primary justifications for excluding (zero-rating or exempting) specific items
from taxation under a VAT.43 First, the VAT would be difficult to collect because sellers of some
types of goods and services could easily avoid reporting their sales. For example, VAT would be
difficult to collect on expenditures for domestic services and expenditures abroad by U.S.
residents. Second, some goods are excluded on equity grounds, since these goods claim
disproportionately large percentages of the incomes of lower-income families. (Data on spending
patterns do not, however, suggest that exclusions can have a very powerful effect on the
distribution of a VAT.)44 Third, some goods may be excluded because they are merit goods, that is
“goods the provision of which society (as distinct from the preferences of the individual
consumer) wishes to encourage.”45 Some items may be justified for exclusion for more than one
reason.
Revenue Performance
Countries’ VATs have different exemptions, zero-rated products, thresholds, single rates or
multiple rates, levels of compliance, and degrees of administrative efficiency. In order to measure
different countries’ revenue “efficiency,” the OECD developed a tool called the VAT Revenue
Ratio (VRR). “The VAT Revenue Ratio” is defined as the ratio between the actual VAT revenue
collected and the revenue that would theoretically be raised if VAT was applied at the standard
rate to all final consumption.46 This is shown by the following formula:
VAT Revenue Ratio = (VAT revenue)/([consumption – VAT revenue] x standard VAT rate)47
Appendix B shows VAT revenue ratios of the 29 OECD countries with VATs. The VRR is not a
precise measure of revenue performance. For example, cascading from exempting a product and
levying the VAT on investment goods could raise the VRR to over 1.0.48 Nevertheless, the VRR is

43 This classification of justifications for exclusion from VAT taxation was derived from the following source: Alan A.
Tait, Value-Added Tax: International Practice and Problems (Washington, International Monetary Fund, 1988), p. 56.
44 Congressional Budget Office, Effects of Adopting a Value-Added Tax (Washington: GPO, February 1992), pp. 22-26.
45 Richard A. Musgrave and Peggy B. Musgrave, Public Finance in Theory and Practice. 4th ed. (New York: McGraw-
Hill, 1984), p. 78.
46 OECD, Consumption Tax Trends 2008: VAT/GST and Excise Rates, Trends and Administrative Issues, (Paris: OECD
Publishing, 2008), p. 67.
47 Ibid.
48 Ibid.
Congressional Research Service
7

Should the United States Levy a Value-Added Tax for Deficit Reduction?

generally considered to be a useful indicator of revenue performance. In 2005, 22 of the 29
OECD had VRR between 0.46 and 0.68. The unweighted average VRR was 0.58. The lowest
VRR was 0.33 for Mexico, and the highest VRR was 1.05 for New Zealand. From 1996 through
2005, the VRR rose for 21 countries, was constant for three countries, and declined for five
countries.
International Comparison of Composition of Taxes
One argument frequently made for a U.S. VAT is the relatively heavy reliance on consumption
taxes by other developed countries. For 2007, for taxes on general consumption (e.g., VATs and
sales taxes), the United States (federal, state, and local governments) had a lower reliance (7.7%)
of total tax revenues than any other OECD nation.49 Also for 2007, the United States’ (federal,
state, and local governments) general consumption taxes as a percentage of gross domestic
product (2.2%) were lower than any other nation in the OECD.50
This lower reliance on consumption taxes may result from all other developed nations having a
VAT at the national level. A VAT is a requirement for membership in the European Union (EU).51
Sweden, Norway, Iceland, and Switzerland had retail sales taxes at the national level but
eventually switched to a VAT.52 According to the OECD,
The spread of Value Added Tax (also called Goods and Services Tax—GST) has been the
most important development in taxation over the last half-century. Limited to less than 10
countries in the late 1960s it has now been implemented by about 136 countries; and in these
countries (including OECD member countries) it typically accounts for one-fifth of total tax
revenue. The recognized capacity of VAT to raise revenue in a neutral and transparent
manner drew all OECD member countries (except the United States) to adopt this broad
based consumption tax.53
Currently, approximately 150 countries have VATs.
Policy insights can be obtained by examining the experiences of other nations; however, simply
because other nations have enacted a specific tax policy does not necessarily mean that it is
appropriate for the United States to adopt this policy. Economic analysis of optimal taxation
suggests that those choices depend on issues of efficiency, equity, and administrative and
compliance costs, and should be made in the context of the overall tax and spending structure.
These considerations may vary from one country to another.

49 OECD, Revenue Statistics: 1965-2008 (Paris: OECD Publishing, 2009), p. 89. For data by country, see Table C-1 in
Appendix C.
50 Ibid. For data by country, see Table C-1 in Appendix C.
51 Sijbren Cnossen, “VAT and RST: A Comparison,” Canadian Tax Journal, vol. 35, no. 3, May/June 1987, p. 583.
52 Cnossen, VAT and RST: A Comparison, p. 585 and OECD, Consumption Tax Trends (OECD, March 2005), p. 11.
53 OECD, International VAT/GST Guidelines (OECD, February 2006), p. 1.
Congressional Research Service
8

Should the United States Levy a Value-Added Tax for Deficit Reduction?

VAT Rates in Other Countries
As shown in Table C-2, VAT rates vary substantially among the 29 countries with VATs in the
OECD and Chile, which will become the 31st member of the OECD in 2011. Japan and Canada
have the lowest rate of 5%. Iceland has the highest rate of 25.5%, and four nations have a 25%
rate. The unweighted average of standard VAT rates has risen from 16.0% in 1976 to 18.0% in
2010. This high average rate is one reason for the robust revenue yield of VATs. Most countries
have reduced VAT rates on certain goods and services.
For 2009, Table D-1 lists the standard VAT rate and the year of VAT introduction for 145
countries. Approximately two-thirds of these countries introduced their VATS in 1990 or later.54
Countries without VATs include the United States, the nations in the Gulf Cooperation Council,
and nations in portions of Africa.55 The Gulf Cooperation Council consists of Bahrain, Kuwait,
Oman, Qatar, Saudi Arabia, and the United Arab Emirates.56 The IMF (International Monetary
Fund) has contributed to the global expansion of the VAT through general tax advice and
normally requiring a country to implement a VAT in order to receive an IMF loan.57
Equity
A major topic concerning any proposed tax or tax change is the distribution or equity of the tax
among households. There are two types of equity: vertical and horizontal. Vertical equity
concerns the tax treatment of households with different abilities-to-pay. Horizontal equity
concerns the degree to which households with the same ability-to-pay are taxed equally. Both
vertical and horizontal equity may be affected by the measure of ability-to-pay and the tax period.
Ability-to-Pay
The most common measure of ability-to-pay is income.58 Proponents of income as a measure of
ability-to-pay argue that saving yields utility by providing households with greater economic
security. Federal data are more readily available on different measures of income than different
levels of consumption. For example, the federal government reports levels of disposable income,
which equals consumption plus saving. Thus, tax economists can more easily calculate tax
incidence if income instead of consumption is the measure of ability-to-pay.
Some arguments for the consumption tax base suggest that personal consumption is the best
measure of ability-to-pay because consumption is the actual taking of scarce resources from the
economic system. Some economists argue that consumption may be a better proxy for permanent
income than is current income (see discussion below).

54 Leah Durner, Bobby Bui, and Jon Sedon, “Why VAT Around the Globe?,” Tax Notes, November 23, 2009, p. 929.
55 Ibid.
56 Ibid.
57 Ibid., p. 930.
58 For an overview of the incidence of the VAT using income as a measure of ability-to-pay, see U.S. Congressional
Budget Office, Effects of Adopting a Value-Added Tax (Washington: February 1992), pp. 31-47.
Congressional Research Service
9

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Time Period
Tax incidence usually is measured by using a one-year period. Data on consumption and income
are readily available in one-year increments and the concept of a one-year period is easily
understood. But many economists believe tax incidence is more accurately determined by
measuring consumption and income over a household’s lifetime. Lifetime income and
consumption are affected by the life cycle concept and transitional components of income.
According to this life cycle concept, a household makes current consumption decisions based on
its expected future flow of income, averaging its consumption over its lifetime.
For example, a common life cycle is low income in the household’s early years, high income in
the household’s middle years, and low income in the household’s retirement years. A young
household may save a small percentage of its income in order to acquire consumer durables. In its
middle years, this household may save a high percentage of its income while its income is
highest. Finally, during its retirement years, this household may save a small percentage of its
income in order to maintain its consumption level. Thus, annual consumption tends to be more
stable than annual income over the household’s life cycle.
Although many economists prefer the concept of lifetime income, federal data are not collected
on a lifetime basis. Consequently, economists have developed life-cycle models in an attempt to
measure equity, but the distributional results from these models are subject to widespread debate.
Vertical Equity59
If disposable income over a one-year period is the measure of ability-to-pay, then a VAT would be
viewed as extremely regressive; that is, the percentage of disposable income paid in VAT would
decrease rapidly as disposable income increases. In most discussions of tax policy, both a one-
year period and annual disposable income (or some other annual income measure) are used;
consequently, the VAT is viewed as being extremely regressive. For example, CBO calculated the
annual incidence of a 3.5% broad-based VAT for 1992. CBO found that all families would have
paid 2.2% of their income in VAT. The burden on family income was 4.8% on the lowest quintile,
3.2% on the second quintile, 2.8% on the middle quintile, 2.3% on the fourth quintile, and 1.5%
on the highest quintile.60
If disposable income over a lifetime is the measure of ability-to-pay, a VAT would be mildly
regressive. For lower- and middle-income households, it appears that nearly all savings are
eventually consumed.61 Thus, it may be that for the vast majority of households, lifetime
consumption and lifetime income are approximately equal. High-income households tend to have
net savings over their lifetimes; consequently, they would pay a lower proportion of their

59 For a comprehensive analysis of the vertical equity of a VAT, see Erik Caspersen and Gilbert Metcalf, “Is a Value-
Added Tax Progressive? Annual Versus Lifetime Incidence Measures,” National Tax Journal, vol. 47, no. 4, December
1994, pp. 731-746; and U.S. Congressional Budget Office, Effects of Adopting a Value-Added Tax, pp. 31-47.
60 U.S. Congressional Budget Office, Effects of Adopting a Value-Added Tax, p. 35.
61 Franco Modigliani, a Nobel Laureate in economics, estimated that at least 80% of all savings by households are
eventually spent on consumption. See Franco Modigliani, “The Role of Intergenerational Transfer and Life Cycle
Saving in the Accumulation of Wealth,” Journal of Economic Perspectives, vol. 2, no. 2, spring 1988, pp. 15-23.
Congressional Research Service
10

Should the United States Levy a Value-Added Tax for Deficit Reduction?

disposable incomes in VAT than would lower-income groups. But these highly stylized life-cycle
models are controversial.62
If consumption is used as a measure of ability-to-pay, a single-rate VAT with a broad base would
be approximately proportional regardless of the time period. In other words, the percentage of
consumption paid in VAT by households would be approximately constant as the level of
household consumption rises.
Another equity issue concerns the burden of a VAT on different age groups. If older individuals
on the average consume more out of savings than younger individuals, then a VAT would fall
more heavily on the old than the young. Most of the elderly are covered by Social Security, which
is indexed for changes in the cost-of-living. Thus most of the elderly poor would be largely
protected from a rise in the price level due to the levying of a VAT.
Policy Options to Alleviate Regressivity
Some supporters of progressive taxation oppose the VAT primarily because they believe that it is
regressive. No mechanism is likely to introduce progressivity at higher income levels. But
critics are especially concerned about the absolute burden of a VAT on low-income households.
The degree of regressivity on lower-income households, however, can be reduced by
government policy. Three often-mentioned policies are exclusions and multiple rates, income
tax credits, and earmarking of some revenues for increased social spending (including indexed
transfer payments).
Exclusions and Multiple Rates
The incidence of the VAT depends on its tax base; therefore, the regressivity of the VAT can be
reduced or eliminated by excluding (zero-rating or exempting) those goods that account for a
disproportionately high percentage of the incomes of lower-income households. The exclusion of
many necessities on equity grounds from retail sales taxes has been politically popular at the state
level. All members of the European Union (EU) exclude some goods from VAT on equity
grounds. Also, most EU nations have multiple tax rates on equity grounds. Reduced rates are
applied to necessities and premium rates are levied on luxuries.
Despite the existing policies in the EU, most tax economists oppose exclusions and multiple rates
to reduce regressivity for three reasons. First, the administrative costs, compliance costs, and
neutrality costs are substantial.63 If a VAT is to raise a given amount of revenue, then revenue lost
from excluding goods must be offset by higher VAT rates. These higher rates increase the
distortion in relative prices, and consequently, reduce the neutrality of the tax system. Second, the

62 For examples of life-cycle models, see Don Fullerton and Diane Lim Rogers, “Lifetime Effects of Fundamental Tax
Reform,” in Economic Effects of Fundamental Tax Reform, Henry J. Aaron and William G. Gale, eds. (Washington:
Brookings Institution Press, 1996), pp 321-352; and David Altig, Alan J. Auerbach, Laurence J. Kotlikoff, Kent A.
Smetters, and Jan Walliser, “Stimulating Fundamental Tax Reform in the United States,” The American Economic
Review, vol. 91, no. 3, June 2001, pp. 574-595. For an overview of the literature on life-cycle models, see Marin
Browning and Thomas F. Crossley, “The Life-Cycle Model of Consumption and Savings,” Journal of Economic
Perspectives, vol. 15, no. 3, Summer 2001, pp. 3-22.
63 For an examination of increased administrative and compliance costs resulting from exclusions and multiple rates,
see Liam Ebrill et al., pp.78-79.
Congressional Research Service
11

Should the United States Levy a Value-Added Tax for Deficit Reduction?

possible reduction in regressivity from exclusion and multiple rates is declining because
consumption patterns for different income levels are becoming more similar.64 Third, for a one-
year time period, the reduction in regressivity is limited, particularly for low-income households.
Money saved for exclusions is largely offset by higher tax rates (needed for revenue neutrality) on
taxed goods.65
Tax Credits
The federal government could allow either a flat tax credit or a credit that diminishes as income
rises, in order to overcome the regressivity of a VAT. This credit method could be operated in two
ways. First, an individual could apply the credit against his federal income tax liability, thus
lowering his liability on a dollar-for-dollar basis. If the tax credit exceeded the individual’s tax
liability, he could apply for a refund of the excess credit. A taxpayer already due a tax refund
could increase the size of his refund by the amount of the tax credit. A household not subject to
income taxation could apply for a tax refund equal to the credit. An income tax credit that
declines as income increases could reduce regressivity more sharply than a flat income tax credit.
Second, a stand-alone credit system could be established which would not require an eligible
household to file an income tax return in order to obtain a refund for VAT paid. An eligible
household would have to submit a simple form in order to receive a refund. A stand-alone credit
system may be more effective than the income tax credit in encouraging low-income households
to file for a refund, but administrative and compliance costs would be higher.
But a federal credit system would incur some administrative costs, which would increase the total
administrative costs of a VAT. Furthermore, households incur implicit taxes if their credits are
phased out (or income tested transfers reduced).
At the federal level, studies have concluded that the refundable earned-income tax credit (EITC)
has had “a significant positive impact on participation in the labor force.”66 But compliance with
EITC provisions has been an ongoing issue.67
Earmarking of VAT Revenues
A third option to reduce or eliminate regressivity is to earmark some of the revenue from a VAT to
finance an increase in income tested transfers. Henry J. Aaron estimated that an increase in
benefits of approximately $5 billion for a VAT yielding $100 billion could fully protect low-
income families from paying the VAT.68
For example, a 10 percent increase in food stamp entitlements would approximately offset
the effect on households eligible for the full food stamp allotment of a VAT that raised $100
billion in revenue. This estimate is based on the fact that $100 billion will be approximately

64 Tait, p. 218.
65 Edith Brashares, Janet Furman Speyrer, and George N. Carlson, “Distributional Aspects of a Federal Value-Added
Tax,” National Tax Journal, vol. 41, no. 2, June 1988, p. 165.
66 CRS Report RL31768, The Earned Income Tax Credit (EITC): An Overview, by Christine Scott, pp. 14-15.
67 Ibid., pp 16-17.
68 Henry J. Aaron, “The Political Economy of a Value-Added Tax in the United States,” Tax Notes, vol. 38, no. 10,
March 7, 1988, p. 1,113.
Congressional Research Service
12

Should the United States Levy a Value-Added Tax for Deficit Reduction?

three percent of consumption in 1989 and that food is estimated to absorb about 30 percent
of the budget in estimates of poverty thresholds.69
Many households with low taxable incomes do not currently receive transfers and would not be
protected by Aaron’s proposal.
Before the passage of the Patient Protection and Affordable Care Act, Leonard E. Burman
proposed that a VAT be levied with the revenue dedicated to paying for a new universal health
insurance voucher. “The health care voucher would offset the inherent regressivity of a VAT,
since the voucher would be worth more than the VAT tax paid by most households.”70
Horizontal Equity
If disposable income is the measure of ability-to-pay, the horizontal equity of a VAT would
depend on the time period. For a one-year period, a VAT would be very inequitable because
households with the same level of disposable income would have widely differing levels of
consumption and, consequently, payments of VAT.
For a lifetime period, the VAT would have a high degree of horizontal equity. For low- and
middle-income households, almost all income is consumed over these households’ lifetimes;
consequently, households with the same lifetime incomes would have the same levels of
consumption and the same VAT payments.71 Over their lifetimes, high-income households with
equal incomes differ in their levels of consumption and, consequently, VAT payments. For
example, assume that two households have $10 million in lifetime income, but the first household
spends $4.5 million on consumption and the second household spends $9 million on
consumption. The second household would pay twice as much in VAT as the first household.
Thus, for a lifetime period, the VAT is not horizontally equitable for high-income households.
Neutrality
In public finance, the more neutral a tax is, the less the tax affects private economic decisions
and, consequently, the more efficiently the economy operates. Conceptually, a VAT on all
consumption expenditures, with a single rate that is constant over time, would be relatively
neutral compared to other major revenue sources.
For households, two out of three major decisions would not be altered by this hypothetical VAT.
First, this VAT would not alter choices among goods because all would be taxed at the same rate.
Thus, relative prices would not change. In contrast, other taxes, such as excise taxes, which
change relative prices, would distort household consumer choices by encouraging the substitution
of untaxed goods for taxed goods. But a hypothetical income tax on all income would be neutral
in this respect.

69 Ibid.
70 Leonard E. Burman, “A Blue print for Tax Reform and Health Reform,” Urban Institute, p. 1. Available at
http://www.urban.org, January 6, 2011.
71 Henry J. Aaron, “The Value-Added Tax: Sorting Through the Practical and Political Problems,” The Brookings
Review, summer 1988, p. 13.
Congressional Research Service
13

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Second, a VAT does not affect the relative prices of present and future consumption. In contrast,
the individual income tax affects the relative prices of present and future consumption because
the income tax is levied on income which is saved, and then the returns on saving are taxed.
A household’s work-leisure decision, however, would be affected by a VAT or any other tax on
either consumption or income.72 Since leisure would not be taxed, any tax increase would fall on
the returns to work.
A VAT would have conflicting effects on the number of hours worked by each household. A
household would have an incentive to substitute leisure for work because of the relative rise in the
value of leisure to work (substitution effect). Conversely, a household would have an incentive to
increase its hours worked in an attempt to maintain its current living standards (income effect).
Thus, a VAT could decrease, increase, or not change a household’s hours worked.
For a firm, the VAT would not affect decisions concerning method of financing (debt or equity),
choice among inputs (unless some suppliers are exempt or zero-rated), type of business
organization (corporation, partnership, or sole proprietorship), goods to produce, or domestic
versus foreign investment. Other types of taxes may affect one or more of these types of
decisions.
But a VAT cannot be levied on all consumer goods; consequently, prices of taxed goods will rise
relative to untaxed goods. Furthermore, most nations with VATs have more than one rate.
Multiple VAT rates alter relative prices of taxed goods. Finally, VAT rates in most nations have
tended to rise over time. Despite these deviations from a pure form of VAT, a broad-based VAT is
relatively neutral compared to most other taxes. This neutrality is greater if the tax rate is
relatively low. But the relative neutrality of a VAT compared to an increase in the personal
income tax is uncertain.73
Inflation
If the Federal Reserve implemented an expansionary monetary policy to offset the contractionary
effects of a VAT, then there would be a one-time increase in the price level. For example, an
expansionary monetary policy to accommodate a 5% VAT on 60% of consumer outlays might
directly cause an estimated one-time increase in consumer prices of approximately 3%. There
would also be some secondary price effects. Some goods would rise in price because their factors
of production, especially labor, are linked to price indexes. Yet, if the Federal Reserve disregarded
these secondary price increases in formulating monetary policy, these secondary price increases
would tend to be offset by price reductions in other sectors of the economy.
An examination of VATs in the OECD has found only an initial effect of a VAT on the price level.
But it is difficult to empirically isolate the effect of a VAT from other possible causes of a change
in the price level.

72 In economics, leisure is any time spent not working.
73 See U.S. Congressional Budget Office, Effects of Adopting a Value-Added Tax, pp. 56-60; and Jane G. Gravelle,
“Income, Consumption, and Wage Taxation in a Life-Cycle Model: Separating Efficiency from Redistribution,”
American Economic Review, vol. 81, no. 4, September 1991, pp. 985-995.
Congressional Research Service
14

Should the United States Levy a Value-Added Tax for Deficit Reduction?

It has been suggested that the federal government exclude the VAT from price indexes. Hence,
existing indexing would not have an inflationary effect.74 But such an approach might prove
unpopular and it might be contested in court.
In summary, the proper monetary accommodation for a VAT would probably cause a one-time
increase in the price level but not affect the subsequent rate of inflation (i.e., cause continual
increases in the general price level).
Balance-of-Trade
Currently, all nations with VATs zero-rate exports and impose their VATs on imports. This
procedure for taxing trade flows is referred to as the destination principle because a commodity is
taxed at the location of consumption rather than production. An alternative would be to apply the
origin principle that would levy a tax at the location of production. Thus, under the origin
principle, nations would levy their VATs on exports but not imports. All leading experts on the
VAT recommend that nations adopting a VAT use the destination principle, which would be
consistent with existing practices of other countries.
The destination principle creates a level playing field because imported commodities rise in price
by the percentage of the VAT, but exported commodities do not increase in price. For a particular
nation, the VAT rate on domestically produced and imported products would be the same. The
VAT rate on a particular good would still vary among nations.
A simple example demonstrates this concept of a level playing field. Assume nation A has a 10%
VAT and nation B has a 20% VAT. Exports from nation A to nation B would not be taxed by
nation A. But nation B would levy a 20% VAT on imports from nation A. Thus, consumers in
nation B would pay a 20% VAT regardless of whether their purchased goods were domestically
produced or imported. Furthermore, exports from nation B to nation A would not be taxed by
nation B. Nation A would levy a 10% VAT on imports. Hence, consumers in nation A would pay a
10% VAT on both domestically produced and imported commodities.
In 1962, the rules applicable to taxation were included in the General Agreement on Tariffs and
Trade (GATT). Under these GATT rules, indirect taxes were rebatable on exports but direct taxes
were not rebatable. Taxes which are not shifted but borne by the economic entity on which they
are levied are classified as direct taxes. From 1962 through 1972, a fixed exchange rate system
prevailed and the United States ran deficits in its balance-of-payments. U.S. officials complained
that the GATT rules favored nations with VATs because their exports were zero-rated. In contrast,
corporate income taxes were not rebated on exports.
In early 1973, the United States and its major trading partners formally shifted to a flexible
exchange rate system. Under this system, the supply and demand for different currencies
determine their relative value. If a country has a deficit in its balance-of-trade, this deficit must be
financed by a net importation of foreign capital. But net capital inflows cannot continue
indefinitely. Thus, over time, this country’s currency will tend to decline in value relative to the
currencies of other nations. Consequently, this country’s balance-of-trade deficit will eventually
decline as its exports rise and imports fall. Hence, economic theory indicated that a VAT offers no

74 Aaron, “The Political Economy of a Value-Added Tax in the United States,” p. 1,113.
Congressional Research Service
15

Should the United States Levy a Value-Added Tax for Deficit Reduction?

advantage over other major taxes in reducing a deficit in the balance-of-trade. Thus, U.S. officials
ended their complaints about the effects of GATT tax rules on international trade.
Since early 1973 there have been periods when exchange rates have been “managed” by mutual
agreement among governments. Central banks have coordinated purchases and sales of different
currencies in order to stabilize their relative values to promote international economic stability.
Even if there were a fixed exchange rate, a U.S. VAT would have slight impact on the balance-of-
trade because the proposed VAT rate of 5% or less is a low tax rate. During the last 25 years the
value of the dollar has fallen relative to an index of major currencies, yet a serious U.S. balance-
of-trade deficit persists. In summary, economic theory indicates that a U.S. VAT offers no major
advantage over other major tax increases in reducing the U.S. balance-of-trade deficit.
Any large U.S. tax increase, which reduces the federal deficit, could reduce the U.S. balance-of-
trade deficit. The U.S. Treasury would reduce its borrowing on financial markets, interest rates
would decline, and foreign capital would flow out of the United States. This capital outflow
would reduce the demand for dollars relative to other currencies. This decline in the value of
the dollar would raise exports, reduce imports, and, consequently, reduce the U.S. balance-of-
trade deficit.
As indicated previously, under the destination principle, a VAT using the credit-invoice method is
border adjustable. Exports are zero-rated and imports are taxed. A standard subtraction method
VAT is origin based and thus is not border adjustable.
Border adjusting a subtraction-method VAT may elicit a challenge under WTO [World
Trade Organization] rules. Under those rules (as originally developed under the General
Agreements on Tariffs and Trade (“GATT”), a border tax adjustment applied to a “direct”
tax is a prohibited trade subsidy. In contrast, WTO rules allow countries to border-adjust
“indirect taxes.” Further, WTO rules require that imported products be accorded treatment no
less favorable than like products of national origin. Lastly, WTO rules require that border
adjustments for indirect taxes not exceed the tax levied on similar products sold in the
domestic market. A subtraction-method VAT might be challenged as a direct tax under WTO
rules.75
National Saving
National saving consists of government saving, business saving, and personal saving.76 A VAT or
any other tax that reduces the budget deficit would be expected to reduce government dissaving,
and, consequently, raise national saving.
A second issue concerns the effect on the personal savings rate of levying a VAT compared to
increasing income taxes. A VAT would tax savings when they are spent on consumption, allowing
savings to compound at a pre-tax rate. But an income tax is levied on all income at the time it is
earned, regardless of whether the income is consumed or saved. The income tax is also levied on

75 Ibid., p. 32.
76 For an analysis of the U.S. savings rate, see CRS Report RS21480, Saving Rates in the United States: Calculation
and Comparison, by Craig K. Elwell. For an analysis of saving Incentives, see CRS Report RL 33482, Saving
Incentives: What May Work, What May Not, by Thomas L. Hungerford.
Congressional Research Service
16

Should the United States Levy a Value-Added Tax for Deficit Reduction?

the earnings from income saved. Consequently, some proponents of the VAT have argued that
choosing a VAT, rather than an income tax, to raise revenue would increase the return from saving
and, consequently, raise the savings rate.
The rate of return on savings, however, has never been shown to have a significant effect on the
savings rate because of two conflicting effects. First, each dollar saved today results in the
possibility of a higher amount of consumption in the future. This relative increase in the return
from saving causes a household to want to substitute saving for consumption out of current
income (substitution effect).
But a higher rate of return on savings raises a household’s income; consequently, the household
has to save less to accumulate some target amount of savings in the future (income effect).
Thus, this income effect encourages households to have higher current consumption and lower
current saving.
A CRS study compared the long-run effects on the capital stock and consumption of a $60 billion
VAT and a $60 billion increase in individual income taxes. This study’s results suggest that
selecting a VAT instead of an increase in individual income taxes would raise the capital stock by
less than 2% and consumption by only a quarter to a third of a percent after 50 years.77
An empirical study by the Congressional Budget Office analyzed the economic effects of
replacing a quarter of the current income tax with a 6% VAT on all consumption. CBO estimated
that this tax substitution would, in the long-run, increase the saving rate by 0.5%, raise the
capital stock by 7.9%, increase output by 1.5%, and raise consumption by 1.2%.78 These CBO
findings of only slight economic effects in the long-run are consistent with the estimates of the
CRS study.
Administrative Costs
A value-added tax would require the expansion of the Internal Revenue Service. But the high
revenue yield from a VAT could cause administrative costs to be low measured as a percentage of
revenue yield. The administrative expense per dollar of VAT collected would vary with the degree
of complexity of the VAT, the amount of revenue raised, the national attitude towards tax
compliance, and the level of the small business exemption.
For tax year 1995, the Government Accountability Office (GAO) estimated the cost of
administering a U.S. VAT at $1.221 billion if the VAT had a single rate, a broad base, and an
exemption for businesses with gross receipts of less than $100,000.79 For tax year 1995, Professor
Sijbren Cnossen estimated that the overall administrative cost of a hypothetical single rate U.S.
VAT at $1 billion.80 He assumed that “the administration of the VAT would be fully integrated
with the administration of the federal income taxes.”81

77 CRS Report 88-697 S, Economic Effects of a Value-Added Tax on Capital Formation, by Jane G. Gravelle, p. 2.
(Archived report; available on request).
78 CBO, Effects of Adopting a Value-Added Tax, pp. 52-53.
79 U.S. General Accounting Office, Value-Added Tax: Administrative Costs Vary with Complexity and Number of
Businesses, Washington, May 1993, p. 63.
80 Sijbren Cnossen, “Administrative and Compliance Costs of the VAT: A Review of the Evidence,” Tax Notes,
(continued...)
Congressional Research Service
17

Should the United States Levy a Value-Added Tax for Deficit Reduction?

In 2008, GAO examined the administrative costs of a VAT. GAO stated that “according to
European Commission officials, VATS in Europe cost between 0.5 percent and 1 percent of VAT
revenue collected to administer.”82
Compliance
Although considerable research has been conducted over the past 15 years on income tax
compliance, research on VAT compliance has been limited.83 For tax year 1995, Professor Sijbren
Cnossen estimates the compliance costs of a single rate U.S. VAT would equal approximately $5
billion.84 He emphasizes that compliance costs “can be reduced by broadening the base of the
VAT, imposing a single rate, and increasing the threshold for registration.”85 Agha and Haughton
summarized estimates of VAT evasion for five European countries.86 These five countries and
their percentage of revenue lost through evasion were Belgium (8%), France (3%), Italy (40%),
Netherlands (6%), and United Kingdom (2%-4%).87 In comparison to other broad-based
consumption taxes such as the retail sales tax, a VAT has produced relatively good compliance for
four reasons.
First, a VAT collected using the credit-invoice method offers the opportunity to cross-check
returns and invoices. For example, VAT shown on a sales invoice of a wholesaler will appear on
the purchase invoice of a retailer. A tax auditor can examine both invoices to cross-check the
accuracy of the tax returns of both the wholesaler and the retailer.
Second, each firm has an incentive not to allow suppliers to understate VAT on their sales
invoices. A firm is able to credit VAT paid on inputs against VAT collected on sales; consequently,
a firm’s net VAT liability will increase if VAT shown on its purchase invoices was understated
by suppliers.
Third, tax auditors can compare information about a VAT with information about business income
taxation, which will increase compliance with both types of taxes. For example, the sales revenue
figure reported on business income tax forms may be checked for consistency with gross VAT
collected as shown on VAT forms. Also, a check of cash receipts during a VAT audit may identify
the under reporting of sales. Firms may attempt not only to evade the VAT but also to evade the
business income tax.88

(...continued)
vol. 62, no. 12, June 20, 1994, p. 1,610.
81 Ibid.
82 U.S. Government Accountability Office, Value-Added Taxes: Lessons Learned from Other Countries on Compliance
Risks, Administrative Costs, Compliance Burden, and Transition. pp. 15-16.
83 For a current examination of VAT compliance from the approach of behavior economics, see Paul Webley, Caroline
Adams, and Henk Elffers, “Value Added Tax Compliance,” in Behavioral Public Finance, eds. Edward J. McCaffery
and Joel Slemrod (New York: Russell Sage Foundation, 2006), pp. 175-205.
84 Sijbren Cnossen, “Administrative and Compliance Costs of the VAT: A Review of the Evidence,” p. 1,609.
85 Ibid., p. 1,615.
86 Ali Agha and Jonathan Haughton, “Designing VAT Systems: Some Efficiency Considerations,” Review of
Economics and Statistics, vol. 78, no. 2, May 1996, pp. 304-305.
87 Ibid., p. 305.
88 Organization of Economic Co-Operation and Development, Taxing Consumption, pp. 199-200.
Congressional Research Service
18

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Fourth, some firms legally required to remit VAT may not register. But these firms receive no
credit for VAT paid on inputs. Hence, these firms are only partially able to evade the VAT because
of the compliance with the VAT by suppliers.
Although compliance with a VAT is higher than other broad-based consumption taxes, the level of
noncompliance is significant. As previously discussed, some firms legally required to remit VAT
may not register.
Furthermore, firms may evade VAT by altering or omitting information as indicated in the
following 10 major types of evasion. First, a registered firm may not record resales of goods
purchased from unregistered suppliers. Second, a seller of both exempt and taxable goods may
divert purchased inputs on which VAT is claimed against taxed sales to help produce and sell
exempt goods. Third, a firm may claim credit for purchases that are not creditable. For example, a
firm’s owner may claim credit for VAT paid on an automobile but then use it for nonbusiness
purposes. Fourth, a firm may illegally import goods, charge VAT on their sale, but not report this
VAT. Fifth, a firm may simply under-report sales, which is the most common type of evasion.
Retailers are the most frequent users of this type of evasion. Sixth, a firm may collect VAT on
sales and then disappear. This type of evasion is particularly common to small firms in the
construction industry. Seventh, in those nations with multiple rates, a firm may illegally reclassify
goods into categories with lower tax rates. Eighth, the owners of some small firms, particularly
retailers, may consume part of their firms’ production but not record their consumption. Ninth, a
firm may submit completely false export claims in order to obtain illegal VAT refunds. And tenth,
two firms may barter goods in order to evade the VAT.89
VAT Registration Thresholds
“Experience has taught, sometimes harshly, that a critical decision in designing a VAT is the
threshold level of firm size above which registration for the tax is compulsory.”90 The threshold
level is important in reducing administrative and compliance costs. “Most countries, but not all,
allow those below the VAT threshold to register voluntarily.”91 Thus a small business with gross
receipts below the threshold could decide whether or not to register and collect the VAT or to be
exempt. “Despite significant variation, a useful rule of thumb is that the largest 10 percent of all
firms commonly account for 90 percent or more of all turnover.”92 Many nations adopting VATs
have set threshold level below that recommended by the Fiscal Affairs Department of the
International Monetary Fund.93 Tax authorities must consider the tradeoff between lower
administrative and compliance costs versus reduced revenue and costs of distortions due to
differential treatment.94

89 For a detailed discussion of these 10 types of evasion, see Tait, pp. 308-314.
90 Ebrill et al., p. 113.
91 Ibid., p. 116.
92 Ibid., p. 117.
93 Ibid., p. 113.
94 Table C-3 has data on annual turnover concessions for VAT registration and collection, which includes registration
thresholds.
Congressional Research Service
19

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Time Required for VAT Implementation
Since a U.S. VAT would be a new tax, the time to implement a VAT is important. In a 2008 study,
GAO examined the time to implement VATs in three nations with relatively new VATs and
preexisting consumption tax administrative structures.
The amount of time tax administrations in Australia, Canada, and New Zealand had to
implement a VAT ranged from 15 to 24 months due to the varying circumstances leading up
to initial implementation in each of these countries. Australia and its states and territories
reached agreement on a VAT in April 1999, 15 months prior to the effective implementation
date of July 1, 2000. In Canada, much of the planning and early efforts to prepare for VAT
implementation occurred before legislation was actually passed. According to one Canadian
official involved in implementation, planning began nearly 2 years in advance, but Canadian
tax authorities had only 2 weeks between final passage of legislation and implementation.
However, because of delays in education activities, implementation was delayed an
additional 6 months.95
An IMF official formulated a “chronological schedule of work to be done to introduce a VAT in
about eighteen months.”96 This schedule lists actions required of tax officials on a month by
month basis.
Intergovernmental Relations
For the United States, a federal VAT raises two primary intergovernmental issues: the federal
encroachment of the state sales tax, and the joint collection of a VAT.97
Encroachment on a State Tax Source
It has been claimed that broad-based consumption taxation has traditionally been a state source of
revenue while income taxation has been a federal revenue source; consequently, a federal VAT
would encroach on a primary source of tax revenue for the states.98
Most states, however, adopted their individual income taxes before they adopted their general
sales taxes. Thirty-nine states levy both individual income taxes and general sales taxes. Twenty-
three of these states adopted their individual income taxes in an earlier year then they adopted
their general sales taxes. Three states adopted both taxes in the same year. Thirteen states adopted
their general sales taxes in an earlier year than they adopted their individual income taxes.99

95 U.S. Government Accountability Office, Value-Added Taxes: Lessons Learned from Other Countries on Compliance
Risks, Administrative Costs, Compliance Burden, and Transition, p. 41.
96 Tait, pp. 409-416.
97 For an overview of state tax officials’ concerns related to the enactment of a broad-based federal consumption tax,
see U.S. General Accounting Office, State Tax Officials Have Concerns About a Federal Consumption Tax,
Washington, March 1990, 77 p.
98 For an examination of this issue, see Robert P. Strauss, “Administrative and Revenue Implications of Federal
Consumption Taxes for the State and Local Sector,” State Tax Notes, vol. 16, March 15, 1999, pp. 831-868.
99 For data on the dates of adoption of major state taxes by state, see Facts and Figures on Government Finance,
Washington: Tax Foundation, 2010.
Congressional Research Service
20

Should the United States Levy a Value-Added Tax for Deficit Reduction?

No constitutional restriction prevents the federal government from levying a VAT. Precedents
exist for the federal government to levy a new tax that many states already levy. For example, the
federal government levied the personal income tax after many states had already imposed this tax.
Also, both the federal government and the states impose many of the same excise taxes.
The federal government relies primarily on income taxes, but taxation of income by states has
risen steadily over the years.100 For 2009, 34.4% of state tax collections consisted of individual
income taxes and 5.6% consisted of corporation income taxes.101 Thus, total state taxes on income
accounted for 40.0% of all state taxes collected. In comparison, for 2009, general sales taxes
accounted for 31.9% of state taxes collected.102 Hence, it can be argued that the states have
encroached on the primary source of revenue of the federal government.
States could continue to levy their retail sales taxes while the federal government levies a VAT. In
Canada, the federal government levies a VAT, and the provinces continue to collect their retail
sales taxes.
Joint Collection
States could piggy-back on a federal VAT. To do this, states would have to replace their retail
sales taxes with a VAT and adopt the federal tax base. Because a federal VAT would probably
have a broader base than any state sales tax, more revenue would be yielded for each 1% levied.
Also, the VAT would eliminate duplication of administrative effort, permit the taxation of
interstate mail order sales, permit the taxation on Internet sales, and lower total compliance costs
of firms.
But, states may decline the opportunity for joint collection because of their desire to maintain
greater fiscal independence from the federal government. In 1972, federal legislation permitted
states to adopt the federal individual income tax base and have the federal government collect its
state income tax, without cost to the states.103 No state delegated collection of its income tax to
the federal government. The law was repealed in 1990.104
In a 2008 VAT study, GAO found that “Canada’s experience demonstrates that, while multiple
consumption tax arrangements in a federal system are possible, such arrangements create
additional administrative costs and compliance burden for governments and businesses.”105

100 For historical data on state tax collection by source, see Facts & Figures on Government Finance, Washington: Tax
Foundation, 2010. Historical data on federal receipts by source is available from the following source: Office of
Management and Budget, Budget of the U.S. Government, Historical Tables, Fiscal Year 2011 (Washington: GPO,
2010), pp. 30-35.
101 Tax Policy Center, “State Tax Collection Shares by Type, 1999-2009,” July 14, 2010, p. 1.
102Ibid.
103 The Federal-State Tax Collection Act was enacted as Title II of the legislation that created the federal revenue
sharing program. U.S. Congress, Joint Committee on Internal Revenue Taxation. State and Local Fiscal Assistance Act
and the Federal-State Tax Collection Act of 1972, H.R. 14370, 92d Congress, Public Law 92-512, JCS-1-73, February
12, 1973, Washington, GPO, 1973, pp. 51-72.
104 Provisions of the Federal-State Tax Collection Act of 1972 (subchapter 64(E), sec. 6361 through 6365 of the
Internal Revenue Code) were repealed by the Omnibus Budget Reconciliation Act of 1990, P.L. 101-508, sec.
11801(a)(45).
105 U.S. General Accountability Office, Value-Added Taxes: Lessons Learned from Other Countries on Compliance
Risks, Administrative Costs, Compliance Burden, and Transition, p. 5.
Congressional Research Service
21

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Size of Government
In the public policy debate over a VAT, one of the more divisive issues concerns the size of the
public sector.106 There is widespread debate among economists and public policy expert
concerning the variables that determine the size of government. These variables include
urbanization, the growth of income, the age distribution of the population, technological change,
relative costs of public services, social philosophy, rates of voter turnout, perceived need for
defense spending, tax structure, and the size of a nation.107
There is an hypothesis that a VAT is a “money machine” because the higher revenue yield per 1%
levied could allow the government to finance a growing public sector by periodically raising the
VAT rate. It can be argued that the VAT is a partially “hidden” tax because consumers pay a small
amount of VAT with each purchase and are not fully cognizant of the aggregate VAT paid for a
year. Furthermore, the tax authorities have the option of prohibiting the VAT from being shown
on retail sales slips.
Most experts generally agree that these concerns are unproven. After all, the tax rate for any tax
can be increased at the margin. Furthermore, there is no proof that taxpayers are any less
cognizant of a tax paid in small amounts than in one lump sum. (Although, even if taxes are
visible, for taxpayers to compare the cost of the tax with the benefits from the tax, the benefits
would have to be similarly visible).
Some empirical studies have found that tax increases lead to increased spending, but other
empirical studies have found that public demands for a larger public sector lead to tax increases.
The President’s [George W. Bush] Advisory Panel on Federal Tax Reform found:
sophisticated statistical studies that control for other factors that may affect the relationship
between the size of government and the presence of a VAT yield mixed results. The
evidence neither conclusively proves, nor conclusively disproves, the view that supplemental
VATs facilitate the growth of government.108
Conclusions
A VAT has numerous positive characteristics such as a robust revenue yield, relative neutrality,
good enforcement, border-adjustability, and reasonable administrative costs. Some critics are
concerned about the VAT’s regressivity; proponents say policies are available to reduce or
eliminate this regressivity. The prevailing view of tax professionals is that an optimal VAT would
have the following characteristics: a broad base, a single rate, the credit-invoice method of
collection, the application of the destination principle, and a significant sales threshold for
registration. The United States is the only developed nation without a VAT. In conclusion, the

106 The optimal size of government is a value judgment. A larger public sector is neither inherently better nor worse
than the existing size of the public sector. For a comprehensive examination of this issue, see Joseph E. Stiglitz,
Economics of the Public Sector, 3rd edition (New York: W. W. Norton & Company, 2000), pp. 3-22.
107 For a discussion of variables that may affect the size of Government, see Richard A. Musgrave and Peggy B
Musgrave, Public Finance in Theory and Practice, 4th ed. (New York: McGraw-Hill, 1984), pp. 146-153.
108 President’s Advisory Panel on Federal Tax Reform, Simple, Fair, & Pro-Growth: Proposals to Fix America’s Tax
System (Washington: U.S. Department of the Treasury, November 1, 2005), p. 203.
Congressional Research Service
22

Should the United States Levy a Value-Added Tax for Deficit Reduction?

option of levying of VAT may warrant inclusion in the debate over the solution to the nation’s
long-term fiscal problems.
Congressional Research Service
23

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Appendix A. Credit-Invoice, Subtraction, and
Addition Methods
This appendix provides numerical examples of the two methods of calculating a VAT: credit-
invoice and subtraction methods. The tax rate for a VAT may be price inclusive (included in the
sales price) or price exclusive (added to the sales price). Most developed nations levy their VAT
rates on a price exclusive basis.
Table A-1. Credit-Invoice Method
(Price-exclusive VAT rate assumed at 10%)
Stage of Production
Sales
VAT
VAT on Purchases
Net VAT
Raw Materials
$100 x 10%
$10
$0
$10
1st processor
$120 x 10%
$12
($10)
$2
Distributor
$140 x 10%
$14
($12)
$2
Retailer
$180 x 10%
$18
($14)
$4
Total

$18
Source: Annette Nel en, “How the VAT works,” Consumption Tax Information, pp. 6, available at
http://www.cob.sjsu.edu/nellen_a/ConsumptionTax.html, January 18, 2011. The author is Professor, Department
of Accounting and Finance, San Jose State University.
Note: There would be no need to separately state the VAT on the invoice because the customer would not be
entitled to a credit for the VAT paid.
Table A-2. Subtraction Method
(Price-exclusive VAT rate assumed at 10%)
Stage of Production
Sales
Less Purchases
Calculation
VAT
Raw Materials
$100
$10
$100 x 10%
$10
1st processor
$120
$12
$20 x 10%
$2
Distributor
$140
$14
$20 x 10%
$2
Retailer
$180
$18
$40 x 10%
$4
Total

$18
Source: Annette Nel en, “How the VAT works,” Consumption Tax Information, pp. 6-7, available at
http://www.cob.sjsu.edu/nellen_a/ConsumptionTax.html, January 18, 2011. The author is Professor, Department
of Accounting and Finance, San Jose State University.
Note: Taxpayer’s records will likely show purchases including the VAT. Thus, an alternative calculation would
be to use the tax-inclusive rate of 9.0909%, rather than the tax-exclusive rate of 10% (rate applied to sales
amount exclusive of the VAT):
Raw materials: ($110 - $0) x 9.0909% = $10
1st processor: ($132 - $110) x 9.0909% = $2
Distributor: ($154 - $132) x 9.0909% = $2
Retailer: ($198 - $154) x 9.0909% = $4
Congressional Research Service
24

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Appendix B. VAT Revenue Ratios in OECD
Table B-1. OECD VAT Revenue Ratios, 1996-2000
Standard VAT
Difference
Country
Rate (2005)
1996
2000
2005
1996-2005
Australiaa 10.0

0.47
0.57
0.10
Austria
20.0
0.58
0.60
0.60
0.02
Belgium
21.0
0.47
0.51
0.50
0.03
Canadab 7.0
0.48
0.52
0.52
0.04
Czech Republic
19.0
0.44
0.44
0.59
0.15
Denmark
25.0
0.58
0.60
0.62
0.04
Finland
22.0
0.54
0.61
0.61
0.06
France
19.6
0.51
0.50
0.51
0.00
Germany
16.0
0.60
0.60
0.54
–0.06
Greece
18.0
0.42
0.48
0.46
0.04
Hungary
25.0
0.43
0.53
0.49
0.05
Iceland
24.5
0.54
0.58
0.62
0.08
Ireland
21.0
0.53
0.64
0.68
0.15
Italy
20.0
0.40
0.45
0.41
0.00
Japan
5.0
0.72
0.70
0.72
0.00
Korea
10.0
0.62
0.65
0.71
0.10
Luxembourg
15.0
0.57
0.68
0.81
0.24
Mexico
15.0
0.26
0.31
0.33
0.07
Netherlands
19.0
0.57
0.60
0.61
0.04
New Zealand
12.5
1.00
1.00
1.05
0.04
Norway
25.0
0.60
0.67
0.58
–0.03
Poland
22.0
0.41
0.42
0.48
0.07
Portugal
19.0
0.57
0.62
0.48
–0.10
Slovak Republicc 19.0

0.46
0.53
0.07
Spain
16.0
0.45
0.53
0.56
0.11
Sweden 25.0
0.50
0.52

0.05
Switzerland 7.6
0.70
0.78
0.55
0.05
Turkey 18.0
0.55
0.59

-0.02
United Kingdom
17.5
0.50
0.50
0.76
-0.02
Unweighted average
17.7
0.54
0.57
0.53
0.04
Source: OECD, Consumption Tax Trends 2008: VAT/GST and Excise Rates, Trends and Administrative Issues,
Paris, 2008, p. 69.
Notes: VAT Revenue Ratio = (VAT revenue)/([consumption - revenue] x Standard VAT rate)
a. For Australia the differential VRR is calculated on the period 2000-2005 since GST was introduced in 2000.
b. Calculation for Canada is for federal VAT only.
c. For Slovak Republic, the differential VRR is calculated on the period 2000-20005 since data is not available
for 1996.
Congressional Research Service
25

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Appendix C. General Consumption Taxes in
OECD Countries
Table C-1. Data on General Consumption Taxes in OECD
(All levels of government)
Total Tax Revenue as a % of
General Consumption
General Consumption Taxes as a
GDPa at Market Prices
Taxes as a % of GDP
% of Total Tax Revenues
Country
(2007)
(2007)
(2007)
Australia 30.8%
4.0%
13.0%
Austria 42.3
7.7
18.3
Belgium 43.9
7.1
16.3
Canada 33.3
4.5
13.6
Czech Republic
37.4
6.6
17.6
Denmark 48.7
10.4
21.4
Finland 43.0
8.4
19.5
France 43.5
7.4
17.0
Germany 36.2
7.0
19.4
Greece 32.0
7.5
23.4
Hungary 39.5
10.3
26.0
Iceland 40.9 10.6
25.9
Ireland 30.8
7.4
24.1
Italy 43.5 6.2 14.2
Japan 28.3 2.5
8.8
Korea 26.5 4.2
15.8
Luxembourg 36.5
5.7
15.7
Mexico 18.0
3.7
20.4
Netherlands 37.5
7.4
19.8
New Zealand
35.7
8.4
23.5
Norway 43.6
8.3
19.1
Poland 34.9
8.2
23.5
Portugal 36.4
8.8
24.1
Slovak Republic
29.4
6.7
22.9
Spain 37.2 6.0
16.2
Sweden 48.3
9.3
19.3
Switzerland 28.9
3.8
13.1
Turkey 23.7
5.1
21.3
United Kingdom
36.1
6.6
18.2
United States
28.3
2.2
7.7
Source: Adapted by CRS from OECD, Revenue Statistics 1965-2008, Paris, 2009.
a. GDP is an abbreviation for gross domestic product, which is a measure of total domestic output of goods
and services.
Congressional Research Service
26

Table C-2. VAT/GST Rates in OECD Member Countries

Implementeda

Specific
Rates in
Year
Reduced
Specific
Country
Implemented 1976 1980 1984 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2007 2008 2009
2010
Ratesb
Regions
Australia
2000
- - - - - - - - - 10.0 10.0
10.0
10.0
10.0
10.0
10.0
10.0
0.0
-
Austriac
1973
18.0 18.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0
10.0/12.0
19.0
Belgium
1971
18.0 16.0 19.0 19.0 19.0 19.5 20.5 21.0 21.0 21.0 21.0 21.0 21.0 21.0 21.0 21.0 21.0
0.0/6.0/12.0
-
Canadad
1991
- - - - - 7.0
7.0
7.0
7.0
7.0
7.0
7.0
7.0
6.0
5.0
5.0 5.0
0.0
13.00
Chilee
1975
20.0 20.0 20.0 20.0 16.0 18.0 18.0 18.0 18.0 18.0 18.0 19.0 19.0 19.0 19.0 19.0 19.0
-
-
Czech Republic
1993
-
-
-
-
-
- 23.0 22.0 22.0 22.0 22.0 22.0 19.0 19.0 19.0 19.0 20.0
10.0
-
Denmark
1967
15.0 22.0 22.0 22.0 22.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0
0
-
Finland
1994
-
-
-
-
-
- 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0
0.0/8.0/13.0
-
Francef
1968
20.0 17.6 18.6 18.6 18.6 18.6 18.6 20.6 20.6 20.6 19.6 19.6 19.6 19.6 19.6 19.6 19.6
2.1/5.5
See
note
Germany
1968
11.0 13.0 14.0 14.0 14.0 14.0 15.0 15.0 16.0 16.0 16.0 16.0 16.0 19.0 19.0 19.0 19.0
7
-
Greeceg
1987
-
-
- 16.0 18.0 18.0 18.0 18.0 18.0 18.0 18.0 18.0 19.0 19.0 19.0 19.0 19.0
4.5/9.0
3.0/
6.0/13.0
Hungary
1988
-
-
- 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 20.0 20.0 20.0 20.0 25.0
18.0/5.0
-
Iceland
1989
-
-
-
- 22.0 22.0 24.5 24.5 24.5 24.5 24.5 24.5 24.5 24.5 24.5 24.5 25.5
0.0/7.0
-
Ireland
1972
20.0 25.0 23.0 25.0 23.0 21.0 21.0 21.0 21.0 21.0 21.0 21.0 21.0 21.0 21.0 21.5 21.0
0.0/4.8/13.5
-
Italy
1973
12.0 15.0 18.0 19.0 19.0 19.0 19.0 19.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0
0.0/4.0/10.0
-
Japan
1989
- - - - 3.0 3.0 3.0 3.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0
-
-
Korea
1977
- 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0
0
-
Luxembourg
1970
10.0 10.0 12.0 12.0 12.0 15.0 15.0 15.0 15.0 15.0 15.0 15.0 15.0 15.0 15.0 15.0 15.0
3.0/6.0/12.0
-
Mexicoh
1980
- 10.0 15.0 15.0 15.0 10.0 10.0 15.0 15.0 15.0 15.0 15.0 15.0 15.0 15.0 15.0 16.0
0.0
11
Netherlands
1969
18.0 18.0 19.0 20.0 18.5 17.5 17.5 17.5 17.5 17.5 19.0 19.0 19.0 19.0 19.0 19.0 19.0
6.0
-
CRS-27

Implementeda

Specific
Rates in
Year
Reduced
Specific
Country
Implemented 1976 1980 1984 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2007 2008 2009
2010
Ratesb
Regions
New Zealand
1986
-
-
- 10.0 12.5 12.5 12.5 12.5 12.5 12.5 12.5 12.5 12.5 12.5 12.5 12.5 12.5
0
-
Norway
1970
20.0 20.0 20.0 20.0 20.0 20.0 22.0 23.0 23.0 23.0 24.0 24.0 25.0 25.0 25.0 25.0 25.0
0.0/8.0/14.0
-
Poland
1993
-
-
-
-
-
- 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0
0.0/7.0
-
Portugali
1986
-
-
- 17.0 17.0 16.0 16.0 17.0 17.0 17.0 17.0 19.0 21.0 21.0 21.0 20.0 20.0
5.0/12.0
4.0/8.0/14.0
Slovak Republic
1993
- - - - - -
25.0
23.0
23.0
23.0
23.0
19.0
19.0
19.0
19.0
19.0
19.0
10
-
Spainj
1986
-
-
- 12.0 12.0 13.0 16.0 16.0 16.0 16.0 16.0 16.0 16.0 16.0 16.0 16.0 16.0
4.0/7.0
See
note
Sweden
1969
17.65
23.46 23.46 23.46 23.5 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0
0.0/6.0/12.0
-
Switzerland
1995
- - - - - - 6.5 6.5 6.5 7.5 7.6 7.6 7.6 7.6 7.6 7.6 7.6
0.0/2.4/3.6
-
Turkey
1985
-
-
- 10.0 10.0 10.0 15.0 15.0 15.0 17.0 18.0 18.0 18.0 18.0 18.0 18.0 18.0
1.0/8.0
-
United Kingdom
1973
8.0 15.0 15.0 15.0 15.0 17.5 17.5 17.5 17.5 17.5 17.5 17.5 17.5 17.5 17.5 15.0 17.5
0.0/5.0
-
Unweighted

Average
16.0 16.9 17.9 17.3 16.7 16.5 17.6 17.8 17.9 17.8 17.9 17.8 17.7 17.8 17.7 17.6 18.0

Source: OECD from national delegates, January 2010.
a. In order to summarize these data, all years are not included.
b. A number of countries apply a domestic zero-rate (or an exemption with right to deduct input tax) on certain goods and services. This is shown as 0.0% in this table.
This does not include zero-rated exports.
c. A standard rate of 19% applies in Jungholz and Mittelberg.
d. The provinces of Newfoundland and Labrador, New Brunswick, and Nova Scotia have harmonized their provincial sales taxes with the federal Goods and Services Tax
and levy a rate of GST/HST of 13,0% . The provinces of Ontario and British Columbia have proposed to harmonize their provincial sales taxes with the federal Goods
and Services Tax effective July 1, 2010, the proposed rates of GST/HST for the provinces is 13.0% and 12.0%, respectively. Other Canadian provinces, with the
exception of Alberta, apply a provincial tax to certain goods and services. These provincial taxes apply in addition to GST.
e. In June 1988, the VAT rate was decreased from 20.0% to 16.0%; In July 1990, the VAT rate was increased from 16.0% to 18.0%; In October 2003, the VAT rate was
increased from 18.0% to 19.0%.
f.
Rates of 0.9%; 2.1%; 8.0%; 13.0% apply in Corsica; rates of 1.05%; 1.75%; 2.1%; 8.5% apply to overseas departments (DOM). There is no VAT in French Guyana.
CRS-28

g. Rates of 3.0%; 6.0%; 13.0% apply in the regions Lesbos, Chios, Samos, Dodecanese, Cyclades, Thassos, Northern Sporades, Samothrace, and Skiros.
h. A VAT rate of 10.0% applies in the border regions (the border zone is usual y up to 20 kilometers south of the U.S.- Mexico border).
i.
The standard VAT rate in the Islands of Azores and Madeira is 14.0%; reduced VAT rates in these areas are 4.0% and 8.0%.
j.
Rates of 2.0%; 5.0%; 9.0%; 13.0% apply in the Canary Islands. The standard VAT rate will be increased from 16.0% to 18.0% and the reduced rate from 7.0% to 8.0% on
1st July 2010.

CRS-29

Table C-3. Annual Turnover Concessions for VAT/GST Registration and Collection 2010

Registration/Collection Thresholdsa

Reduced Threshold
for Suppliers of
Special Threshold for Non-

General Threshold
Services Only
Profit and Charitable Sector

Registration/
Collection Allowed
Minimum
National
National
Prior to Exceeding
Registration
Country National
Currency

USD
Currency USD Currency USD Thresholdb
Periodc
Australia AUD
75,000
51,197 150,000 102,393
Yes
1
year
Austriad EUR
30,000
33,783

Yes
5
years
Belgiumd EUR
5,580
6,119

Yes
None
Canada CAD
30,000
25,172
50,000 41,953
Yes
1
year
Chile CLP
none

Czech Republice CZR 1,000,000 68,389

Yes
1
year
Denmarkf
DKK
50,000
5,923

Yes None
Finland EUR
8,500
8,803

Yes
None
Franceg EUR
80,000
87,265
32,000
34,906

Yes
2
years
Germany EUR
17,500
20,473

Yes
5
years
Greece EUR
10,000
13,519
5,000
6,760

Yes
5
years
Hungary HUF
5,000,000
36,914

Yes
2
years
Iceland ISK
500,000
3,733

Yes
2
years
Ireland
EUR
75,000
80,071
37,500
40,036

Yes None
Italyh
EUR
30,000
35,302

Yes None
Japani JPY
10,000,000
86,969

Yes
2
years
Korea KRW
none

Luxembourg EUR
10,000 10,800

Yes
5
years
Mexico MXN
none

CRS-30

Registration/Collection Thresholdsa

Reduced Threshold
for Suppliers of
Special Threshold for Non-

General Threshold
Services Only
Profit and Charitable Sector

Registration/
Collection Allowed
Minimum
National
National
Prior to Exceeding
Registration
Country National
Currency

USD
Currency
USD
Currency
USD
Thresholdb
Periodc
Netherlandsj EUR 1,345 1,548

No
None
New
Zealand NZD 60,000 37,891

Yes
None
Norway NOK
50,000
5,755 140,000 16,114
Yes
2
years
Poland PLN
100,000
50,702

Yes
1
year
Portugalk EUR
10,000
14,962

Yes
None
Slovak Republic
EUR
49,790
90,311

Yes
1 year
Spain EUR
none

Sweden SEK
none

Switzerland CHF
100,000
61,450

150,000 92,175
Yes
1
year
Turkey TRY
none

United Kingdom
GBP
68,000
102,808

Yes
None
Source: OECD, data from national delegates, January 1, 2010.
a. Registration/collection thresholds identified in this chart are general concessions that relieve suppliers from the requirement to register and/or to collect for VAT/GST
until such time as they exceed the threshold. Except where specifically identified, registration thresholds also relieve suppliers from the requirement to charge and
collect VAT/GST on supplies made within a particular jurisdiction. Relief from registration and collection may be available to specific industries or types of traders (for
example non resident suppliers) under more detailed rules, or a specific industry or type of trader may be subject to more stringent registration and collection
requirements.
b. “Yes” means a supplier is al owed to voluntarily register and col ect VAT/GST where their total annual turnover is less than the registration threshold.
c. Minimum registration/collection periods apply to general concessions. Specific industries, types of traders, or vendors that voluntarily register/collect may be subject to
different requirements.
d. In these countries, a collection threshold applies. All taxpayers are required to register for VAT/GST, but will not be required to charge and collect VAT/GST until
they exceed the collection threshold.
e. The registration threshold does not apply to fixed establishments in the Czech Republic of non-resident businesses.
CRS-31

f.
A higher threshold of DKK 170 000 (EUR 22 840) applies to the blind, and a threshold of DKK 300 000 (EUR 40 300) applies to the first sale of works of art by their
creator or his successors in title. For the purposes of the latter exemption, the threshold of DKK 300 000 must not have been exceeded in the current or preceding
year.”
g. Specific thresholds apply for certain activities. EUR 41 700 for lawyers, writers and artists; EUR 32 000 for providers of services other than hotel accommodations and
restaurants.
h. “Self-employed that have an income lower than EUR 30,000 can choose the Lower Taxpayer Regime (regime dei contribuenti minimi). It involves IRAP (Regional tax
on productive activities), VAT exemption and a 20% tax rate in place of the ordinary PIT.”
i.
Businesses (companies and individuals) are not required to register and account for Consumption Tax (VAT) during the first two years of establishment (except for
companies whose capital is of JPY 10 000 000 or more. In this case they should be registered for Consumption Tax from the beginning). After this two year period,
whether businesses should be registered as a taxable person is determined every year based on their annual taxable turnover for the accounting period/tax year two
years before the current accounting period/tax year. If that turnover has exceeded JPY 10 000 000, the business should be registered. Businesses can opt for a
voluntary registration for Consumption Tax, even if their turnover is below the threshold. In that case, the businesses have to remain registered for two years.
j.
The amount of EUR 1 345 is based on the special scheme for smal businesses. It is not a threshold based on turnover but on net annual VAT due. If the net annual
VAT due (VAT on outputs minus VAT on inputs) is EUR 1 345 or less, the taxpayer gets a ful VAT rebate and no VAT is due to the Tax Authorities. In this case, the
taxpayer has no obligation to file VAT returns. However, businesses under the small business scheme must still register as VAT taxpayers. In that sense, there is no
threshold for registration for VAT purposes. If the net annual VAT due is more than EUR 1 345 but less than EUR 1 883, the taxpayer gets a partial VAT rebate. In this
case, the taxpayer must file a VAT return.
k. The collection threshold does not apply to commercial legal entities; for small retailers that fulfill some specific conditions the col ection threshold is EUR 12 500.

CRS-32

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Appendix D. VAT Rates by Country
Table D-1. Standard VAT Rates by Country
(Tax-exclusive rate in percentage for 2009)
Standard Rate
Country Year
VAT
Introduced
(Goods/Services 2009)
Albania 1996
20%
Algeria 1992
17
Antigua and Barbuda
2007
15
Argentina 1975
21
Armenia 1992
20
Australia 2000
10
Austria 1973
20
Azerbaijan 1992
18
Bangladesh 1991
15
Barbados 1997
15
Belarus 1992
18
Belgium 1971
21
Benin 1991
18
Bolivia 1973
13
Bosnia and Herzegovina
2006
17
Botswana 2002
10
Brazil 1967
19
Bulgaria 1994
20
Burkina Faso
1993
18
Cambodia 1999
10
Cameroon 1999
19.25
Canada 1991
5
Cape Verde
2004
15
Central African Republic
2001
19
Chad 2000
18
Chile 1975
19
China 1994
17
Colombia 1975
16
Congo 1997
18
Cook Islands
1997
10
Costa Rica
1975
13
Cote d'Ivoire
1960
18
Congressional Research Service
33

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Standard Rate
Country Year
VAT
Introduced
(Goods/Services 2009)
Croatia 1998
22
Cyprus 1992
15
Czech Republic
1993
19
Denmark 1967
25
Djibouti 2009
7
Dominica 2006
15
Dominican Republic
1983
16
Ecuador 1970
12
Egypt 1991
10
El Salvador
1992
13
Equatorial Guinea
2004
15
Estonia 1992
18
Ethiopia 2003
15
Fiji 1992
12.50
Finland 1994
22
France 1968
19.60
French Polynesia
1998
16/10
Gabon 1995
18
Georgia 1992
18
Germany 1968
19
Ghana 1998
12.50
Greece 1987
19
Grenada 2010
10
Guatemala 1983
12
Guinea 1996
18
Guinea-Bissau 2001
15
Guyana 2007
16
Haiti 1982
10
Honduras 1976
12
Hungary 1988
20
Iceland 1990
24.50
India 2005
12.50
Indonesia 1985
10
Ireland 1972
21.50
Israel 1976
15.50
Italy 1973
20
Congressional Research Service
34

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Standard Rate
Country Year
VAT
Introduced
(Goods/Services 2009)
Jamaica 1991
16.50
Japan 1989
5
Kazakhstan 1992
12
Kenya 1990
16
Kosovo 2001
15
Kyrgyzstan 1992
12
Laos 2009
10
Latvia 1992
21
Lebanon 2002
10
Lesotho 2003
14
Liberia 2009
7
Lithuania 1992
19
Luxembourg 1970
15
Macedonia 2000
18
Madagascar 1994
20
Malawi 1989
16.50
Mali 1991
18
Malta 1995
18
Mauritania 1995
14
Mauritius 1998
15
Mexico 1980
15
Moldova 1992
20
Mongolia 1998
10
Montenegro 2003
17
Morocco 1986
20
Mozambique 1999
17
Namibia 2000
15
Nepal 1997
13
Netherlands 1969
19
New Zealand
1986
12.50
Nicaragua 1975
15
Niger 1986
18
Nigeria 1994
5
Norway 1970
25
Pakistan 1990
16
Panama 1977
5
Congressional Research Service
35

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Standard Rate
Country Year
VAT
Introduced
(Goods/Services 2009)
Papua New Guinea
1999
10
Paraguay 1993
10
Peru 1973
19
Philippines 1988
12
Poland 1993
22
Portugal 1986
20
Romania 1993
19
Russia 1992
18
Rwanda 2001
18
Senegal 1980
18
Serbia 2005
18
Singapore 1994
7
Slovak Republic
1993
19
Slovenia 1999
20
South Africa
1991
14
South Korea
1977
10
Spain 1986
16
Sri Lanka
1998
12
Sudan 2000
15
Suriname 1999
10/8%
Sweden 1969
25
Switzerland 1995
7.60
Tajikistan 1992
20
Tanzania 1998
20
Thailand 1992
7
Togo 1995
18
Tonga 2005
15
Trinidad and Tobago
1990
15
Tunisia 1988
18
Turkey 1985
18
Turkmenistan 1992
15
Uganda 1996
18
Ukraine 1992
20
United Kingdom
1973
15
Uruguay 1968
22
Uzbekistan 1992
20
Congressional Research Service
36

Should the United States Levy a Value-Added Tax for Deficit Reduction?

Standard Rate
Country Year
VAT
Introduced
(Goods/Services 2009)
Vanuatu 1998
13
Venezuela 1993
9
Vietnam 1999
10
Zambia 1995
16
Zimbabwe 2004
15
Source: Leah Durner, Bobby Bui, and Jon Sedon, “Why VAT Around the Globe?,” Tax Notes, November 23,
2009, pp. 5-7. The authors compiled data for this table from a variety of sources.

Author Contact Information

James M. Bickley

Specialist in Public Finance
jbickley@crs.loc.gov, 7-7794

Congressional Research Service
37