CRS REVIEWS THE EFFECTS OF A VAT.

JAMES M. BICKLEY ANALYST IN PUBLIC FINANCE ECONOMICS DIVISION

NOVEMBER 27, 1989

SUMMARY

Some Members of Congress have expressed interest in the feasibility of levying a value-added tax (VAT) to reduce large forecast budget deficits. A VAT is imposed at all levels of production on the differences between firms' sales and their purchases from all other firms. A VAT is assumed to be fully shifted forward to consumers, hence, a VAT is a type of general consumption tax. In comparison to the United States, most member nations of the Organization for Economic Cooperation and Development (OECD) place both a higher reliance on general consumption taxation and a lower reliance on individual income taxes. Of the 25 nations in the OECD, only the U.S. does not have a broad-based consumption tax at the national level.

For fiscal year 1989, a comprehensive U.S. VAT would have raised approximately $27 billion for each one percent levied. Data on VATs in other OECD nations suggest that a U.S. VAT could be administered at a reasonable cost and with reasonably good compliance.

If disposable income over a one-year period is the measure of ability-to-pay, then a VAT would be extremely regressive; that is, the percentage of disposable income paid in VAT would decrease rapidly as disposable income increases. If disposable income over a lifetime is the measure of ability-to-pay, a constant-rate VAT would be mildly regressive. Options do exist to reduce or eliminate this regressivity; three possible methods are exclusions and multiple rates, income tax credits, and earmarking of some revenue for increased social spending. If consumption over either a one-year period or a lifetime is the measure of ability-to-pay, a VAT would be proportional; that is, the percentage of consumption paid in VAT would be the same as consumption increases.

From an economic perspective, a major revenue source is better the greater its neutrality; that is, the less the tax alters economic decisions. A VAT is a relatively, but not completely, neutral tax. A VAT or any other tax that sharply reduces the deficit would raise the rate of national savings. But the prevailing view of economists is that neither a VAT nor any other major tax change would significantly affect households' propensities to save.

The imposition of a VAT would cause a one-time increase in this country's price level. But a VAT would not 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 continues its policy of flexible exchange rates, then the imposition of a VAT would not significantly affect the U.S. balance-of-trade. Empirical studies of the effect of a VAT on the size of the public sector are inconclusive. A Federal VAT would encroach on the States' primary source of revenue, the retail sales tax; but the Federal Government and the States already share many sources of revenue in relative harmony. Public opinion surveys show a preference for a VAT over higher individual income taxes.

                          TABLE OF CONTENTS

Large projected deficits in the Federal budget have generated congressional interest in new sources of revenue. One policy option has been the imposition of a value-added tax (VAT) because of its high revenue potential and widespread use by other developed nations. This CRS report examines 15 aspects of a VAT relevant to the issue of levying a VAT for deficit reduction. These aspects are the concept of a value-added tax, comparison of the composition of taxes between the United States and other OECD nations, revenue yield, administrative cost, compliance, equity, neutrality, saving, inflation, balance-of- trade, size of Government, intergovernmental relations, and public opinion. This report considers the experiences of the 19 nations (out of 23 nations) with VATs in the Organization for Economic Cooperation and Development (OECD) relevant to the feasibility and operation of a U.S. VAT. ¹

CONCEPT OF A VALUE-ADDED TAX

A value-added tax is a tax, levied at each stage of production, on firms' value added. 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 factors of production (land, labor, capital, and entrepreneurial ability). ² Another method of calculating a firm's value added is to total the firm's payments to its factors of production.

TYPES OF VAT

There are three types of VATs which differ in their tax treatment of purchases of capital inputs (plant and equipment). Under the CONSUMPTION VAT, capital purchases are treated the same way as the purchase of any other input. This tax treatment of capital purchases is equivalent to expensing. Under the INCOME VAT, the VAT paid on the purchases of capital inputs is amortized (credited against the firm's VAT liability) over the expected lives of the capital inputs. Under the GROSS PRODUCT VAT, no deduction for the VAT on purchases of capital inputs is allowed against the firm's VAT liability.

All 19 OECD nations with VATs use the consumption type. The consumption VAT is the type usually advocated for this country. Indeed, most VAT advocates intend to shift tax burdens from capital income to consumption. Furthermore, a consumption VAT is simpler to compute because firms do not have to separate expenditures for capital from other expenditures.

METHODS OF CALCULATING VAT

There are three alternative methods of calculating VAT: credit method, subtraction method, and addition method. ³ Under the CREDIT METHOD, a firm would calculate the VAT to be remitted to the Government by a two step process. First, the firm would multiply its sales by the tax rate to calculate VAT collected on sales. Second, the firm would credit VAT paid on inputs against VAT collected on sales and remit this difference to the Government. The firm would calculate its VAT liability before setting its prices in order to fully shift the VAT to the buyer. Under the CREDIT-INVOICE METHOD, a type of credit method, the firm is required to show VAT separately on all sales invoices and to calculate the VAT credit on inputs by adding all VAT shown on purchase invoices.

Under the SUBTRACTION METHOD, the firm would calculate 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. Under the ADDITION METHOD, the firm would calculate its value added by adding all payments for untaxed inputs (e.g. wages and profits). Next, the firm would multiply its value added by the VAT rate to calculate VAT to be remitted to the Government.

The credit-invoice method is used by eighteen OECD nations. The subtraction method is being used by Japan and has been proposed for Canada. Both methods have been discussed for the United States.

The prevailing view of economists is that the credit-invoice method is superior. 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 their purchase orders is not understated in order that the firm receive full credit against VAT liability for VAT previously paid. Thus, the credit invoice method could be easier to enforce. The credit-invoice method is probably the only feasible method if there are to be multiple tax rates.

In the United States, the subtraction method could have lower compliance and administrative costs than the credit-invoice method. A firm would be able to obtain all information to comply with a VAT from its Federal business income tax forms. Internal Revenue Service (IRS) personnel already audit selective Federal business income tax returns; consequently, the additional audit cost of a subtraction VAT could be lower. The subtraction method would not work administratively if many goods are exempt or if multiple tax rates are levied. Thus, the subtraction method would reduce the flexibility of Congress in formulating a VAT. Special interest groups, however, would have difficulty amending legislation to assist their memberships. Unless specified otherwise, this report will assume that the credit-invoice method is used and that the VAT is the consumption type. ⁴

EXEMPTION VERSUS ZERO-RATING

No VAT proposal would require all firms to collect the VAT. The two fundamental methods of giving special tax treatment to businesses in an industry under a VAT are exemption and zero-rating. 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, of course). An exempt business's costs, however, include any tax paid on inputs, because it receives no credit for previously paid taxes.

A zero-rated business would 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, receives a refund of any VAT paid on its inputs, so its costs do not include VAT paid at earlier stages. The effects on final prices and total VAT collected by the Government caused by exempting or zero- rating firms would vary with the stage of production. (The operational assumption is that a VAT is fully shifted forward in all prices.)

An exempt retailer would not charge any VAT on his sales but he would not receive any credit for VAT previously paid on inputs, so his price to the final consumer would include all VAT paid except that on his own value-added. The Government would have collected a tax on all the value added in the product except the retailer's.

A zero-rated retailer would not charge any VAT on his sales, but he would receive credit for all VAT previously paid on inputs. A zero-rated retailer would not remit VAT to the Government, but he would receive a refund for VAT previously paid by suppliers. Hence, the price of the commodity would not include any VAT, and the Government would receive no revenue.

Exempting or zero-rating a retailer, the final stage of production and distribution, would not affect the linkage (or chain) of VAT collections and credits between different stages of production. But exempting or zero-rating an intermediate stage such as manufacturing of wholesaling would break the chain between firms at different stages of production.

Exempting, however, causes a far more serious break than zero- rating. For example, an exempt manufacturer would not collect VAT on sales to a wholesaler and would not receive credit for VAT paid on inputs. A nonexempt wholesaler would not receive credit for the VAT paid on the manufacturer's inputs included in the price he paid the manufacturer. But the wholesaler would remit VAT collected on all of his sales, so some of the value added in the product would be taxed twice. Consequently, exempting a manufacturer or any other intermediate producer would increase total VAT collected by the Government and the final retail price of the commodity.

A zero-rated manufacturer would not collect VAT on sales but would receive credit for VAT paid on inputs. The price paid by the wholesaler, therefore, would contain no VAT. The nonexempt wholesaler would collect VAT on sales and would not be eligible for any VAT credits, but the total VAT at that point would exactly equal what it would have been had there been no untaxed stage. Subsequent stages of production would charge VAT on sales and would receive credit for VAT paid on inputs as though there had been no break in the chain. Hence, zero-rating a manufacturer or other intermediate stage would change neither total VAT remitted nor the retail price on the commodity. ⁵

If both zero-rated firms and exempt firms operate at the same level of production in the same industry, the zero-rated firms would have a competitive advantage, because their costs are less by the amount of the VAT.

COMPOSITION OF TAXES: UNITED STATES COMPARED TO OTHER OECD NATIONS ⁶

One argument frequently made for a U.S. VAT is the relative reliance on consumption taxes in other developed countries. Most other countries do in fact rely more on consumption taxes.

For fiscal year 1985, the United States (Federal, State, and local governments) relied less on taxes on goods and services (17.7 percent of total tax revenues) than any other nation in the OECD except Japan (14.0 percent). For general taxes on goods and services (e.g., VATs and sales taxes), the United States had a lower reliance (7.4 percent of tax revenues) than any other nation except Japan (zero percent). ⁷

For fiscal year 1985, the reliance of the United States on individual income taxes (35.7 percent of total revenue) was exceeded by only five other OECD nations. Four out of five of these nations (Australia, Finland, New Zealand, and Sweden) did not levy social security taxes on employees, and the fifth nation (Denmark) relied on social security taxes on employees for only 1.9 percent of its total tax revenue. For the United States, direct taxes on employees (individual income taxes and social security taxes) accounted for a higher percentage of tax revenue (46.8 percent) than in all but three other OECD nations. These three nations were Belgium (46.9 percent), Denmark (52.1 percent), and New Zealand (80 percent). ⁸

In summary, the U.S. places a much higher reliance on direct taxes on employees and a much lower reliance on taxes on goods and services than most other nations in the OECD.

REVENUE YIELD ⁹

The primary reason for considering a VAT for deficit reduction is the enormous revenue potential. 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. This assumption of full shifting was used to make the revenue estimates in this report. A VAT (or any other major tax increase) would have a contractionary effect on the economy unless offset by other economic policies. Consequently, the revenue estimates in this report are made under the assumption that the Federal Reserve would use an expansionary monetary policy to neutralize the contractionary effects of a VAT. These revenue estimates also do 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.

VAT BASE

The potential revenue per one percent rate from a VAT would vary with the comprehensiveness of the tax base. A broad-based VAT would have limited exclusions, while a narrow-based VAT would have numerous exclusions. Obviously, the broader the tax base, the lower the tax rate necessary to raise a given amount of revenue.

Furthermore, the broader the VAT base, the more efficient is the tax system. The exclusion of goods from taxation changes their prices relative to taxed goods. Changes in relative prices cause economic distortions. Consumers tend to substitute lower priced goods for higher priced goods.

There are two primary justifications for excluding specific items from taxation. First, the VAT would be too difficult to collect on some goods and services because sellers could easily avoid reporting their sales. Second, some goods are excluded on equity grounds, since these goods claim disproportionately large percentages of the incomes of lower income families.

As shown in appendix D, broad and narrow bases for a VAT were formulated by CRS after reviewing the literature and examining practices of countries in the OECD. A broad-based VAT would tax 79.4 percent of total consumption and a narrow-based VAT would tax 48.4 percent. ¹⁰ OECD "data . . . suggest that . . . over 70 percent of total consumption was usually in the base of VAT countries." ¹¹ For OECD nations, particularly those in the EEC, there has been a trend towards broadening their VAT bases. ¹² But OECD nations still exempt or zero-rate numerous goods. ¹³

REVENUE ESTIMATES

Data Resources, Inc. (DRI) estimates that personal consumption expenditures were $3,412.87 billion in current dollars for fiscal year 1989 (October 1, 1988-September 30, 1989). ¹⁴ This aggregate level of personal consumption expenditures and the tax bases formulated by CRS may be used to estimate revenue yields per one percent VAT. Each one percent tax would yield $27.1 billion (.01 x .794 x $3,412.87 billion) for a broad-based VAT. If a VAT is levied on 70 percent of total consumption (typical of many OECD nations with VATs) then the revenue yield would be $25.9 billion (.01 x .70 x $3,412.87 billion).

A VAT will cause a one-time increase in the price level as discussed in the section on inflation in this report. For example, a four percent VAT on 75 percent of consumer expenditures would raise the price level by approximately three percent. The greater the revenue yield from a VAT, the greater will be the rise in the price level. Inflation lowers the real dollar value of the revenue yield from a VAT. Thus, the expected yield in real dollars from a broad- based U.S. VAT would be slightly lower than the estimates in the preceding paragraph.

The robustness of the VAT not only makes it a possible source for deficit reduction but also has generated concerns among some that VAT revenues may finance a larger public sector. This issue of VAT and the size of government is examined in a later section of this report.

ADMINISTRATIVE COST

The value-added tax would require the expansion of the Internal Revenue Service. But the high revenue yield from a VAT would cause administrative costs to be low measured as a percentage of revenue yield. Tax studies in Sweden, the United Kingdom, Portugal, and Australia found that administrative costs as a percentage of revenue were less for their broad-based consumption taxes than for their income taxes. ¹⁵ The OECD has concluded that "data . . . suggest from the experiences of a few countries that consumption tax revenues can be collected at a lower average cost than income taxes for a similar amount of revenue". ¹⁶

But, for the purposes of this report, the relevant comparison is between a VAT collected by the credit-invoice method and an increase in the individual income tax because the United States already has an administrative apparatus to collect the individual income tax. A VAT would have significant administrative costs because it is a new tax, while the administrative costs of an increase in the individual income tax would be minimal.

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. Proposed VATs for deficit reduction usually are estimated to yield approximately $100 billion per fiscal year which would result in the spreading of administrative costs.

In 1984, officials at the United States Treasury estimated that a completely phased in VAT would require additional staff of 20,694 at a cost of $700 million or approximately $1 billion at 1989 salary levels. This Treasury estimate was based on the assumption that all 20 million U.S. firms would be taxed. ¹⁷ Many countries exempt small businesses from the VAT in order to eliminate compliance costs of small businesses and reduce administrative costs of government. In 1985, approximately 80 percent of all agricultural and nonagricultural firms (sole proprietorships, partnerships, and corporations) had business receipts of less than $25,000. ¹⁸ These small firms accounted for less than one percentage of total business receipts. ¹⁹ Thus, under the assumption that firms' total receipts and value-added are highly correlated, the IRS could reduce the number of firms subject to the VAT from 20 million to eight million with little loss of revenue. There would, of course, be some loss in economic efficiency (see infra).

As shown in table 9, however, the Treasury's estimated ratio of staff to taxpayers of 1 to 1,000 is much lower than the actual ratio of the six listed nations in the EEC. Even if the number of taxpayers is reduced to eight million, the ratio remains at a fairly low 1:400. There may be some economies of scale in the administration of a VAT, furthermore, the VAT constructed by the Treasury for the United States is simpler, and less costly to administer than existing VATs in the EEC, so Treasury's cost estimates could be fairly close to the mark. But a VAT may start out simple yet become extremely complex over time.

       TABLE 9. RATIO OF STAFF TO TAXPAYERS TO ADMINISTER A VAT

For fiscal year 1988, the U.S. Internal Revenue Service had operating costs of $5.069 billion and average positions realized of 114,873. ²⁰ For fiscal year 1988, the IRS collected $935.107 billion; consequently, operating costs were 0.54 percent of revenue collected. ²¹

Table 10 lists administrative costs of value-added taxes for 12 nations in the OECD. It is difficult to compare administrative costs of a VAT among nations because of differences in tax complexity, quality of administration, standard rate of taxation, and tax compliance. ²²

          TABLE 10. ADMINISTRATIVE COSTS OF VALUE-ADDED TAXES

COMPLIANCE

Nations in the OECD have experienced better compliance with their VATs than with either their individual or business income taxes. There are four reasons for this better compliance. 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 underreporting of sales. The firm may attempt not only to evade the VAT but also to evade the business income tax. ²³ Having a single agency audit the VAT and business incomes taxes promotes efficiency in comparing tax information. Only three nations in the OECD have more than one tax agency. ²⁴

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. This partial taxation of the underground economy by the VAT contrasts with the complete evasion of income taxation by underground firms.

Although compliance with a VAT is higher than the individual or business income tax, the level of compliance has been below initial expectations of tax authorities. 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 ten major types of evasion. ²⁵ 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 underreport 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. Tenth, two firms may barter goods in order to evade the VAT. ²⁶

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

Some economists argue that personal consumption is the best measure of ability-to-pay because consumption is the actual taking of scarce resources from the economic system. Resources that are consumed could have been used for investment or government purchases. In the past 15 years, the support for consumption as a measure of ability-to-pay has increased.

The most common measure of ability-to-pay is still income. 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 available on different measures of income. For example, the Federal Government reports levels of disposable income which equals consumption plus saving.

Most economists prefer a theoretical concept of income called Haig-Simons income which equals consumption plus change in net worth. The Federal Government does not collect data on Haig-Simons income. The U.S. Treasury has used available data to approximate Haig-Simons income with a measure which the U.S. Treasury calls ECONOMIC INCOME. ²⁷

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 income pattern 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 borrow heavily to acquire consumer durables. This household may repay outstanding debts and accumulate saving during its middle years. Finally, this household may maintain its consumption level by dissaving during its retirement years. 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 EQUITY

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.

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.

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. ²⁸ Thus, it may be that for the vast majority of households, lifetime consumption and lifetime income are approximately equal. Right income households tend to have net savings over their lifetimes; consequently, they would pay a lower proportion of their disposable incomes in VAT than lower income groups.

POLICY OPTIONS TO ALLEVIATE REGRESSIVITY

Some supporters of progressive taxation oppose the VAT primarily because they believe that it is regressive. Some of these critics are especially concerned about the absolute burden of a VAT on low income households. The degree of regressivity, 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 disproportionally 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 Economic Community exclude some goods from VAT on equity grounds. Also, except for Denmark and the United Kingdom, all EEC 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 EEC, most tax economists oppose exclusions and multiples rates to reduce regressivity for three reasons. First, the administrative costs, compliance costs, and neutrality costs are very high. 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 possible reduction in regressivity from exclusion and multiple rates is declining because consumption patterns for different income levels are becoming more similar. ²⁹ 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. ³⁰

In 1980, economists from six European nations discussed the experiences of their nations with the value-added tax at a conference sponsored by the Brookings Institution. These economists wrote papers about their nations' experiences with the VAT. After editing these papers, Henry J. Aaron, a Senior Fellow at Brookings, concluded that

European experience with the value-added tax proves that it is possible to convert a tax that in its simplest form is proportional with respect to consumption and regressive with respect to income into a tax that is progressive with respect to consumption and proportional or slightly progressive with respect to income. The use of different rates for different classes of goods and services and of zero rating and exemptions is the mechanism for achieving this goal.

Participants at the conference agreed that the use of multiple rates and especially of exemptions complicates administration and compliance and distorts consumption in ways that are unlikely to promote economic efficiency. Most conference participants agreed that these disadvantages outweighed any gains from reduced regressivity. They held that distributional objectives should be sought with other instruments, notably income taxes and direct transfers. ³¹

The EEC has recognized the advantages of a single rate and a broad base for a VAT. The EEC is attempting to harmonize its value- added taxes by 1992. The Commission of the European Communities believes that a single rate for the entire EEC would be too drastic a change to be feasible. Therefore, the Commission has proposed a system of two rate ranges with a standard rate between 14 and 20 percent and a reduced rate between four and nine percent. ³² Also, in the OECD nations, there is a trend towards fewer rates and a broader base. ³³

Credit

The Federal Government could allow either a flat 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 different ways. First, an individual could apply the credit against his Federal incomes tax liability and thus lower 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.

A study by Brashares, Speyrer, and Carlson concluded that

* * * a system of reimbursements to low income individuals and families for value-added tax paid targets the most needy groups with comprehensive relief from the tax without requiring high value-added rates. These reimbursements, when combined with the automatic indexation of transfers, almost completely relieve the burden on those in the lowest income category and may, in fact, overcompensate some families. ³⁴

An examination of sales tax credits at the State level may yield some implications for a credit against a Federal VAT. At the State level, many eligible poor people have not filed for their State income tax refunds resulting from the sales tax credit. At the Federal level, the refundable earned income tax credit is not claimed by many eligible poor.

At the State level, tax administrators generally prefer the income tax credit over exempting food from the retail sales tax. ³⁵ But the general public may favor the food exemption over the income tax credit. As of January 1982, 25 out of 45 States with the sales tax exempted all, or almost all, food. ³⁶ Only seven States have an income tax credit for their sales taxes. These States are Hawaii, Idaho, Kansas, New Mexico, South Carolina, Vermont, and Wyoming. ³⁷ In the early 1980s, Massachusetts and Nebraska cancelled their credits against their sales taxes. ³⁸

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. Aaron estimates 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. ³⁹

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 three percent of consumption in 1989 and that food is estimated to absorb about 30 percent of the budget in estimates of poverty thresholds. ⁴⁰

Most households with low taxable incomes do not currently receive transfers and would not be protected by Aaron's scheme.

HORIZONTAL EQUITY

If consumption is the measure of ability-to-pay, a single-rate VAT with a broad base would be horizontally equitable for either a one-year period or a lifetime period. Households with the same level of consumption would pay approximately the same VAT at all levels of consumption.

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. ⁴¹ Over their lifetimes, high incomes households with equal incomes differ in their levels of consumption, and, consequently, VAT payments. Thus, the VAT is not horizontally equitable for high income households.

NEUTRALITY

From an economic perspective, a source of revenue is generally preferred, the greater its neutrality; that is, the less it affects 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.

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.

Second, a VAT would not affect the saving-consumption decision because saving would only be taxed once; that is, when saving are spent on consumption. In contrast, the individual income tax affects the saving-consumption decision by taxing saving twice. The income tax is levied on income which is saved, and then the returns on saving are taxed. Thus, an increase in the individual income tax would tax saving more heavily than consumption.

Third, a household's work-leisure decision would be affected by a VAT. Leisure would not be taxed, but the returns from work would be taxed when spent on goods. 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 does 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), and goods to produce. Other types of taxes may affect one or more of these types of decisions.

But a VAT can not 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 VAT is relatively neutral. This neutrality is greater if the tax rate is relatively low, as would be the case for a U.S. VAT to reduce the deficit.

SAVING

A VAT or any other tax that reduces the budget deficit would be expected to raise the rate of national saving. A second issue concerns the effect on the national saving rate of a VAT versus higher income taxes (or some other form of taxation). A VAT only taxes savings once; that is, when savings are spent on consumption. But an income tax is levied on all income at the time it is earned, regardless of whether the income is consumed of saved. Then the income tax is levied on 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 will increase the return from saving, and, consequently, raise the savings rate.

The rate of return on savings has no significant effect on the savings rate because of two conflicting effects. Theory holds that a higher rate of return on savings encourages an individual to consume less today and more in the future. Each dollar saved today results in a higher amount of consumption in the future. This relative increase in the return from saving causes a household 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 two percent and consumption by only a quarter to a third of a percent after 50 years. ⁴²

INFLATION

A VAT initially would cause a one-time increase in the price level, if the Federal Reserve implemented an expansionary monetary policy to offset the contractionary effects of the tax. For example, a four percent VAT on 75 percent of consumer outlays would directly cause an estimated one-time increase in consumer prices of approximately three percent. A VAT would also have 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 have 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.

It has been suggested that the Federal Government exclude the VAT from price indexes. Hence, existing indexing would not have an inflationary effect. ⁴³ But this proposal would be unpopular and could be contested in court.

In summary, 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 by having all nations levy their VATs on exports but not imports. All experts on the VAT recommend that nations adopting a VAT use the destination principle in order to 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 consumed products would be the same. The VAT rate on a particular good would vary among nations.

A simple example demonstrates this concept of a level playing field. Assume nation A has a 10 percent VAT and nation B has a 20 percent VAT. Exports from nation A to nation B will not be taxed by nation A. But nation B will levy a 20 percent VAT on imports from nation A. Thus, consumers in nation B will pay a 20 percent VAT regardless of whether or not their purchased goods were domestically produced or imported. Furthermore, exports from nation B to nation A will not be taxed by nation B. Nation A will levy a 10 percent VAT on imports. Hence, consumers in nation A will pay a 10 percent 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 nation has a deficit in its balance-of- payments, its currency will tend to decline in value relative to the currencies of other nations. 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 five percent or less is a low tax rate. During the past three years the value of the dollar has fallen by almost one-half relative to an index of major currencies, yet a serious U.S. balance-of-trade deficit persists. In summary, 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.

SIZE OF GOVERNMENT ⁴⁴

In the public policy debate over a VAT, one of the more divisive issues concerns the size of the public sector. There is widespread debate among economists and public policy experts 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. ⁴⁵

It can be argued that a VAT is a "money machine" because the high revenue yield per one percent levied allows the government to finance a growing public sector by periodically raising the VAT rate. Furthermore, 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 can prohibit the VAT from being shown on retail sales slips.

But it can be argued that the tax rate for any tax can be increased at the margin. There is no proof that taxpayers are any less cognizant of a tax paid in small amounts than in one lump sum. Tax authorities can require that the VAT be shown on retail sales slips. OECD nations with VATs have larger public sectors, on average, than nations without VATs, but this was also true before these nations approved their VATs. 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. Hence, empirical studies are inconclusive concerning whether or not the passage of a VAT will increase the size of the public sector.

INTERGOVERNMENTAL ISSUES

Six of the 23 OECD nations including the United States, have federal systems of government. For the United States, a Federal VAT raises two primary intergovernmental issues: the Federal encroachment on the State sales tax and the joint collection of a VAT.

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 the primary source of tax revenue for the States.

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 levies death taxes and personal income taxes after many States had already imposed them. Also, both the Federal Government and the States impose many of the same excise taxes.

The Federal Government relies primarily on income taxes (table Gl of appendix G), but taxation of income by States has risen steadily over the years (table Fl of appendix F). For fiscal year 1986, 29.6 percent of State tax collections consisted of individual income taxes and 8.1 percent consisted of corporation income taxes. Total State taxes on income accounted for 37.6 percent of all taxes collected compared to only 32.8 percent collected from general sales taxation (including use taxes and gross receipts taxes). 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 levied a VAT. The combined total of State (and local) sales taxes and a five percent VAT would be less than the standard VAT rate for most developed nations. In Canada, the federal government has proposed a VAT. If this VAT is approved, provinces will continue to levy their retail sales taxes.

JOINT COLLECTION

States could piggy-back on a Federal VAT. 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 one percent levied. Also, the broader VAT base would reduce economic distortions. A joint Federal-State VAT would eliminate duplication of administrative effort, permit the taxation of interstate mail order sales, and lower total compliance costs of firms.

But, States may refuse to piggy-back because of their desire to maintain greater fiscal independence from the Federal Government. In 1962, Federal legislation permitted States to adopt the Federal individual income tax base and have the Federal Government collect their State income tax. No State has yet delegated collection of their income tax to the Federal Government.

PUBLIC OPINION

Public opinion polls on a VAT for the U.S. have been limited. The public has been questioned, however, about a national sales tax (NST) and an increase in individual income taxes. A NST and a VAT are both broad-based-consumption taxes with similar economic effects. The mass media sometimes refers to the VAT as a form of a NST. Hence, this section of the report assumes that public opinion to warn a VAT would be the same as public opinion has been toward a NST.

Three opinion polls were selected for discussion in this report. First, a poll conducted for the Advisory Commission on Intergovernmental Relations (ACIR) has a detailed breakdown by demographic characteristics and individuals were asked to CHOOSE BETWEEN an increase in individual income taxes and a NST on all purchases other than food. The two other polls, a Media General/Associated Press Poll and a Harris Poll, were selected because they are current and were conducted by different polling organizations.

Data from these surveys are shown in appendix H. These data suggest a public preference for a VAT over an increase in individual income taxes. Demographic characteristics have only a slight influence on this preference.

APPENDIX A: CREDIT, SUBTRACTION, AND ADDITION METHODS

The CREDIT METHOD of calculating a VAT is demonstrated in table A1. The rate for the value-added tax is assumed to be 10 percent. The product manufactured and sold is a widget. The production of widgets involves firms at four different stages of production: raw material producer, manufacturer, wholesaler, and retailer. The operating assumption is that the VAT is fully shifted forward to the next stage of production; consequently, the consumer pays the entire VAT.

At the first stage of production, the simplifying assumption is made that the raw material producer provides all of his own inputs. The raw material producer has sales of $200 and VAT on sales of $20 (10 percent of $200). Because the raw material producer purchased no inputs, he receives no credit for prior VAT paid. Hence, the raw material producer remits $20 to the Federal Government.

At the second stage of production, the manufacturer has sales of $500 and VAT on sales of $50 (10 percent of $500) which is shown separately on the sales invoice. The manufacturer purchased $200 in raw material on which $20 was paid in VAT as listed on the purchase invoice. The manufacturer credits the $20 paid in VAT on inputs against the $50 in VAT collected on sales and remits the difference of $50 to the Federal Government.

                               TABLE A1.

At the third stage of production, the wholesaler has sales of $750 and adds a VAT of $75 (10 percent of $750). The wholesaler purchased inputs for $500 and paid an additional $50 in VAT. Consequently, the wholesaler credits $50 in VAT paid on inputs against $75 paid in VAT sales and remits $25 in VAT to the Federal Government.

Finally, the retailer has sales of $1,000 and adds VAT of $100 (10 percent of $1,000). The retailer purchased $750 in inputs and paid an additional $75 in VAT. The retailer credits the $75 in VAT paid on inputs against the $100 in VAT collected on sales and remits $25 to the Federal Government. The VAT remitted by the four firms was $100. The consumer paid $100 in VAT on top of $1,000 in retail sales.

The last line of figures in table Al indicates the value added at each stage of production. The sum of all firms' value added is $1,000, which equals the sales price of the widgets exclusive of VAT.

                               TABLE A2.

The manufacturer subtracts his purchases of $200 from his sales of $500 to calculate his value added of $300. The manufacturer multiplies his value added of $300 by the tax rate of 10 percent and remits his VAT liability of $30 to the Government. This procedure continues through the wholesale and retail stages and total VAT remitted by all firm is $100 as indicated in the last column.

The ADDITION METHOD is shown in table A3. The raw material producer calculates his value added by adding all payments for factors of production the firm owned and applied to the production process. Thus, the raw material had value added of $200 (wages of $100, rent of $50, interest of $30, and profit of $20). Next, the raw material producer calculates his VAT by multiplying his value added by the tax rate. Thus, the raw material producer must remit $20 ($200 x 0.1) to the Government. This procedure applies to all other stages of production and total VAT remitted is $100.

        APPENDIX B. ECONOMIC EFFECTS OF A SPECIAL VAT TREATMENT

                   APPENDIX C. COMPOSITION OF TAXES

/b/ Includes taxes on self-employed.

/c/ Includes import duties, profits on public fiscal monopolies, licenses, and other business taxes.

/d/ Includes taxes on movable and immovable property, net wealth taxes, and estate and gift taxes.

/e/ Includes general and selective taxes on payrolls which are not earmarked for social security purposes, and other taxes not elsewhere classified.

/f/ Income and profit taxes are 25.9% of total taxes and are included under "other and unallocable," as they are not segregable between individuals and corporations.

Source: Tax Foundation, Inc. Facts and Figures on Government Finance. 24th ed. Baltimore, Johns Hopkins University. 1988. p. 37.

APPENDIX D. POSSIBLE BASE FOR A VALUE-ADDED TAX

                               TABLE D1.

Source: Base formulated by CRS using data from U.S. Department of Commerce. Survey of Current Business, July 1988. Washington, 1988. p. 52.

       APPENDIX E. SUMMARY EXAMPLES OF EXEMPTIONS AND ZERO RATES

     APPENDIX F. PERCENTAGE DISTRIBUTION OF STATE TAX COLLECTIONS

          APPENDIX G. FEDERAL TAX COLLECTIONS BY TYPE OF TAX

/b/ Data for 1987 and 1988 are estimates from the Budget presented in January 1987.

/c/ Old-age, survivors, disability, and hospital insurance; and railroad retirement.

/d/ Includes state taxes deposited in Treasury.

/e/ Includes collections from windfall profits tax beginning 1980.

/f/ Less than 0.5%.

Source: Tax Foundation, Inc. Facts and Figures on Government Finance. 24th ed. Baltimore, The Johns Hopkins University, 1988. p. 119.

APPENDIX H: SURVEYS OF PUBLIC OPINION

ACIR SURVEY

The Advisory Commission on Intergovernmental Relations contracted with Gallup to survey the public on the following question: "If the Federal Government had to raise taxes substantially, which would be a better way to do it?" ⁴⁶ The three possible responses were: (1) increasing individual income taxes; (2) a new national sales tax on all purchases other than food; and (3) don't know. ⁴⁷ This survey may be particularly relevant since the choice for a Federal tax increase may be between a value-added tax and higher Federal income taxes.

From April 29 through May 2,1983, personal interviews were conducted in the homes of a sample of 1,517 men and women 18 years and over. The results were weighted using demographic factors so that they could be projected to the total adult civilian population. The survey results are accurate within a three percent margin of error at a 95 percent level of confidence. ⁴⁸

Data in table H1 show both aggregate results and detailed results based on demographic factors. For the total public, 24 percent favored increasing individual income taxes, 52 percent favored a new national sales tax on all purchases other than food, and 25 percent did not know. Regardless of the demographic characteristics considered, a statistically significant percent of respondents preferred a new national sales tax over an increase in individual income taxes with a substantial proportion not knowing. The demographic characteristics considered were sex, head of household, age, level of education, household income, home ownership status, race, employment status, occupation, marital status, household size, children in household, region, and nonmetro/metro status. ⁴⁹

The ACIR survey is the only survey in which the public was asked to only select between increasing individual income taxes and establishing a new national sales tax (on all purchases other than food). The ACIR survey also has a detailed breakdown of public opinion by characteristics of households. But the ACIR survey occurred in 1983, and public opinion may change over time.

                               TABLE H1.

MEDIA GENERAL/ASSOCIATED PRESS POLL

Between November 10 and November 20, 1988, Media General Research conducted a public opinion poll for Media General/Associated Press. A representative sample of 1,084 adults were called by telephone from listed and nonlisted telephones. Men accounted for 48 percent of the sample and women for 52 percent. ⁵⁰

The sample was asked the following question:

Here are some possible ways for the Government to raise money to reduce the Federal budget deficit. For each, please tell me whether you support or oppose it.

The public's responses concerning a national sales tax and higher personal income taxes were ⁵¹

                               TABLE H2.

Thus, this poll found that the public support for a NST was approximately double that of an increase in personal income taxes, although both taxes were opposed.

THE HARRIS POLL

Between December 2 and 6, 1988, a Harris Poll was conducted by telephone using a nationwide sample of 1,248 adults. The results of a poll this size have a 95 percent probability of being within three percent of the opinions of the entire adult population. ⁵²

The nationwide sample was asked the following question:

Now let me ask you about specific tax increases that some people feel are necessary to balance the Federal budget and end deficit spending. In each case, the Congress would pass a tax increase that would make sure none of the money raised from added taxes would be used for additional spending. Instead, all of the new tax money would have to be used to reduce the Federal deficit. This tax would be in effect for only three years. If (read specific tax) combined with spending reductions would eliminate the Federal deficit in three years, would you favor or oppose that tax? ⁵³

The sample's answers to this question for a national sales tax or a 10 percent surcharge on Federal income taxes are shown in table H3. Individuals favored a NST over an income tax surcharge by approximately a two to one margin. This approximately two to one margin also existed for those individuals who voted for Bush and those who voted for Dukakis. ⁵⁴

                               TABLE H3.

SELECTED BIBLIOGRAPHY

Aaron, Henry J. The political economy of a value-added tax in the United States. Tax notes, v. 38, no. 10, March 7, 1988: 1,111- 1,115.

____, ed. The value-added tax: lessons from Europe. Washington, The Brookings Institution, 1981. 107 p.

____, The value-added tax: sorting through the practical and political problems, The Brookings review, v. 6, summer 1988: 10- 16.

Advisory Commission on Intergovernmental Relations. Changing public attitudes on government and taxes. Washington, 1983. 59 p.

Brashares, Edith, Janet Furman Speyrer, and George N. Carlson. Distributional aspects of a Federal value-added tax. National tax journal, v. 41, no. 2: 155-173.

Cnossen, Sijbren. The value-added tax: questions and answers. Tax Notes, v. 42, no. 2, January 9, 1989: 209-213.

Due, John F., and John L. Mikesell. Sales taxation: State and local structure and administration. Baltimore, Johns Hopkins University Press, 1983. 350 p.

Focus on the value-added tax. Washington, Coopers & Lybrand, 1986. 34 p.

Harris Poll. Los Angeles, Creators Syndicator, Inc., January 8, 1989. 2 p.

Kotlikoff, Laurence J. Intergenerational transfers and savings. Journal of economic perspectives, v. 2, no. 2, spring 1988: 41- 58.

McLure, Charles, Jr. The value-added tax: key to deficit reduction? Washington, American Enterprise Institute for Public Policy Research, 1987. 184 p.

Media General/Associated Press Poll. Richmond, Media General, November 20, 1988. 5 p.

Modigliani, Franco. The role of intergenerational transfers and life cycle saving in the accumulation of wealth. Journal of economic perspectives, v. 2, no. 2, spring 1988: 15-40.

Musgrave, Richard A., and Peggy B. Musgrave. Public finance in theory and practice. 4th ed. New York, McGraw-Hill, 1984. 824 p.

Tait, Alan A. Value-added tax: international practice and problems. Washington, International Monetary Fund, 1988. 450 p.

Tax Foundation Inc. Facts and figures on government finance. 24th ed. Baltimore, The Johns Hopkins University press, 1988. 359 p.

Taxing consumption. Paris, Organization for Economic Co-operation and Development, 1988. 335 p.

Turner, William J. Designing an efficient value-added tax. Tax law review, v. 39, no. 2, summer 1984: 435-472.

____ VAT: minimizing administrative and compliance costs. Tax notes, v. 38, no. 11, March 14, 1988: 1257-1268.

U.S. Congress. Joint Committee on Taxation. Description of tax bills: S. 353 (Educational Savings Bond); S. 442 (Value-Added Tax); S. 659, S. 838, S. 849 (Estate Freezer); and S. 800 (Moratorium on Certain State Tax Laws). Washington, U.S. Govt. Print. Off., 1989. p. 1-2, 6-31.

U.S. Department of the Treasury. Office of the Secretary. Tax reform for fairness, simplicity, and economic growth. v. 3, value-added tax. [Washington], November 1984. 128 p.

U.S. General Accounting Office. Tax-credit and subtraction methods of calculating a value-added tax; Report to the Congress by the Comptroller General of the United States. Washington, June 1989. 55 p.

U.S. Library of Congress. Congressional Research Service. Value-added tax: tax bases and revenue yields, by James M. Bickley. [Washington] 1989. 8 p.

CRS Report No. 89-52 E

____ Economic effects of a value-added tax on capital formation, by Jane G. Gravelle. [Washington] 1988. 14 p.

CRS Report No. 88-697 S

____ Economic effects of a VAT on small business, by James M. Bickley. [Washington] 1988. 23 p.

CRS Report No. 88-288 E

____ Value-added tax for deficit reduction, by James M. Bickley. [Washington] 1987. (Updated regularly)

CRS Issue Brief No. IB87097

____ The incidence of a value-added tax on the family, by James M. Bickley. [Washington] 1985. 15 p.

CP 1950

____ National sales tax: selected policy issues, by James M. Bickley. [Washington] 1984. 44p.

CRS Report No. 84-141 E

² 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 which has been made by man. The entrepreneur is the decision maker who operates the firm.

³ Numerical examples with explanations of these three methods of calculating VAT are shown in appendix A.

⁴ For a comprehensive comparison of the credit-invoice method and the subtraction method, see: U.S. General Accounting Office. Tax- credit and Subtraction Method of Calculating a Value-added Tax; Report to the Congress by the Comptroller General of the United States. June 1989. Washington, 1989. 55 p.

⁵ Table Bl in appendix B summarizes the selective economic effects of exemption and zero-rating which were discussed in this section.

⁶ For fiscal year 1985, the composition of taxes for all current members of the OECD is shown in table Cl of appendix C.

⁷ A Japanese VAT of three percent began on April 1, 1989.

⁸ Since fiscal year 1985, New Zealand has approved a VAT and reduced individual income taxes.

⁹ This section of this report summarizes and updates the following source: U.S. Library of Congress. Congressional Research Service. Value-added Tax: Tax Bases and Revenue Yield. Report No. 89- 52 E, by James M. Bickley. Washington, 1989. 8 p.

¹⁰ These CRS bases are remarkably close to the VAT bases formulated by Charles E. McLure, Jr., and Richard A. and Peggy B. Musgrave. For a comparison of these tax bases, see: Value-added Tax: Tax Bases and Revenue Yields, p. 2-7.

¹¹ Taxing Consumption. Paris, Organization for Economic Co- operation and Development, 1988. p. 107.

¹² Ibid., p. 36.

¹³ For summary examples of VAT exclusions for 15 OECD nations, see appendix E.

¹⁴ Data Resources, Inc. Forecast Summary. Review of the U.S. Economy. July 1989. p. 7-8.

¹⁵ Taxing Consumption, p. 203.

¹⁶ Ibid., p. 205.

¹⁷ U.S. Department of the Treasury. Office of the Secretary. Tax Reform for Fairness, Simplicity, and Economic Growth. Volume 3. Value-added Tax. [Washington] November 1984. p. 124. (Hereinafter referred to as Treasury I.)

¹⁸ CRS calculation using data from the following sources: Internal Revenue Service. Statistics of Income Bulletin. Summer 1988. Washington, 1988. p. 137; and, Treasury I, p. 63.

¹⁹ Ibid.

²⁰ U.S. Department of the Treasury. Internal Revenue Service. Annual Report 1988. Washington, U.S. Govt. Print. Off., 1989. p. 58.

²¹ Ibid.

²² Taxing Consumption, p. 203, 205.

²³ Taxing Consumption p. 199-200.

²⁴ Ibid., p. 201.

²⁵ For a detailed discussion of these ten types of evasion, see: Tait, Alan A. Value-added Tax: Internal Practice and Problems. Washington, International Monetary Fund, 1988. p. 308-310.

²⁶ Ibid p. 308-314.

²⁷ Brashares, Edith, Janet Furman Speyrer, and George N. Carlson. Distributional Aspects of a Federal Value-added Tax. National Tax Journal, v. 41, no. 2. p. 158-159, 174.

²⁸ Modigliani estimates that at least 80 percent of all savings by households are eventually spent on consumption, see: Modigliani, Franco. The Role of Intergenerational Transfer and Life Cycle Saving in the Accumulation of Wealth. Journal of Economic Perspectives, v. 2, no. 2, Spring 1988. p. 15-23.

²⁹ Tait Value-added Tax: International Practice and Problems, p. 218.

³⁰ Brashares et al. Distributional Aspects of a Federal Value- added Tax, p. 165.

³¹ Aaron, Henry J., ed. The Value-added Tax: Lessons from Europe. Washington, The Brookings Institution, 1981. p. 8-9.

³² Taxing Consumption, p. 276-278.

³³ Ibid. p. 36.

³⁴ Brashares et al. Distributional Aspects of a Federal Value- added Tax, p. 172.

³⁵ Due John F., and John L. Mikesell. Sales Taxation: State and Local Structure and Administration. Baltimore, Johns Hopkins University Press, 1983. p. 65.

³⁶ Ibid. p. 74.

³⁷ Talt, Value-added Tax: International Practice and problems, p. 218.

³⁸ Ibid.

³⁹ Aaron, Henry J. The Political Economy of a Value-added Tax in the United States. Tax Notes, v. 38, no. 10, March 7, 1988. p. 1113.

⁴⁰ Ibid.

⁴¹ Aaron, Henry J. The Value-added Tax: Sorting Through the Practical and Political Problems. The Brookings Review, Summer 1988. p. 13.

⁴² U.S. Library of Congress. Congressional Research Service. Economic Effects of a Value-added Tax on Capital Formation. Report No. 88-697 S, by Jane G. Gravelle. Washington, 1988. p. 2.

⁴³ Aaron, The Political Economy of a Value-added Tax in the United States, p. 1,113.

⁴⁴ 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.

⁴⁵ For a discussion of variables that may affect the size of government, see: Musgrave, Richard A., and Peggy B. Musgrave. Public Finance in Theory and Practice. 4th ed. New York, McGraw-Hill, 1985. p. 146-153.

⁴⁶ Advisory Commission on Intergovernmental Relations. Changing Attitudes on Governments and Taxes. Washington, 1983. p. 4.

⁴⁷ Ibid.

⁴⁸ Ibid.

⁴⁹ Ibid., p. 9.

⁵⁰ Media General/Associated Press Poll. Richmond, Media General, November 20, 1988. p. 1.

⁵¹ Ibid., p. 2.

⁵² The Harris Poll. Creators Syndicator, Inc., Los Angeles, January 8, 1989. p. 1.

⁵³ Ibid.

⁵⁴ Ibid., p. 2.

* Note: Figures may not total 100% due to rounding.