State and Local Impacts of a Federal VAT

There has been ongoing discussion about implementing a federal consumption tax in the United States. One type of consumption tax that has been proposed is a value added tax (VAT). The VAT is widely used around the world. Over 150 countries worldwide, and every member of the Organization for Economic Co-operation and Development (OECD) besides the United States, use a VAT. A VAT is applied to the difference between a business’s sales of final goods and services and its purchase of goods and services (excluding wages).  The key distinction between a VAT tax and retail sales taxes is that VAT taxes are collected at each stage of production, whereas retail sales taxes are only collected at the point of final sale.

A report by the Brookings Institution found that implementing a 10 percent VAT in the United States could raise just over 2 percent of GDP in revenues.¹ This figure also accounts for offsetting adjustments in other taxes and the costs of either cash payments or narrowing the base. One concern that is raised frequently with the possibility of the United States incorporating a VAT is the impact it will have on the states ability to administer their own sales taxes.

Canada provides an example of how a federal VAT along with a variety of provincial VATs and sales taxes is feasible to administer. But the question of whether the added benefits of the VAT are offset by the administrative costs incurred by the lack of uniformity in consumption taxation among provinces (with some choosing to forfeit a retail sales tax and others retaining it).

Currently, Canada has four types of national/subnational consumption tax structures, each of which are administrated differently: a separate federal and provincial VAT, both of which are administered by the province; a joint federal and provincial VAT administered by the federal government; a separate federal VAT and provincial retail sales tax administered separately; and a federal VAT only. This has created administrative and compliance challenges for both the government and businesses. The burden is especially felt by businesses in provinces with a retail sales tax, because they are subject to dual reporting, filing, and remittance requirements.²

The aforementioned report by the Brookings Institution argues that states could avoid some of this burden by converting their sales tax to VATs and piggybacking on the federal VAT.  This could offer advantages to the states, such as lower administrative costs. States could link their VAT tax base to the federal VAT tax base, similar to how many states currently link income tax, and reduce the costs of administering consumption taxes.¹

Introducing a federal VAT tax does not seem politically feasible at this time because of economic instability. However, with the system being widely administered internationally, it is worth analyzing what implications this would have not only for the federal revenue raising system, but also state and local governments.

1. Brookings Institution: "A Value-Added Tax for the United States: Part of the Solution"

2. GAO Report: "Potential Lessons for the United States from Other Countries' Experiences"