Value Added Tax(VAT) in the United States: Tax Policy Reasons and Aspects

The VAT in the United States
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Abstract
This paper examines the United States’ Value-Added Tax regime and the vital policies regarding the VAT system. It is made up of eight sections. Section one introduces the general topic. Section two contains the rationale of VAT including its definition and explanation of the concept. Section three delves into VAT in the United States including the history, current status, tax policy behind it and insights into why the U.S. is the only OECD member state that does not apply the VAT system. Section four handles VAT outside of the U.S. with a keen focus on the VAT status in other OECD countries. Section Five delves into the proponents of the VAT in the U.S. including various scholars’ theories and tax policy reasons behind their argument. Section Six is about the opponents of VAT in the U.S. including different scholars’ theories and tax policy reasons behind their contention. Section Seven is a discussion of possible tax policy issues regarding the VAT while Section Eight offers and overall conclusion.
Introduction
The concept of value added tax (VAT) stems from a German businessman, Von Siemens’ writings in the 1920s. However, it was until 1948 that the first VAT was applied in France. Initially, France employed VAT that was GNP-based that covered up to manufacturing level before completely replacing it in 1954 with a consumption VAT. Throughout theory and research, it is evident that to establish an efficient system; the VAT must be broad, based on consumption and applied up to the retail phase.

Evidence shows the link between a country’s advancements and its VAT performance (U.S. Chamber of Commerce, 2010). There is a possibility of higher VAT revenue gains in economies with higher literacy, per capita income level and reduced agriculture share. Thus, VAT is one of the efficient revenue collection tools and fiscal mobilization, development and stability are directly dependent on the VAT performance.
In comparison with the other indirect taxation approaches, the potential revenue from VAT is much higher. Basically, it is because it is quite broad and tracks numerous invoices to ensure sound tax enforcement and individuals are fully complying. Moreover, VAT possibly eliminates the common cascading challenge encountered in turnover tax. Except the United States, OECD member states have identified VAT as their choice of taxation (Engel, 2012). These countries still use the income tax collection, but the revenue collected by VAT has significantly risen over the years. VAT is also used in developing countries which primarily depend on sales tax compared to industrialized countries. With most companies incorporating VAT in their tax collection approaches, it is an indication of how successful it has been in tax collection.
The Rationale for VAT
Ideally, VAT is a type of indirect tax that is usually collected at different production-distribution chain stages. VAT best works with proper structures put in place to ensure that tax is collected at all stages based on the values added at each stage (James, 2011). Therefore, it only varies in the design of implementation, but VAT is almost similar single stage retail sales tax. Discussed below are some of the great rationales for a VAT.
VAT as an alternative to other inadequate indirect taxes
Most of the countries which are utilizing the VAT taxation approach are dissatisfied with turnover tax and single-stage sales tax. These other methods have been challenging regarding economic inefficiency or revenue leakage and sometimes both. An illustration of problems of single-stage and turnover taxation demonstrates the advantages of VAT.
Turnover taxation
All through the production-distribution chain, the tax is levied at each stage. Usually, the tax imposed at any single stage is an accumulation of the tax at the previous stages as well as the value of the products (Graetz, 2002). This type of taxation is marred with the cascading effect or tax on tax problem. All through the chain, there are taxations distortions which make it less efficient.
Single-stage taxation
Taxation may be at the manufacturing, retailing or wholesale stage. Single-stage may look efficient because of the elimination of the cascading effect and also requires fewer administration costs. It, however, harbors numerous potential challenges.
For instance, ring-fencing is necessary at the manufacturing level taxation to eliminate any bias on capital as well as stopping the increase of the price. Efficient surveillance is equally necessary to prevent distortion of the tax base through reselling of the inputs (James, 2011). On the same not, taxation at the wholesale phase also poses some challenges especially because the stage is not clearly defined yet. To collect maximum taxes at these two stages then it will mean imposing very high rates. But with high rates, it creates more room for avoidance and evasion whereby individuals would lower prices at the taxation stages and raise them up at untaxed stages.
However, the retail sales tax that is vastly used in the U.S calls for extensive registration. Evidence shows that two conditions must be upheld including the use of a standard rate of tax as production, savings and consumption should be exempted from taxation. According to
In his brief ‘Retail Sales Tax’, Mikesell suggested that to ensure effectiveness in the economy of any retail sales regime, the two fundamental principles should be strictly upheld. First, there should be uniform tax rate applied and second no tax charges should be imposed on savings, consumption or production. Practically, the two conditions are very hard to meet because most taxation systems contain several rates and exemptions. Thus, it is quite challenging to differentiate between production purchases which should be exempted and consumption which should be taxed.
Single-stage sales taxation faces the high chances of revenue leakage. It is particularly true if there is strictly one stage of tax collection. In the same regard, some business may successfully fall out of the tax net which consequently reduces the revenue collected (Graetz, 2002).VAT thus remains a safer approach in comparison with the alternatives because it is very broad and encompasses both goods and services. Moreover, it is almost practically impossible to experience revenue leakage because it is invoice-based. Therefore, the VAT is a much potentially viable option compared to the alternatives.
Invoice-based credit VAT as an efficient self-enforcing approach
Principally, VAT is regarded as self-enforcing usually because of the invoice-based credit it applies. Technically, any business that is taxable can only request a refund of the VAT input if the details provided are supported by the purchase invoices (Graetz, 2002). At such, most organization are encouraged to keep their invoices for the authorities to cross-check and ensure compliance. But still, issues of ghost invoices and manipulations are commonplace.
The VAT has its own inadequacies especially regarding administration, but studies show that it is one of the most effective tax collection methods. Most of the countries employing the VAT system started out by acknowledging the numerous loopholes in their existing sales tax system and needed reforms taxation (Engel, 2012). After some time, however, the VAT system proved to enhance revenue especially because the compliance levels were high. Studies show that the VAT system has worked in most regions except for Russia, Central Europe and some nations in the former Soviet Union. The VAT system also promises the reduction of the income taxes which makes it more stable and politically acceptable.
No distortion of consumption savings or investment decision in consumption-based VAT
VAT is a consumption tax thus does not discriminate on investments or savings as they are exempted from the base of consumption VAT.
VAT on destination principle
On destination principle, VAT applies zero rates on exports. If proper structures are established, the zero rating plan eliminates exports from any VAT burden (Gale & Harris, 2013). Ideally, there is not VAT applied on exporters but can still claim for a refund in the event all the VAT is paid on their input purchase but only when done promptly.
III. Value-Added Tax System in the United States
The United States steps towards introducing the VAT regime have continually been marred with heated debates. There has been continuous efforts and conversations about replacing the existing revenue collection approach with VAT in an effort to reduce the revenue loss through income tax. (Gale & Harris, 2011). The debate has also been motivated by the desire to save the long-term fiscal situation of the nation.
Globally, more than 160 countries have espoused the consumption tax regime particularly Value-Added Tax. Except for the United States, every member of OECD employs a VAT approach (James, 2011). In these countries, VAT is the third largest revenue resource behind payroll and income taxes. Statistics show that in 2012, cutting across all the governmental levels, the revenue generated from VAT in the OECD countries averaged 5.5 percent and 17 percent of the GDP and total revenues respectively.
The U.S government has been entangled in a financial crisis, and it is looking for other means of collection more revenue. The national debt has been on the increase to unsafe levels. Several revenue collection plans that have been thoroughly examined to determine their viability (Graetz, 2002). For instance, imposing higher taxes on the wealthy or even making a complete overhaul of the international tax provisions in the U.S. This has been marred with cold reactions especially from critics who are not fully convinced about their productivity.
Lately, in the rigorous debates going on about the U.S. financial situation, VAT has increasingly been mentioned as one of the possible approaches that would save the current situation. Some individuals suggest VAT as a parallel system while others indicate that it should completely replace the current income tax. Some of the recent examples include Senator Ted Cruz’s Business Flat proposal which is a VAT approach that would entirely replace the payroll and income tax (Graetz, 2011). Senator Ben Cardin also proposed the Progressive Consumption Tax that would introduce VAT and utilize the revenues to exclude most of the households from personal income tax. Currently, most of the U.S. tax policy commentators argue that the introduction of VAT is almost inevitable. Thus, there is no doubt about most Americans considering the possibility of introducing VAT into the taxation system.
3.1 History of the Value-Added Tax
The VAT’s origin has always been attributed to Wilhelm Von Siemens and Thomas, S. Adam. Siemens’s VAT idea was an advancement of the turnover taxation approach (Gale & Harris, 2013). The VAT would counter the cascading effects that resulted from the existing tax methods. Adams’s idea of the VAT was the business income tax replacement. He emphasized on the governmental tax policy which needed reforms.
With different adopting the VAT concept in varied ways clearly, depicts the distinct motives of the two innovators. For instance, Western European nations including France and Germany adopted the VAT system as an alternative to the existing tax regime. The U.S. tax policymakers, however, only considered it as complementary to the federal income tax yet its implementation has never been implemented.
3.2 The Taxation system in the U.S.
American currently pay a plethora of taxes ranging from payroll taxes to the alternative minimum taxes. All these taxes never existed, and first American had the privilege to enjoy no taxes (Gale & Harris, 2013). So many changes have happened since then including introducing taxes and increasing them which resulted in the tax regime that currently exists.
The estate tax is one of the oldest taxes in the U.S. that was passed into law in 1797. Later it was repealed and reconstructed through the years often directed by the finance war requirements. In 1916, the modern estate tax was implemented and later in 1924; the gift tax was enacted. The federal and the corporate income tax were passed into law in 1913 and1909 respectively (McLure Jr, 2005). Multiple taxes were passed in the 1920s and 1930s including the Sale taxes and social security taxes. In 1978, the Alternative minimum tax (AMT) which is one of the federal income taxes was enacted to prevent individuals from evading taxpaying.
Through the years, the amount of taxes that American taxpayers pay has considerably increased. The establishment of the federal income tax was an attempt to raise funds for the first world war, but the tax rates were somewhat lower than it is today(Graetz, 2002). For instance, the marginal tax rates on income between $20,000 and $30,000 was only one percent while for the income between $50,000 and $75,000 was three percent. During this period, there was not any clear disparity in the taxes paid by various people. Issues of filing status, the distinction between single taxpayers, joint filing for married taxpayers and so on were not experienced. President Reagan adopted the Tax Reform Act in 1986 while the Revenue Reconciliation Act was passed by President Bill Clinton in 1993. Tax rates were shockingly high by 2009 at 35 per cent and the modern tax rates became dependent on filing status.
3.3. Administration Panels on VAT over the years
There have been several congressional national sales tax proposal primarily to finance the wars carried out by the U.S. Some of them include 1862 civil war and 1942 second world war funding proposals. None of them was passed into law because the Treasury Department rejected them. In 1969, President Nixon was in office, and there were reports about his administration considering a federal VAT where the revenue will be shared by local governments and the state (Schenk, 2011). It was to fund the learning system and to abate the dependence on property taxes. According to studies done, the VAT plan was stalled and ultimately because the professional tax payers including accountants and lawyers were not aware of VAT. Later on, President Nixon appointed a tax force to look into the VAT tax policy. The task force did not agree on whether the VAT system should be incorporated partially or entirely replace the corporate income tax system.
In 1971, a special subcommittee was established by the American Bar Association. It was tasked with examining the VAT system and demonstrating to the Treasury and Congress its potential (Gale & Harris, 2013). The Congress had a hiring on Nixon New Economic Policy that included exporter’s tax benefits but not none for the VAT action plan. The Advisory Commission on Intergovernmental Relations denied Nixon request to replace the residential school property taxes with federal VAT. The commission cited that the federal VAT plan was unnecessary and undesirable.
In January 1977, William E. Simon who was then the Treasury Secretary provided a document which demonstrated fundamental principles for tax reforms. The document had discussions on the possibility of using cash flow, the broad-based consumption tax that would replace income taxes on trusts, corporations, individuals and households (Schenk, 2011). Unfortunately, this consumption tax never received any action by the committee. In 1984, plans were in place for significant tax changes and did away with the income tax system. The Treasury presented to President Reagan a three-volume report that covered VAT at the third volume. The Treasury would not suggest the adoption of the VAT that was common in Europe as an alternative to the income tax because it felt that it was not repealing it.
Congressional Kemp Commission would reiterate on the same in 1996 as it suggested a system that was fair and simpler. The year before 1995, the House Ways and Means Committee Chairperson Bill Arener held a meeting about establishing a consumption tax to replace the income tax as he expressed commitment to solving the taxation problems at the roots. In 2005, President George W. Bush formed his Advisory panel on tax reforms which was tasked with developing a tax system that was simple, far and economically viable. The panel considered a credit invoice, a limited VAT alternative and a corporate income tax reduction. However, the panel failed to support it unanimously and was not recommended but rather welcomed more research on it. Instead, the Growth and Investment Tax plan was recommended and ideally it did not include sales tax or federal VAT tax but its adoption would be very close to consumption-bases tax.
The debate on whether the United States should shift its tax system to territorial from the current worldwide concept has been on-going for so many years. Currently, the system imposes a tax on the U.S. companies on a global income scale employing the foreign tax credit to avoid double taxation. The Growth and Investment Tax (GIT) on the other hand is territorial-based. The GIT has features almost related to VAT although it cannot be classified as VAT.
Leonard Burman who was a witness to the debate on national health care plan facilitated by President Obama and the Congress, suggested the introduction of VAT to finance the plan. His estimation was around 10 percent of VAT would cater for everyone that did not have a cover at the moment with the government healthcare insurance (Schenk, 2011). Burman also suggested that combined refundable tax credit for the lower-income household and VAT would be stepping in the right direction. A task force was established by President Obama who was led by Paul Volker from the Economic Recovery Advisory Board that would deliberate on the best possible ways of narrowing the deficit. He reiterated that the proposed tax reforms must not violate his pledge of minimizing the tax charged on households that make less than $250,000 in a month.
3.4 VAT in the United States currently
VAT’s acceptance has been on the rise in the recent years. However, policymakers in the United States are not fully convinced about its viability regarding revenue collection. To unravel the intricacies of the VAT system, there has been numerous studies done by individuals and agencies affiliated to the government and otherwise (Toder Nunns, & Rosenberg, 2012). Moreover, countless proposals about reforming the taxation system to a consumption-based have been presented, but none fell in favor of the Congress. The whole situation creates doubt about the possibility of the United States very taking the VAT debate seriously.
Most of the VAT proposals in the United States are focus on fundamental tax reform. Currently, the bone of contention regarding adoption of VAT is how the state administration and local sales taxes will be coordinated with the federal VAT tax. The other issue is about the federal VAT shrinking the sales tax bases under the revenue estimation assumption and procedures. The Congress probably demands more solid evidence before considering the VAT system.
IV. VAT outside of U.S.
Japan has the highest corporate tax rate followed closely by the U.S. The U.S average combined rate is 39.3 percent which makes it greater than all the member states of the OECD (Toder Nunns, & Rosenberg, 2012). Moreover, the U.S is the only superpower nation that has not incorporated the Value Added Tax (VAT). All OECD member nations adopted VAT, and that includes Mexico and Canada who are part of the North American Free Trade alongside the United States. The European Union has 27 member states and has the provision that all member states must adopt a VAT to ensure the tax imposed on locally produced services and goods is at par with the tax on imports and also ensure that the exports are not taxed.
The Rise of VAT
At a national level, the VAT was first introduced in 1954 in France. It has limited coverage, and until 1968 France was applying partial VAT and did not consider applying it in the broader retail arena. In 1967, VAT was first passed, and before Denmark sort membership at the European Economic Community, it adopted the VAT system. (James, 2011). The implementation of the VAT occurred in two legs. In the 1960s and 1970s, the first progression occurred and was primarily in Latin America and Western Europe. EEC had stipulations that all member states should adopt the VAT system which led to most of the Western European countries to adopting it.
In the 1980s, the second phase occurred which included the adoption of VAT in other industrialized nations outside the European Union such as Australia, Japan, Switzerland, and Canada. During this period, other developing and transitional economies including Africa and Asia adopted the VAT system.
The key influences in the adoption of VAT so rapidly are the World Bank and IMF. The United States policymakers also played a significant role in promoting the VAT system. Shoup Mission pioneered although failed at introducing the VAT system after World War II when the United States occupied Japan (James, 2011). USAID was also instrumental in promoting VAT provision of technical assistance and funding to transitional and developing economies. Ironically, the tax policy experts in the United States have exported abroad the tax reform that they avoided at home.
Most of the countries that adopted the VAT regime because they agreed it best-suited their economic requirements. There is a uniform VAT rate throughout the production process to the retailing stage. (Toder Nunns, & Rosenberg, 2012). Additionally, the exclusions are reduced, and the tax is levied on a wider goods and services. Unlike the U.S. system of taxation which imposes taxes only at the retail stage, VAT is levied at each stage of the production-distribution chain.
Currently, Japanese, New Zealand, and Canadian models are the principal VAT models. The New Zealand model is the most preferred since it only levies a single tax rate on a vast base. However, most economies adopted the European model which has varying degrees of exemptions and multiple rates. Ideally, VAT models are different especially on the thresholds, coverage, rates, refund and exemptions. In some case, the VAT is limited to the wholesale or manufacturing level.
It is imperative to note that a nation’s administrative capability determines VAT’s income generating capacity. Consequently, countries with weak administrative structures record lower revenue. However, high administrative economies are not immune to tax avoidance and evasion which usually step from the manipulation of the credit invoice mechanism by the taxpayers.
The global absorption of VAT has been attributed to it being the best broad-based consumption tax method, its neutrality towards exports as well as its capacity to raise revenues. There in increased championing of the VAT virtues which inevitably overlooks why most VAT regimes depart from the standard policies (Toder Nunns, & Rosenberg, 2012). For instance, during the VAT adoption in Europe, it was not a direct transition from the existing one but rather it happened in phases. Thus, the various reduced rates and exemptions experienced in Western European Vas are basically as a result of the initial turnover tax.
There was prolonged and fierce opposition experienced after the national broad-based consumption was introduced in industrialized economies such as Japan and Canada (James, 2011). For instance, in Australia, the resistance was demonstrated by excluding essential services including food from the VAT base which was an attempt to minimize the objection to the VAT regime. Japan used the Subtraction VAT method while Canada took longer to harmonize the VAT tax and sales. The United States is at a point where tax reforms are inevitable, and insights into the tax systems of countries using the VAT is very essential because it will define the next step for the U.S. It is particularly effective when the information is from the partner members of the OECD.
V. Proponents of the VAT in the United States
The United States has encountered instability in its financial situation having recorded a deficit in its budget. Economists argue that if the current situation is not attended to, then the economy will be adversely affected (Schenk, 2011). Ideally, the most viable option of closing the gap is by raising taxes or reduce the spending. The federal VAT is one of the recommended constructive solution to the elaborate fiscal problem in the United States.
5.1 Revenue
Most of the financial analysts recommending adoption of the VAT have recognized the inadequacy of the income tax and argue that the Vat will be very instrumental in bridging the gap between the U.S. revenue and spending (Graetz, 2011). Some of them include liberal economist Bill Gale and conservative Bruce Bartlett who proposed a VAT regime as a solution to minimizing the U.S. deficits and debt. Len Burman made a proposal about generating funds specific programs including the health care by adopting the VAT system. Research has it that there are large amounts of revenue being collected by VAT and also does not hurt the economic system.
Those who support the VAT system in the U.S conceptualize that the proper design of the VAT may assist the U.S. deal with its fiscal problems. It is also argued that phased-in VAT enhances the pace at which the economy recover (Schenk, 2011). Statistics from the OECD members that have adopted the VAT system indicate that in 2006, VAT increased the GDP by almost seven percent in revenue and around 19 percent increase at all government level. The revenue generated from VAT relies on the base and structure as it is the case in any other tax. Statistic obtained from the OECD member states suggest that there has been stability recorded on the standardized VAT rate through the years.
The VAT yield ratio is used to measure the amount of revenue that has exclusively collected from VAT. It is obtained from the VAT revenue as a GDP share divided by the standard VAT rate. In 2006, the OECD nations recorded yield ratio ranging from Mexico with 0.28 while on the high is New Zealand with 0.69. The rest of the members fell within 0.3 to 0.4. The yield ratio is very dependent on how broad the VAT base is maintained and eroded by exemptions on goods and services as well as preferential rates (James, 2011). Even in the OECD countries, there is the application of preferential rates on various items. For instance, in 2007, the 29 OECD members with VAT had 17 zero rated some items. It was only in the Slovak Republic and Japan that do not administer preferential rates.
In 2015, research showed that if the United States adopted the VAT system, it would increase the gross revenue to $355 billion (U.S. Chamber of Commerce, 2010). It would be through application of a 5 percent VAT application to a broad base which would include any consumption except Medicare, charitable organization, Medicaid, the state and local government, education and charitable organization.
5.2 Efficiency
The Vat system is believed to be very efficient. With a broad-based VAT, there is the uniform levying of the tax on all goods and services thus the possibility of distorting the relative prices on consumption goods is very dismal. In the same light, a constant tax rate over a period will not interfere with the saving preferences of households (Toder Nunns, & Rosenberg, 2012). A VAT would not similarly destroy business choices concerning organizational form, financing instrument and new investments. However, just like the payroll or income taxes, the VAT would possibly affect the household choices between leisure and work. The VAT is also border adjustable which makes it possible to exempt exports as well as tax imports.
Various studies have been done on the theoretical linkages between consumer behavior and consumption taxes. For instance, a study was done by Lewis and Seidman (1999) and examined the influence of the shift from income to consumer tax on the saving elasticity. The authors’ conclusion was that regardless of the elasticity of savings, the conversion always maintained a steady-state capital/ state ratio. Mutsuzaki (2003) carried out a study on the effects of the consumption tax on demand under stagnation. The author concludes that an increase in the consumption tax on wealthier households does not influence their consumption since the marginal utility of money in such scenarios goes to its lower bound (U.S. Chamber of Commerce, 2010). On the other hand, increasing the consumption tax on poor households yield two possible scenarios include an increase in the marginal utility of money which reduces consumption and also the redistribution effect that leads to an increased consumption of poor households.
There is substantial literature basing on simulation models and economic theory which demonstrates the probable efficiency benefits obtained when an income tax system is substituted with a broad-based consumption tax (Graetz, 2011). The benefits stem from a mixture of eliminating distortion in saving behavior, widening the tax base and imposing the tax on existing wealth just once. Taxation on wealth that is accumulated is a lump sum tax and are mostly preferred because they are efficient and do not distort the economic preferences. Usually, it creates consumption tax which increases the useful gains.
A short-term fiscal stimulus would boost a lagging economy. However, large and persistent deficits will eventually have a grave effect on the economy. Several studies have been done on the same and show that investors are worried about the increasing deficits which might lead to a financial crisis. Analysts support the VAT system is also based on the same understanding.
5.3 Low Cost of Enforcement
It would cost less to administer a broad-based income tax compared to the existing income tax. For instance, in the United Kingdom, the cost of enforcing the VAT was lower by half compared to those of the income tax. Likewise, in New Zealand, the revenue department used 25 percent of income tax returns but only three percent of the VAT returns (U.S. Chamber of Commerce, 2010). Calculation of VAT is very direct and to receive refunds, all businesses need to do is produce their invoices. The standard VAT used in Europe and around the world is the Credit Invoice VAT that employs a tax-against-tax method to calculate tax liability for businesses. For audit purposes, tax authorities rely on invoices which they use to verify tax compliance. Ideally, the VAT is in two forms including the tax collected at the border on imports and domestic supplies tax usually overseen by the tax administration.
VI. Opponents of VAT in the U.S.
Most of the proposition provided to explain the viability of the VAT regime have not been tested and proven to be effective. It has been a continuous debate on the potential the VAT system presents including the neutral treatment of exports which makes it the best option for a globalized economy (Graetz, 2011).The proponents of the VAT have failed at fully convincing the skeptical U.S. public thus failed to win the domestic political acceptance.
The United States has notably been resistant to a federal VAT regime. Whenever there was a VAT-based reform proposal raised right from President Richard Nix to Barack Obama, it has always faced the same opposition (McLure Jr, 2005). Some of the views raised by the proponents are the fear of the administrative burden and complexity of the VAT regime. The state and local governments have also raised concerns about balancing the sales tax area intrusion and the federal taxing power. The opposition from the liberals is based on the regressively that a VAT system is perceived to have. On the other hand, conservatives have fears about the VAT’s perception as a money machine would perpetuate government growth.
6.1 Offsetting Policies and Distribution Effects
Theoretically, the VAT’s distribution burden is dependent on the way household resources are measures. Ordinarily, the distributional analysis made consider the current income. VAT would be regressive whenever the households are classified and the tax burden measured as part of the existing income. VAT is directly proportional to consumption, and since poorer households spend more compared to richer households, the VAT burden on the low-income household is higher.
The other possible perspectives include VAT as a proportional tax when households get taxed at the same rates on the consumed amount. For instance, assuming that the current consumption reflects an average lifetime income then the VAT will be proportional with regards to lifetime income (Graetz, 2011). Additional, opponents back up their argument with issues of fairness and a one-time burden especially if the tax is levied on a person’s current wealth. The elderly will be part of the collateral damage in this case because there is relativity regarding consumption and an individual’s income. But with the Social Security and Medicare gains meant for them, the situation can be salvaged.
Regressivity is also among the chief concerns regarding VAT. The OECD have handled the regressivity issue by offering zero or preferential rates on food or healthcare items and other essential services in an attempt to enhance progressivity (Nunns & Toder, 2016). The approach has however been somewhat ineffective since most of the products with preferential rates are consumed by the wealthy and medium-income taxpayers but not the poorer ones. Other issues are regarding the complexity of the VAT system and the fact that consumers tax-preferred good over fully-taxed ones thus inviting tax avoidance. There is also the problem of policymakers not been able to characterize products properly. For instance, Halloween costumes can be classified as clothing while other as toys thud if the clothing is exempted from VAT, the toys including the costumes would not.
6.2 Issues with administration
There are the compliance burden concerns raised through theory and evidence, particularly on small enterprises. The matter is handled by most countries including the 29 OECD member countries by exempting the small businesses from collecting the VAT.
6.3 State Concerns
Some opponents have raised concerns regarding the national VAT impinging on state’s ability to administer their sale taxes. Ideally, states do not have proper structures put in place for the revenue collection (McLure Jr, 2005). However, with a systematic VAT regime, it would be easier to maximize the revenue collected which is beneficial to the respective states. Moreover, tax collection will be more efficient since the hard-to-tax sectors including internet business will be included, and the cost of administration will be lowered. The federal government can collect the revenue on behalf of the states then reimburse them for administration costs, or the states would independently maintain their VAT bases.
6.4 VAT’s ability to produce more revenue
It would probably help close the deficits that the U.S. is experiencing. However, it would also lead to issues if the increased revenue increases the unsustainable ending by the federal (Nunns & Toder, 2016). Some analysts are opposing the VAT regime primarily on the grounds that ‘starve the beast’ theory cannot apply to taxes thus it is impossible that extra revenue would lead to a small government. According to Romer and Romer (2009), tax meant for long-run growth does not result in a reduced spending by the local government. Other studies supported the finding, for instance, the fact that the existing system has a fiscal system that is very coordinated and whenever there was cut tax then it resulted in increased spending and increased tax resulted in reduced spending.
Other analysts also argue that the fact that VAT is an invisible tax and quite efficient, it would be easier for the federal governments to use it for increased government spending. Studies have shown that in the OECD countries that adopted the VAT system, most of them in the earlier stages in 1970’s during the high-inflation increased their VAT but a different scenario was observed for countries that adopted a VAT system after 1975. The post-1975 period had 17 OECD countries adopting the VAT system but four decreased their VAT, and another four have not changed the rates.
6.5 Transparency
Concerns about the VAT being hidden in overall prices and the fact that it would enable increased spending. With this, it would be difficult for taxpayers to notice how VAT is spent and would ultimately allow the Congress to increase the VAT easily and the taxpayer would not have any grounds to resist ( Nunns & Toder, 2016). However, this can be addressed by ensuring the VAT is very visible. For instance, in Canada, the VAT is printed on the receipt that the consumers are given. Also, the VAT rates and revenues can have links that are transparent with spending on certain goods. The VAT related to the health care proposal had provisions of ensuring the cost of VAT as well as government spending were transparent.
6.6 VAT’s role in Inflation
There have been notable concerns about VAT adoption enabling the business to raise their prices possibly triggering long-lasting inflation. With add-on VAT, there will be pressure created by the prices (Nunns & Toder, 2016). In the event the federal government fails to accommodate the one-time price, there would be unnecessary and significant adjustment costs regarding lost wages and jobs. Evidence on the possibility of the VAT system increasing the continuing inflation is limited thus it more research should be done on the same.
VII. Discussion of possible tax policy issues regarding the VAT
7.1 Principles of Tax collection
Under the destination principle usually, the consumption stage is where the VAT is levied. To establish an efficient VAT system, then the destination principle is a more viable option. It taxes exports and zero rates imports (Nishiyama, 2012). There are border tax adjustment requirements although there are no provisions demanding from exporter to under-declare or importers to overvalue their products and services. With a proper VAT application, then the inputs are freed any tax burden. Thus, the destination principle supports production efficiency.
The origin principle imposes a tax at provides that the tax is charged at the production phase. In this regard, the imports are not taxed, but the exports are subject to tax (Nunns, & Toder, 2016). With the origin principle, there is global consumption efficiency since consumers in various countries are faced with the same consumer prices the tax rates in different countries notwithstanding. Moreover, there are no border tax adjustment requirements under the origin principle which promote smoother trader.
Some regional trade associations and federal governments employ a mix of the destination and origin principles. Most member nations favor the origin principle for their transaction whereas the non-member nations choose the destination principle. Brazil, for example, applies the origin principle for its VAT system.
7.2 VAT exemption
The cascading effect would be avoided with a non-exemption VAT and consequently no distortion in production. Moreover, a broad-based VAT reduces the inherent deadweight loss that characterizes any form of indirect tax (Mesdom, 2011). However, VAT exemption erodes the tax base and reduces the collected revenue, destroys the VAT chain and introduces the cascading effect. But still, in practical terms, the exemption is very common and covers items such as education, health, and financial services.
VAT exemption is the preferred option for reducing the VAT regressivity. Education, unprocessed and staple foods as well as public health service are among the items that are not taxed. Usually, they include items consumed by households which record low income. Most states consider VAT exemption administratively and economically viable unlike reduced rates or zero rating on services and goods (Nishiyama, 2012). The VAT exemption is economically efficient especially in public health and learning services because ideally, they should not bear any tax burden and also deserve the federal subsidies. Regarding revenue loss and tax administration, the exemption is less costly compared to zero-rating. It is also simpler and easier to get political acceptance from the public. In the VAT policy design, the exemption is one of the attractive options, but it remains very difficult to quantify its effectiveness. The exemption also generates another technical problem regarding compliance and administration particularly in the even a form produces both taxable and exempt items. Thus, the exemptions create various effectiveness and efficiency issues and consequently erodes the sustainability and integrity of the VAT system. Therefore, for a more efficient VAT system, exemptions should be minimized to the bare minimum.
7.3 Treatment of hard-to-tax sectors
Financial, housing, and agriculture sectors are some of the areas that are quite difficult to tax because of the high costs of administration required. Moreover, the taxpayers’ compliance charges in these areas are prohibitively high.
Financial sector
The invoice-based credit method is not effective in the financial sector (Merrill, 2011). With so many inherent problems within the financial sector, in most cases, the financial sectors are exempted except fee-based services such as safekeeping and brokerage.
Agriculture
The agricultural sector has numerous social, political and technical reasons that make it difficult to be taxed. Some of them include that it is an informal sector and the poor are the most actively involved in this area (Nishiyama, 2012). The sector also needs favorable consideration because of political reasons particularly in the developing nations since it is where most of the constituents’ interests lie. Most countries exempt the agricultural sector from VAT but with strict monitoring to ensure that it is limited solely to inputs used for agricultural purposes. This is, however, a challenge because, with various exemptions, the VAT regime is exposed to abuse. Thus, exemptions in the agricultural sector should be strictly on agriculture-related inputs.
Small enterprises
There is a huge compliance charge, imposed on small enterprises in particular for traders who lack adequate resources to ensure that their transactional records are well maintained, and they comply with the accounting rules (Gale, Gelfond & Krupkin, 2015).There is a threshold set which determines what businesses would be exempted from taxation. The threshold, however, differs in various countries depending on economic structures and administrative tax capacity.
Housing sector
While the office buildings are completely taxed, rent and residential buildings are exempted from taxation (Nishiyama, 2012). To impute the rent values for owner occupation would require subjective house valuation and extensive information which makes it tough. To ensure equity, if the rented units are exempted from tax, then the residential buildings should also be exempted. However, different countries including the OECD members treat the real estate VAT system differently.
Public sector
Ideally, the public sector should not receive any special provisions or tax exemption. With full taxation treatment in the public sector, it preserves the VAT chain and enhances tax neutrality across both private and public sectors. For instance, New Zealand has been at the forefront of ensuring both the public and private sectors are effectively taxed.
7.4 VAT’s Rate Structure
A multiple rate structure is very complex but usually supported because of its efficiency and equity. Ideally, tax rate and demand of the good are inversely proportional (Nunns, J., & Toder, 2016). However, the tax rate differentiation helps in avoiding the VAT regressivity thus lower tax rates must be applied to goods and services consumed by the poorer individuals. The challenge with a multiple tax rate structure is however about administration and compliance challenge. The multiple tax rate system is, however, the most adopted in most countries.
Conclusion
There has been an increasing number of nations adopting the VAT regime around the world. Moreover, most of the discussions on tax reforms have always had the VAT systems as one of the viable options. In the United States, there is a dire need for tax reforms, but any VAT recommendation has always faced opposition. But still, economic analyst are advocating for the VAT system because of the various benefits the U.S would probably gain from it. It is argued that the revenue that will possibly be collected from VAT would be sufficient enough to cater for the long-term fiscal gap that the U.S has been facing and also would enhance the state-level sales taxes. It will also send a political statement about policymakers being willing to increase savings and reduce consumption. The current economic challenge in the U.S.is dire but adoption of a VAT system is only productive when the economy is normal and not during the recession. However, the VAT is only part of the solution, but there are so many other numerous solutions to the existing fiscal problem. But still, when the policymakers oppose the VAT system they are making an assumption about how dire the economic situation is and also that there can be other better ways to handle the situation. The economic costs resulting from the fiscal unsustainability are vast, and as long as the policymakers have not provided a better alternative to solving the current financial crisis, then they should probably reconsider the reliable VAT regime.

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