This report examines the effects of imposing a new value added tax (VAT) in the United States and using the revenue raised to lower payroll tax and corporate income tax rates. We summarize how different forms of VAT operate and compare how a VAT, payroll tax, and corporate income treat different sources of income and the different ways each tax distort economic decision-making.
We then present estimates of the revenue effects from a VAT and the reduction in payroll and corporate income taxes that a VAT could potentially finance. We examine several prototype VAT bases, including a broad tax base on just under 80 percent of consumption and a narrower tax base on about 50 percent of consumption that reduces adverse impacts on low-income households by exempting housing, food consumed at home, and medical expenses, other than those already financed by government. We also examine an alternative in which a broad VAT base is combined with a per-capita refundable tax credit instead of exemptions of necessities as a method of relieving the burden on low-income taxpayers.
The estimates in this report are “static” estimates, meaning they assume no behavioral response. We discuss, but do not estimate, potential behavioral responses to a VAT and how they might affect revenue raised and economic performance. We also briefly discuss the effects of adding a new VAT on administrative and compliance costs.
A major concern with a VAT is that it could be regressive, raising tax burdens proportionately more on lower income than on higher income taxpayers. The report provides estimates of the distributional effects by income group of substituting a VAT for cuts in employer contributions to Social Security taxes, the corporate income tax, and a combination of the two taxes.