VAT Rates Needed to Erase Obama Deficits

February 16, 2011

Although President Obama's recently released budget includes roughly $1.6 trillion in new tax revenues over the next ten years, it still racks up $7.2 trillion in deficits through 2021. We are often asked what kind of tax increases would be needed to raise enough money to erase these deficits.

Some experts have suggested that the U.S. levy a Value Added Tax (VAT) as a less economically harmful way of raising additional funds to balance the federal books and solve some of our major entitlement problems. (See the recent hearing at the Senate Budget Committee).  So the question is, what rate would a VAT have to be to raise sufficient funds to close the budget deficit over the next ten years?

The chart below illustrates the VAT rates that would be necessary to erase Obama's projected deficits through 2021. (For perspective, the FY 2011 deficit of $1.6 trillion is so large, it would require a VAT rate of 27 percent to raise enough revenue to erase it.) For 2012, the first year of Obama's budget plan, Washington would need a 17 percent VAT rate to close the $1.1 trillion deficit.

In subsequent years, the deficits would require VAT rates between 7 and 11 percent to close them, even though the President's budget assumes higher revenues from allowing the Bush-era tax rates on upper-income households to expire.

Of course, these estimates assume that every dollar raised by a VAT would be used to lower the deficit and not be used to fund new spending. Considering the experiences of other countries who have VATs, this is a big assumption.

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