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Would a VAT Increase the Total U.S. Tax Burden?

2 min readBy: Gerald Prante

Most conservatives have long favored moving the U.S. taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. system to more of a consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. and would in theory likely favor a value added tax if it was assured that the revenue was used to replace revenue from some other tax. However, some are worried that a new tax would just “feed the beast” and would not really lead to reductions in the more distortive taxes like the personal income tax and the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. .

But who’s right?

A priori, it’s possible for a VAT to decrease the overall tax burden faced by U.S. taxpayers even if it increased revenues. That’s because a VAT tends to have a lower deadweight loss per dollar of revenue raised than other taxes, especially compared to other taxes at their current high marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. levels.

So from the perspective of those who wish to minimize total tax burden (revenue plus efficiency costs of taxation) and who would thereby ignore the social benefits of any additional government spending, the condition for a VAT to lower the total tax burden if it was used to partially or fully replace the corporate income tax (or any other inserted tax) is as follows:

(VAT_Revenue + VAT_DWL + CIT_Revenue_after + CIT_DWL_after) <
(CIT_Revenue_before + CIT_DWL_before)

The relationship between the “before” and “after” CIT values is obviously dependent on what fraction of the VAT revenue is actually used to replace the CIT. If there was no change in the CIT as a result of the implementation of a VAT, then CIT_Revenue_after = CIT_Revenue_before and CIT_DWL_after = CIT_DWL_before, assuring the VAT would only increase the tax burden. On the other hand, if the VAT revenue was totally used to reduce the CIT, then it would be obvious that the overall tax burden would fall.