Special Academic Paper
Executive Summary Despite the passage of recent revenue generating legislation such as the Revenue Reconciliation Act of 1993 (RRA ’93), the U.S. budget deficit remains a concern nationwide. Adding to this concern are the fiscal implications of health care reform. Various 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. es have been proposed in conjunction with health care reform. For example, taxes on cigarettes, ammunition, and payroll have been suggested along with more sweeping versions of tax reform such as the credit-invoice or European-style value-added tax (VAT). In view of this continued discussion about the need for additional government revenue, this paper reexamines the VAT and evaluates the so – called “money machine’ problem.
The automatic growth feature of revenues under the VAT has been offered as both an advantage and a potential disadvantage for this form of taxation. Proponents of a VAT point to the stability of the VAT as a revenue source while VAT critics fear that the VAT will become a money machine in the hands of the government. VAT critics argue that the high revenue yield per percentage of tax rate allows the government to finance a growing public sector by periodically raising the VAT rate with less political risk, because the VAT is less visible to the taxpayer than is, for example, an income tax.
Some European Community (EC) countries have relied on the VAT for more than twenty years. Accordingly, the EC experience is examined in this paper to determine whether the growth of the VAT out paced the growth of other forms of taxation relative to Gross National Product (GNP). The relative growth in taxation to GNP is used to measure changes in tax shares. The original objective of EC countries implementing VATs was to replace other existing forms of 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. es.
To the extent that a country successfully accomplished this objective, the total share of consumption taxes relative to its GNP should have remained fairly constant. If the implementation of a VAT caused any significant increase in the percentage of consumption taxes relative to GNP, then this would provide evidence that the VAT tends to become a money machine in the hands of the federal government. All EC countries that have adopted a VAT have adopted a credit-invoice VAT, under which the tax is calculated and reported based on a paper trail of invoices that develop at each stage of production.
There are, however, other forms of a VAT, such as the subtraction-method VAT and the consumed-income tax which, while having essentially the same tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. as a credit-invoice VAT, may be more similar operationally to an income tax. Only Japan currently employs a non-credit-invoice VAT, though many of these are under active consideration in the U.S. The results reported in this paper clearly extend to the possibility of the U.S. adopting a credit-invoice VAT, but may or may not shed light on the consequences of the U.S. adopting an alternative-method VAT.
The first section of this paper presents on overview of the VAT debate. This is followed by a review of prior research on the VAT. The third section presents the research design used to measure both the changing tax shares in EC countries and the stability of their respective tax systems. Included in this section is a discussion of the concept of tax buoyancy. Fourth, the empirical test results for this analysis are presented. The fifth section discusses the implications of EC VAT reform for U.S. tax policy. Included in this section is a brief review of various U.S. consumption tax proposals.
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