New Deficit Reduction Proposal Includes a VAT

November 17, 2010

Hot on the heels of the Bowles-Simpson deficit plan released last week, a group at the Bipartisan Policy Center released its own proposal today to address the United States’ growing national debt. The plan from the BPC Debt Reduction task force, headed by former CBO director Alice Rivlin and former Senator Pete Domenici (R-NM) would cut federal spending in many areas, and would dramatically simplify the federal income tax by lowering rates, eliminating most itemized deductions and replacing others with simplified tax credits, and reducing the number of income tax brackets. In what is sure to be a controversial proposal, the plan calls for making up some of this lost revenue by imposing what it calls a “Deficit Reduction Sales Tax” – in other words, a national sales tax imposed on top of existing state and local sales taxes. To combat tax evasion, it is likely that the tax would take the form of a Value-Added Tax, or VAT- a system where a portion of the sales tax is collected at each stage of production, rather than all at the final sale.

According to the document released by BPC, the VAT would be phased in over two years, beginning with a 3% rate in 2012 and a 6.5% rate for 2013 and beyond. BPC states that this would raise $3,048 billion dollars from 2012 to 2020; according to some quick calculations, I estimate that the tax base for the VAT would have to be approximately 29% of GDP – this assumes the BPC rates are tax-exclusive (the standard for sales taxes) and no tax evasion. This would likely include purchases of durable goods, clothes, and gas, among many other things, but would probably exclude purchases that are commonly exempted from sales taxes, such as groceries, health care, housing, and education.

Fortunately, the Tax Foundation has recently released a VAT calculator that allows people to see how this sales tax could affect their household finances. The calculator is highly customizable, allowing users to pick both the tax rate and define the tax base as a percentage of GDP. The user can enter in the values for BPC’s proposed VAT: a 6.5% rate on a tax base of 29% of GDP, and then enter his or her own financial information – the calculator estimates consumption in 21 broad categories and calculates the VAT burden accordingly. In the near future, we will be releasing a modified version of the income tax calculator on mytaxburden.org that includes the various recent tax reform proposals. Since the purpose of this particular VAT is partially to offset revenue losses from income tax cuts, the two tools combined will help taxpayers get a sense of how these proposals affect them.

Update: Robert Dietz from the National Association of Home Builders writes to clarify: “For what it is worth, the proposal, with respect to housing, excludes rental payments, imputed rent for homeowners, that portion of the mortgage interest payment due to financial intermediation, and the purchase of an existing home — but it would include new home sales and remodeling.”

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