What VAT Rate Could Solve CBO’s Long-Term Budget Outlook?

July 1, 2010

Yesterday, the Congressional Budget Office released its long-term projections of federal spending and tax revenues under different scenarios. As has been the case for many years now, CBO's projections show an unsustainable budgetary path for the next 75 years.

CBO charts two possible long-term paths, the extended-baseline scenario and the alternative fiscal scenario. The extended-baseline scenario "adheres closely to current law. It incorporates CBO's current estimate of the impact of the recently enacted health care legislation on revenues and mandatory spending." It also assumes that most of the Bush tax cuts expire and that lawmakers don't patch the Alternative Minimum Tax as they have in recent years.

Under these assumptions, revenues would rise to 23 percent of GDP by 2035 and more than 30 percent of GDP in 2080. Even with these unlikely revenue assumptions, the public debt would reach 79 percent of the economy by 2035 and 107 percent by 2080.

CBO's alternative fiscal scenario is, perhaps, more politically realistic. For example, on the spending side it assumes that some of Medicare cuts enacted in the recently passed health care bill will not continue over the long-term and that discretionary programs will be funded at their average levels over the past 40 years. As for revenues, this scenario assumes that millions of taxpayers will be spared from the AMT, many elements of the Bush tax cuts will be extended, and revenues will remain at their historic average of 19 percent of GDP.

Under these assumptions, the public debt would hit 185 percent of GDP by 2035 and an unfathomable 854 percent of GDP by 2080.

Since the Value Added Tax is being talked about as a possible solution to the nation's long-term fiscal problems, we did some back of the envelope estimates of what percentage VAT would been needed to fill CBO's projected budget gap over the long term.

Assuming a VAT base of 41 percent of GDP (the average of European-style VATs[1]), the government would need a 11.7 percent VAT each year to close the 25 year gap, a 16.8 percent VAT to close the 50 year gap, and a 21.2 percent VAT to close the 75 year gap.

VAT rates in excess of 20 percent are pretty common in Europe and haven't seemed to prevent their fiscal woes. One has to wonder whether it would be the salvation for ours.

Present Value of the Future Stream of Revenues
or Outlays over a Given Period
(Percentage of GDP) Revenues Outlays Fiscal Gap (Outlays minus Revenues) VAT Needed to Fill Gap
Alternative Fiscal Scenario
25 Years (2010 to 2034) 20.7 25.5 4.8 11.7%
50 Years (2010 to 2059) 19.8 26.7 6.9 16.8%
75 Years (2010 to 2084) 19.5 28.2 8.7 21.2%

[1] http://www.urban.org/UploadedPDF/1001262_blueprint_reform.pdf



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