What VAT Rate Would Be Needed To Erase Obama’s Deficits?

July 27, 2010

Over the past weekend, the Office of Management and Budget released its annual Mid-Session Review of the Budget which projects the administration's policies over the next ten years. The big news is that OMB is projecting a $1.4 trillion deficit for 2011 (the third year in a row at this level), a $911 billion deficit in 2012, and deficits between $698 billion and $900 billion for the remainder of the decade.

These deficit estimates assume the extension of the Bush tax cuts for families under $250,000 but $639 billion in new tax revenue from repealing the tax cuts for upper-income families. These estimates also assume $702 billion in "other revenue changes and loophole closers" along with some $711 billion in spending cuts, mostly in defense.

Because a Value Added Tax (VAT) has been floated as a solution to the government's budget problems, we did a back of the envelope estimate of the VAT rates that would be needed to raise enough money to cut Obama's deficits to zero. Assuming a VAT base of 41 percent of GDP (the average of European-style VATs) [1], we would need a 22 percent VAT in 2011 to close the $1.4 trillion deficit.

In future years, as the deficit is expected to fall, we would still need a VAT rate of 8 to 14 percent to raise enough revenues to close the budget gap. Of course, these VAT rates would assure that federal revenues stayed above 22 percent of GDP for the next 10 years. Something that has never happened before in U.S. history.

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

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