The Macroeconomic Effects of a Value Added Tax

1. The Macroeconomic Effects of a Value Added Tax Rachelle Bernstein National Retail Federation June 3, 2011

2. VAT – Why is it on the table? • Deficit projection 2011: $1.4 trillion (9.8% of GDP) • Deficit projection 2021: $7 trillion • Debt to GDP ratio 2021: 98.1% • Solutions will require some combination of • Discretionary spending cuts • Mandatory spending cuts • Revenue increases

3. I. How a VAT works • Primary features of VATs • Consumption-type taxes that are similar to retail sales taxes, but spread the remittance of tax across businesses based on their value-added. • Both relieve the tax on the return to saving and investment, but do so in different ways. • Generally are destination based with border adjustments (tax imports, but exempt exports). • Virtually all 150 countries with a VAT use the credit method. • Subtraction method has received some interest in the U.S. because its structure is similar to the corporate income tax.

4. How credit and subtraction method VATs work • Both tax business receipts, but remove the tax on intermediate production. This helps avoid tax cascading. • Accomplished in somewhat different ways. • Credit method: Firms claim a credit for taxes previously paid. • Subtraction method: Firms claim a deduction for business purchases. • The two methods generate the identical amount of tax for each taxpayer (if comprehensive and single rate)

5. An illustration ...

6. II. Key Findings EY/Tax Policy Advisors Study – An add-on VAT poses substantial risks to the economy • Lower retail spending • Initially 5 percent lower. • $2.5 trillion lower over the next decade. • Over the longer term, 3.7 percent lower. • Initially, lower economic activity • GDP falls for the first three years, then flat for several years. • Rises by only 0.3 percent ten years after enactment. • Reduces employment • 850,000 fewer jobs in first year. • 700,000 fewer jobs over the longer-term. • Most working Americans alive today are worse off. • Enacting an add-on VAT is particularly troubling during period of economic weakness.

7. III. VATs Analyzed Three VAT Policy Scenarios Analyzed 1. 10.3% Narrow-based VAT with exemptions 2. 8.0% Broader-based VAT with a rebate 3. 12.4% Narrow-based VAT with a rebate • Report also considered a reduction in government spending to reduce the deficit by 2% of GDP. • Helps disentangle the benefits of deficit reduction from the effects of the VAT. • Focuses on the relative benefit of reducing the deficit through spending reductions rather than a tax increase.

8. Defining the tax base Major items excluded from VAT base (2010):

9. VATS Are Highly Regressive • VATs hit lower and middle income taxpayers much harder than wealthier individuals. • Consumption taxes will hurt senior citizens more than working-aged citizens.

10. Distributional Effects of Narrow-based VAT (no rebate)

11. Impact on State and Local Governments • A VAT would greatly hurt the states, 45 of which rely on sales taxes as a major source of revenue. • A VAT would also hurt all of the local governments that impose their own sales taxes. • The enactment of a federal consumption tax would crowd out the ability of state and local governments to raise their own sales taxes at times when they are desperately in need of revenue. • Because a VAT would cause retail spending to decline by $2.5 trillion over the next decade, state and local governments that rely on sales tax revenues would have significant revenue shortfalls.

12. Experience with VATs Abroad

13. CONCLUSION • NRF study found that an add-on VAT would result in less economic growth as compared to a reduction in government spending. • NRF study found that an add-on VAT would lose 850,000 jobs in the first year, as compared to a reduction in government spending, which would add 250,000 jobs in the first year.