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Value-added tax (VAT) looms in our future

Is there a value-added tax, or VAT, in our near future? According to a story by Shawn Tully in Fortune, this new tax scheme is not only possible, but perhaps inevitable, given the danger to the U.S. economy posed by our enormous and growing national debt.

The article cites a recent sobering report from the Congressional Budget Office about the ramifications of our growing national debt. In comparison to our gross national product, our current deficit is the highest since WW II. The CBO did one projection assuming that the Bush tax cuts were extended, the alternative minimum tax was indexed to inflation, and income tax revenue yielded 19% of GDP. The results? By 2020, our debt would equal 90% of our GDP; by 2035, 180%.



The report goes on to warn that the tipping point of a catastrophe, that day that our creditors lose confidence in the U.S. and start demanding better interest rates from us, isn't predictable. But the potential is real, the consequences dire.

The solution? The hard choice is between cutting spending and raising taxes (or both). Tully interviewed Republican Congressman Paul Ryan, who states that he believes the VAT is "far more likely than most Americans imagine."

So what is a value-added tax? A VAT is a tax levied on an item at each step of its production. For a harmonica, the ore sellers, the metal makers, the component crafters, the assemblers, the wholesellers and the retailers would all pay a tax at the time they sold their materials to the next company up the production chain. Today, taxes are only collected from the company that retails the product to the end user; in this case, a blues musician.

The average VAT rate among countries that already employ it? Eight-teen percent. According to one expert cited by Tully, a 25% VAT could balance our budget, pay for health care, and reduce income taxes. Of course, everything you buy would be 25% more expensive.

So why impose a VAT instead of increasing sales taxes? Sales taxes in the U.S. are collected by the states and their municipalities; a value-added tax would be national. Therefore, don't expect sales taxes to go away if value-added taxes are imposed. The result? An increased price on all products covered under the VAT.

Another reason that we might see VAT is that it would be a way to tap into revenue from tax-free Internet sales, by taxing the products during each step of production and collecting the VAT nationally.

The most important reason to impose a VAT, however, might be to boost the confidence of outside investors that the U.S. recognizes and is dealing with its debt problem. We can't afford international doubt about our ability to pay our bills; that way lies disaster.

On the other hand, many critics note that the financial burden of a VAT is unfairly regressive. That's because, on a percentage basis, it has a bigger impact on the poor and smaller impact on the rich. Low income households have to spend more of their income on essential goods and services. But as household income grows, more spending becomes optional, or discretionary. A big VAT could lead households with higher incomes to simply spend less on discretionary goods and services, thus slowing the economy.

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