Raising revenue with a progressive-value added tax

Cropped shot of an unrecognizable man paying for his purchase by card
Editor's note:

The report below is a chapter from the book, “Tackling the tax code: Efficient and equitable ways to raise revenue.” Read the full book here.

The Problem

The future fiscal and economic health of the United States depends on the federal government’s ability to increase revenues above their current, historically low rate. Tax policies used today by the U.S. federal government have advantages and disadvantages, but few can match the efficiency of a well-designed value added tax (VAT). A VAT does not distort savings decisions and is very difficult to avoid or evade. However, VATs have been criticized for being excessively burdensome for low earners, given that consumption is a higher share of income for people of limited means and consumption taxes are typically applied at a flat rate.

The Proposal

Gale proposes a broad-based, credit-invoice value-added tax (VAT)—sometimes referred to as a “goods and services” tax. This VAT would include a rebate to households that renders the tax progressive as well as efficient. By lowering the real value of existing assets, it would also function as an implicit one-time tax on accumulated wealth. Specifically, Gale’s proposal would implement a VAT with:

  • a broad base, including essentially all consumption that is associated with explicit payments
  • a standard rate that applies to all taxable purchases;
  • exemption for small businesses with gross annual revenue below $200,000; and
  • a refundable credit available to all households to make the tax progressive.

The authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. Neither is currently an officer, director, or board member of any organization with a financial or political interest in this article.