The Congressional Budget Office just projected a series of $1 trillion budget deficits—as far as the eye can see. Narrowing that deficit will require not only spending reductions and economic growth but also new taxes. One solution that I’ve laid out in a new Hamilton Project paper, “Raising Revenue with a Progressive Value-Added Tax,” is a 10 percent Value-Added Tax (VAT) combined with a universal basic income (UBI)—effectively a cash payment to every US household.
The plan would raise substantial net revenue, be very progressive, and be as conducive to economic growth as any other new tax. The VAT would complement, not replace, any new direct taxes on affluent households, such as a wealth tax or capital gains reforms.
A VAT is a national consumption tax—like a retail sales tax but collected in small bits at each stage of production. It raises a lot of revenue without distorting economic choices like saving, investment, or the organizational form of businesses. And it can be easier to administer than retail sales taxes.
William G. Gale
The Arjay and Frances Fearing Miller Chair in Federal Economic Policy
Senior Fellow - Economic Studies
Director - Retirement Security Project
Co-Director - Urban-Brookings Tax Policy Center
An American VAT
The structure of an American VAT should mirror those of the most effective existing VATs around the world. It should be built on a broad consumption base. It should adjust (impose or rebate) taxes at the border so it applies only to goods and services purchased in the US no matter where they are produced. Small businesses should be exempt, though they should be able to choose to join the VAT system. Social Security and means-tested government programs, such as Temporary Assistance to Needy Families, should be adjusted to reflect the after-VAT price of relevant purchases.
Border adjustments are ubiquitous in VATs around the world and do not constitute tariffs. And almost all VAT countries exempt small businesses (somehow defined). Limiting the VAT to firms with more than $200,000 in gross receipts would exempt 43 million small businesses.
Finally, the UBI payment would eliminate the burden of the VAT and give additional resources to low- and moderate-income households. My version would set the UBI at the federal poverty line times the VAT rate (10 percent) times two. For example, a family of four would receive about $5,200 per year. My UBI proposal is similar to, but smaller than, the version proposed by Democratic presidential candidate Andrew Yang.
A 10 percent VAT would raise about $2.9 trillion over 10 years, or 1.1 percent of Gross Domestic Product, even after covering the cost of the UBI.
As with any tax, its effects on the economy would depend on how government uses the revenue. But all else equal, it would be better for the economy (that is, less distortionary) than hiking income tax rates.
To avoid disrupting the economy in the short run, the VAT proceeds should be used in the early years to stimulate the economy, and the Fed should accommodate the VAT by letting the consumer price level rise.
The Tax Policy Center estimates that the VAT in conjunction with a UBI would be extremely progressive. It would increase after-tax income of the lowest-income 20 percent of households by 17 percent. The tax burden for middle-income people would be unchanged while incomes of the top 1 percent of households would fall by 5.5 percent.
It may seem counter-intuitive, but the VAT functions as a 10 percent tax on existing wealth because future consumption can be financed only with existing wealth or future wages. Unlike a tax imposed on accumulated assets, the VAT’s implicit wealth tax is very difficult to avoid or evade and does not require the valuation of assets.
A VAT also could benefit states. While states would not have to conform to the new federal law, doing so could improve the structure of their consumption taxes, which tend to exempt services and necessities and often tax businesses. Canada’s provinces provide an example of how national and sub-national VATs can “harmonize.”
One hundred sixty-eight countries have a VAT. But would Congress ever pass one? It may not be so far-fetched. In recent years, such a tax (under other names) has been proposed by leading Republicans such as senators Ted Cruz of Texas and Rand Paul of Kentucky, former House Speaker Paul Ryan, and others.
Many years ago, former Treasury Secretary Larry Summers quipped that a VAT has little political support because liberals think it is regressive and conservatives think it is a money machine. He was right.
But liberals should realize that the VAT can be progressive, especially when combined with the UBI. It would be even more progressive if the revenues financed, say, health care or childcare.
There are benefits for conservatives as well. Despite claims to the contrary, there is little evidence that VATs ever increase overall government spending. And in the US, A VAT could be enacted as part of a broader budget agreement that explicitly slows federal spending growth over time.
Ultimately, the real debate will be about how to use the money generated by the VAT. But if new revenues are an inevitable part of any effort to control the federal budget, a VAT with a UBI could be one of the best policy options.
I would like to thank Grace Enda and Claire Haldeman for providing valuable research assistance.