The surge in projected government spending, coupled with diminishing sources of revenue, raises the probability that lawmakers may look toward a value-added tax to close the gap.
"We have to expect it will be on the table for discussion in the United States," said Harley T. Duncan, tax managing director at KPMG. "The reason is straightforward. Look at long-term expenses on the federal level. As people get older and consume larger amounts of medical care, coupled with the expected revenue pattern, debt as a percentage of gross domestic product increases each year. This can't be sustained over the long term."
First put into practice in Europe in the 1950s, a VAT is a tax that is applied at each level of production. Every person or entity that adds value to a product pays tax on the amount of the increase in value, and recovers a VAT credit on the cost of materials and services utilized to add value. Since a VAT is collected from a person or entity that is not responsible for the entire cost of the tax, it is considered an "indirect" tax.
More than 150 countries now have indirect tax systems, and many governments that already have these systems are expanding or considering expanding the list of goods and services subject to VAT. "There needs to be some surplus so that debt doesn't increase relative to the economy," Duncan said. "There has been a tremendous reliance on income tax at the federal level, so you have to expect the government to look at VAT as a possible source of new income."
Carla Yrjanson, vice president of tax research at global transaction tax management provider Sabrix, agreed. "The most active discussion concerning VAT has taken place in the past year," she explained. "Before that, it was more of a fad, but now the conversation is hanging around longer because we're in such desperate times. Some of its advocates say that a 25 percent VAT can do it all - pay for health care, balance the federal budget, and exempt millions of families from income tax."
Politically, both liberals and conservatives might have a problem with indirect taxes such as a VAT. Conservatives see it as a hidden tax, which once in place can be changed without the direct involvement of the end user, who is also the end payer. Liberals see it as a highly regressive tax, one that hits low- and middle-income taxpayers more severely than those in the top brackets. Yet it is becoming increasingly attractive where there are few other revenue-raising options.
"The basic issue comes down to size of government," said Duncan. "That's the threshold question. The biggest opposition comes from those interested in smaller government. After that, you get into other questions, such as how does the tax deal with distribution across income levels? It is a tax on consumption, so even if you leave necessities like food out of the tax base, it will be regressive, hitting low-income households in greater proportion than upper-income ones. There are ways to deal with this, such as rebates to low-income households through the income tax system. It's one of the political issues that will have to be dealt with."
VAT RISES GLOBALLY
KPMG's 2009 Corporate and Indirect Tax Rate Survey found that a critical need for revenue is causing governments worldwide to turn increasingly to indirect taxes as a source of funds. The survey findings indicate that many countries increased tax rates on their VAT or Goods and Services Tax, or GST (Canada's version of a VAT).
"These shifts present clear evidence of a major and a potential long-term change in the way that many governments around the world are funded," said Tim Gillis, partner-in-charge of state and local tax at KPMG. "For U.S. multinationals, it means that the management of indirect taxes will become much more important from a compliance, risk management and performance perspective."
Currently, the U.S. is the only G-20 country without a federal VAT or GST - though it has one of the world's highest statutory corporate income tax rates.
"Here in the U.S., indirect taxes already exist at the state and local level in the form of sales taxes," explained Gillis. "Now the possibility of a federal VAT is starting to be put forth as a potential revenue-raiser to help address the fiscal void that exists between the country's existing tax base and its largest deficit in history due to the economic recovery measures and the rising cost of entitlement programs."
"Up until this year, taxes on corporate profits have tended to decline each year, while indirect taxes have stayed roughly the same," noted Gillis, who added that indirect taxes have quietly been contributing a larger and larger part of many government incomes.
"We're not advocating adoption of a VAT," maintained Duncan. "But it is a conversation that is going on, and picking up some volume. Over the years, multiple experts have said we need to examine it, with different motives. Some say look at it to solve near-term deficits, some for income tax reform, and some say we need it to pay for health care. The upshot is that you can't finance the growing national debt without another revenue source coupled with expenditure restraint, and you can't do it solely through one or the other."
A VAT is preferable to a national sales tax for a number of reasons, according to Duncan: "The retail sales tax, as implemented in the U.S., imposes tax on a lot of business purchases, some of which get incorporated into products that are sold. The theory is that you shouldn't tax business because it creates distortion in the system. A VAT, on the other hand, is applied at each stage of production so that it doesn't inordinately tax business."
"Moreover, the conventional wisdom is that VAT compliance rates are higher," said Duncan. "There's a self-enforcing aspect to it, since each has an incentive to pay tax and get a credit back."
"The benefit to the government is they get the money upfront," Yrjanson said. "The money flows more quickly, and the burden is on the taxpayer to go back and get a credit."
As result of VATs in over 150 countries, many American companies have already been exposed. "Once they exceed the threshold requisite to register, they're under the same tax reporting requirement as anyone else," Yrjanson explained.
One of the chief doubts about adding a VAT to U.S. taxation is the effect it would have on the economy. "Retailers, and some economists, are concerned that with a VAT, the price of everyday items will go up," she said. "There is obviously anxiety that this would impact consumption and sales, and consequently the economy as a whole."
In fact, the National Retail Federation wrote the House Ways and Means Committee earlier this year, urging it not to consider a VAT as a means of funding health care reform, saying that a VAT would have a negative effect on the economy during the recession. In addition, a VAT would greatly hurt the 45 states that rely on sales tax as a major source of revenue, according to the NRF. "The enactment of a federal consumption tax would greatly crowd out the ability of the states to raise their own sales taxes at a time when they are desperately in need of revenue," it stated.
