Saturday, April 24, 2010

The Impact of A US VAT Tax

Background On The VAT
A VAT or value added tax is looming. President Obama said it is a "novel idea" and "on the table." Democrats favor adding VAT on top of current taxes and several Republicans would like to see it replace the Federal Income Tax. (There are no proposals to eliminate the FIT.)

The first VAT was implemented in France in 1954 as a way to increase taxes on top of an already high tax base. VAT is virtually invisible to the end user, so it quickly gained political popularity. The VAT tends to be introduced at a low rate, but quickly climbs. For instance, Sweden had a rate of 17.7% in 1976 and now has a VAT of 25% on top of a 55% personal tax rate. Today, most countries outside of the US have an added VAT of approximately 20% on goods and services plus income taxes.

How A VAT Would Affect Businesses
The VAT is levied on goods and services at each stage of production. However, your business is able to recover these costs by passing them on. Only the consumer must pay the full cost. In a quote from The Hill, "So the raw material seller charges the manufacturer who then adds a new tax onto the price when he sells his finished product to a retailer who then adds on a new levy when he sells it to a customer. "

From an accounting perspective, VAT is generally invoice-based, meaning each seller stage passes an invoice along to the next buyer stage and so on until all of the charges are finally passed to the consumer.

Look for sales to go down. As a function of supply and demand, when the price of goods increases from a VAT, the quantity of goods sold can be expected to decrease.

How A VAT Would Affect Consumers
For the most part, the consumer won't see the tax. But they will feel the pain. Again, quoting from The Hill, "When you buy something for $10 and the clerk asks for "$10.65, please", you know that you are paying a 6.5% sales tax. But when $4 of hidden VAT taxes causes the item to cost $14, you pay the $14 without knowing that it includes the extra tax." State taxes would be levied on top of the VAT.

What people will realize is their weekly paychecks will no longer stretch as far. Low and middle income earners will be affected the most and can be expected to buy less. See below.

How A VAT Would Affect the US Economy
It's important to see how debt and the VAT go together. At the end of the Bush Presidency, (Oct. 2008,) the US debt was a record, but manageable $438B dollars.

The first TARP bailout for another $700B was actually approved by Mr. Bush and Mr. Obama, as each shouldered responsibility for increasing the deficit to $1.2T. For 2010, the CBO deficit projections total $1.6T. (This does not include the healthcare costs that Associated Press on April 23rd reported were severely underestimated and will add another $1T to the deficit.) The total US debt now stands at $13T, a number incomprehensible to most. But, here's why these numbers matter.

66% of Americans (Rasmussen, April 2010) are against raising taxes for more programs. And 66% want deficit reduction. Since the President already spent money he didn't have, he can now cleverly argue that he is merely trying to reduce the deficit. While there is resistance in Congress, a VAT is a very real possibility.

The VAT impact on consumers and the overall economy would be substantial. A single taxpayer earning $75,000 yearly would pay 25% Fed Tax, 7.65% FICA + Medicare, 20% VAT, State income tax averaging 9.7% and State sales tax of approximately 6.5% . This totals 68.85% of income. In addition there will be a minimum 2.5% tax on uninsured's for healthcare and, according to the CBO, an additional $1500 in annual utility bill increases for families under a Cap and Trade type legislation now working its way through Congress and the EPA.

A Trade-off You May Not Want
Because a VAT hits everyone equally, it will have the heaviest impact on the poor and the middle classes. Since 26.5% of taxes would be based on spending, you can expect consumers in these brackets to reduce consumption. This will mean less trips to the theater, fewer dinners out and in many cases people would be forced to choose less expensive appliances, recreation equipment and cars.

Americans have often been credited with enjoying the highest standard of living in the world. This is partly because we are unencumbered by the onerous tax structures plaguing so many nations. The VAT coupled with the current tax and fee proposals from the 111th Congress would reduce, if not eliminate that advantage.

If the VAT is passed, most Americans, other than the wealthiest, can expect their living standards to drop. In return, the deficit should slow, but is unlikely to return to pre-Obama levels.


Sources: ABC News, The Hill, Wikipedia, Associated Press, Bloomberg, Rasmussen Polls, US Treasury, Congressional Budget Office, Health and Human Services, OECD Tax Database

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