“Concerns about the regressivity of the VAT are complex, but they should not obstruct the creation of a VAT for two reasons. First, while we accept the validity of distributional considerations, what matters is the progressivity of the overall tax and transfer system, not the distribution of any individual component of that system. Clearly, the VAT can be one component of a progressive system.
“The Canadian VAT. In 1991, Canada implemented a 7 percent VAT at the national level to replace a tax on sales by manufacturers. Many of the concerns associated with the VAT in the United States can be assuaged by observing the Canadian experience.
“An American VAT. The structure of an American VAT should include:
– a very broad base;
– rebates or income tax credits (rather than product exemptions) to achieve progressivity;
– efforts to raise transparency (for example, having VAT listed separately on receipts); and
– explicit links to spending discipline.
While we are not wedded to a particular rate, we do note that a 10 percent VAT with a broad base could raise about 2 percent of GDP in revenues, even after netting out the offsetting adjustments in other taxes and the costs of compensating households for VAT payments on a reasonable level of consumption.