Toder, Eric, Jim Nunns and Joseph Rosenberg, “Implications of Different Bases for a VAT,” Tax Policy Institute, 02/12

“The federal budget outlook is unsustainable over the long run.  The latest (June 2011) projections by the Congressional Budget Office (CBO)1 show the ratio of publicly-held debt held to GDP, which was 40 percent at the end of 2008, rising from 69 percent in 2011 to 187 percent in 2035 under their Alternative Fiscal Scenario, which assumes that current federal spending and revenue policies will largely continue.  Even under CBO’s Extended-Baseline Scenario, which assumes that all of the 2001-2003 tax cuts expire at the end of 2012, the AMT will no longer be patched, and that Medicare and other health-related spending will be held to modest growth rates, debt held by the public is projected to rise to 84 percent of GDP by 2035.  Rising debt levels increase the chance of a fiscal crisis, a sudden spike in the interest rate the federal government must pay on its debt that would necessitate large adjustments to spending, revenues, or both.  More gradual adjustments could be better designed and less damaging to long-run growth and social welfare.

Two prestigious groups, the President’s National Commission on Fiscal Responsibility and Reform and the Bipartisan Policy Center’s Debt Reduction Task Force, both recommended a sweeping set of changes in taxes and spending policies to address future deficits and eventually reduce the ratio of publicly held debt to GDP below its current level.2  The Debt Reduction Task Force recommendations included adopting a “debt reduction sales tax” structured as a value-added tax (VAT).  A VAT is a broad-based tax on household consumption that is collected incrementally by businesses at each stage of their production and distribution of goods and services.  VATs are an important source of revenue for nearly all countries, and among major countries, the United States is alone in not imposing a VAT.

VATs around the world typically exclude certain consumption items from the VAT base for policy or administrative reasons.  This paper describes the policy and administrative reasons for exclusions from the VAT base and the design of a rebate as a substitute for base exclusions to address distributional objectives.  The paper then analyzes the effect of possible exclusions from a U.S. VAT base or a rebate on the VAT rate necessary to achieve a specific deficit reduction target and on the distribution of the tax burden.   Two options for the base of a VAT are analyzed: a broad base, which would allow the lowest rate necessary to meet the specific target for deficit reduction, and a narrower base that is designed to address the distributional effects of a VAT by omitting items that are disproportionately consumed by lower-income households.  A higher rate would be required on this narrower base to meet the deficit reduction target.  A third VAT option that takes a different approach to addressing the distributional effects of a VAT also is analyzed.  This option uses the broad base of the first option but provides a rebate to households, so it would also require a higher rate than the first option to meet the deficit reduction target.”

 http://www.urban.org/uploadedpdf/412501-Implications-of-Different-Bases-for-a-VAT.pdf