Accounting

EFFECTS OF IMPOSING A VALUE-ADDED TAX

TO REPLACE PAYROLL TAXES OR CORPORATE TAXES

Eric Toder

Institute Fellow, Urban Institute

Joseph Rosenberg

Research Associate, Urban-Brookings Tax Policy Center

March 18, 2010

This report is a project of the Urban-Brookings Tax Policy Center

and the Economic Growth Program of the New America Foundation.

Introduction

This report examines the effects of imposing a new value added tax (VAT) in the United

States and using the revenue raised to lower payroll tax and corporate income tax rates.

We summarize how different forms of VAT operate and compare how a VAT, payroll

tax, and corporate income treat different sources of income and the different ways each

tax distort economic decision-making.

We then present estimates of the revenue effects from a VAT and the reduction in

payroll and corporate income taxes that a VAT could potentially finance. We examine

several prototype VAT bases, including a broad tax base on just under 80 percent of

consumption and a narrower tax base on about 50 percent of consumption that reduces

adverse impacts on low-income households by exempting housing, food consumed at

home, and medical expenses, other than those already financed by government. We also

examine an alternative in which a broad VAT base is combined with a per-capita

refundable tax credit instead of exemptions of necessities as a method of relieving the

burden on low-income taxpayers.

The estimates in this report are “static” estimates, meaning they assume no

behavioral response. We discuss, but do not estimate, potential behavioral responses to a

VAT and how they might affect revenue raised and economic performance. We also

briefly discuss the effects of adding a new VAT on administrative and compliance costs.

A major concern with a VAT is that it could be regressive, raising tax burdens

proportionately more on lower income than on higher income taxpayers. The report

provides estimates of the...