So, what is wrong with a VAT?

The VAT is generally believed to be, from a policy perspective, a sound method of taxation. It is a broad based tax with a (hopefully) low uniform rate. The simplicity of the VAT allows a reduction in compliance cost (e.g. no more H&R Block) and accounting and it reduces market-distortion. The VAT is a broad based consumption tax that applies equally to every person that purchases products. For example, if the VAT is 10% on a piece of furniture then everyone from Warren Buffett to your poor old granny will pay 10% on that piece of furniture.

There are advocates that argue in favor of the VAT on both sides of the political spectrum. Many (primarily on the left) advocate that the VAT should be implemented in the US as a supplement to a "progressive income" tax system. Others (primarily on the right), believe that the VAT should only be introduced if it completely replaces the current income tax.

Some believe that a fundamental problem with the VAT, however, is that it is a tax generating (revenue) machine. An American VAT has the potential to greatly increase government revenue which will simultaneously allow for increased government spending. Those that tend to criticize the expansion of government tend to disfavor the VAT. Also, because of its broad base, even minor increases in the VAT percentage rate result in tremendous increases in government revenue.

The Value Added Tax (VAT): What is it?

The Value Added Tax (VAT) is a system of taxation which has been getting a lot more press in the US lately. VATs are currently in many countries around the world, most notably in Europe.

The VAT is a type of national sales tax which is levied on "value-added" at each stage of production. That means that each different "producer" throughout the chain of manufacture pays the tax at each different stage of production. The tax rate is single and it is a consumption based system.

Daniel J. Mitchell explains it like this:

Consider a piece of furniture: The VAT would be imposed when the raw timber is sold, when the sawmill produces lumber, when the manufacturer builds a chair, a tax at the wholesaler level and then when a retailer sells the chair to a consumer.

In order to avoid double taxation, each seller gets a credit for the taxes paid by the earlier stages of the production process. When the end consumer purchases the product at the retail store, it pays the final tax levy.

Many analysts favor the VAT because it reduces economic distortion in the market-place and is a far more simple system than our current income tax.