Frequently Asked Questions about the Tax Foundation's VAT Calculator

1. What is a VAT, or Value-Added Tax?
A value added tax is a form of consumption tax that taxes the "value added" at each stage of production. It is economically equivalent to a retail sales tax. It is a consumption tax in that it exempts the time value of money portion of the return to saving. Administratively, there are two ways of administering value added taxes: the credit-invoice method and the subtraction method.

2. What are the chances that the U.S. actually adopts a VAT?
This is a political probability question that we cannot answer definitively. There is always opposition to any new tax or tax increase by itself, and therefore, the chances of a VAT may be slim. However, at some point, a VAT may be the likely response to a U.S. fiscal crisis and/or receive considerable attention among policy makers as a way of avoiding such a crisis. The U.S. has mostly reserved consumption taxes for state governments to raise their revenue, and those taxes -- general and selective sales taxes -- generate over 50% of state revenue in some states. A few states even have VAT-like taxes imposed on businesses instead of, or in addition to, retail sales taxes.

3. How did you come up with your calculations?
For detailed methodology, click here.

4. How do I use the policy parameter section?
The policy parameter section allows the user to change the structure of the VAT, allowing for control over the tax rate and the base subject to the tax.

Time Period
The primary reason why the U.S. might consider a VAT in the near future is to raise revenue to close the federal budget deficit, and the calculator uses deficit projections from the Office of Management and Budget to set the VAT amount. The user can choose either the ten-year period from 2011 to 2020 (meaning the VAT rate would be based on eliminating the 10-year budget deficit) or choose a specific year between 2011 and 2020 to see how much of a VAT would be needed to eliminate the deficit for that year.

VAT Amount
The calculator is not limited to setting tax rates necessary to eliminate the deficit. The user can instead select the second option and opt to set a tax rate that would be necessary to merely reduce the deficit to 3% of annual GDP, which many economists would say is sustainable. The third option allows the user to manually enter any VAT rate, and the fourth allows the user to enter the needed revenue that would be raised by the VAT, and then sets the VAT rate automatically based on the revenue amount entered. Revenue amounts are inflation-adjusted to 2010 dollars.

Tax Base
This section allows the user to choose which sectors of the economy would be subject to the tax. The first option allows the user to enter a percentage of the US GDP to tax, and will enable and disable the categories below based on the percentage entered, and on the Tax Foundationís prediction for the likelihood of various sectors being subject to the tax. Since the entered percentage is likely to fall somewhere in between the sum of the included sectors, an indicator appears showing which sector is being partially taxed. Alternatively, the user can pick the second option, choosing the sectors he or she thinks are most likely to be taxed.

5. Why did you do this calculator?
The purpose of the calculator was to provide a simple gauge for taxpayers to estimate how much they would pay if a value added tax was implemented in the United States. Most Americans are unfamiliar with a VAT, and thereby should be informed about how it works and how they might be affected personally.

6. What do you assume about the money that a VAT goes to fund, and do you take that into account?
This calculator does not take into account the benefits of a VAT. It is solely a look at the cost side of a VAT. For example, benefits of a VAT such as lower taxes elsewhere (or in the future) or higher spending elsewhere (or in the future) are not counted due to the political uncertainty over what the actual use of such additional funds would be. If/when a specific VAT proposal was put forth by the president, a member of Congress or a commission appointed by Congress or the president, this VAT calculator would likely be updated to include that policy option. Like with recent cap-and-trade proposals, such a specific plan could include rebates to those at the low end of the income spectrum. Again, this calculator currently assumes no such rebates exist.

7. What is the likelihood of a U.S. VAT having a broad base?
If one judges the likelihood based upon historical evidence in other countries, then from the perspective of broad-base VAT advocates, foreign VATs offer little in the way of positive inspiration: most are poorly designed, riddled with hundreds or thousands of exemptions, special rates, and other complexities that produce a result worse than what an economics textbook says about a simple, broad-based value-added tax.

8. What does it mean for my VAT burden to be negative?
It is possible, though rare, for a person's VAT burden to be less than zero, meaning that this person is actually better off under a VAT. Two sides of the VAT burden are calculated - the "sources" side and the "uses" side. We assume that the VAT results in higher prices for consumers and no change in the return to labor (i.e., wages) or capital (i.e., wealth). The "sources" side (the bulk of the VAT burden) is therefore paid by workers whose wages are lower in real terms due to the price inflation caused by the VAT (as well as the reduced real rate of return for owners of capital). However, this part of the burden only applies to individuals with labor or capital income. People with transfer income, such as social security, will see their payments rise proportionally to the price inflation resulting from the VAT because we assume that such benefits would be indexed for such inflation. If an individual's consumption of items included in the tax base is lower than the national average (for example, if the base included all consumption but health care and the individual in question is an elderly social security recipient) that person ultimately spends less money, when accounting for inflation. This is accounted for on the "uses" side of the tax burden, which can be negative.

9. What is the Tax Foundation's position regarding a VAT?
The Tax Foundation has not taken a formal position on whether or not the U.S. should adopt a value added tax. Broad-based value added taxes have economically beneficial characteristics compared to other tax sources, and the Tax Foundation's position is typically one in favor of broad based tax systems. However, there are always political constraints that get in the way of good tax policy and this would be no exception, making the net benefits of VAT adoption uncertain.