NCPA - National Center for Policy Analysis


May 4, 2010

The policy world is abuzz with talk about whether a value-added tax, or VAT, should be part of the solution to our long-term fiscal problems.  Most recently, Paul A. Volcker, head of President Obama's economic advisory board, said a VAT was "not as toxic an idea" as it used to be.  But is it actually a good idea, asks N. Gregory Mankiw, a Harvard University professor of economics and former adviser to President George W. Bush. 

Although a value-added tax is just another form of a retail sales tax, a VAT has the advantage of being harder to evade.  Tax experts believe that large retail sales taxes lead to compliance problems, which we can avoid by collecting the same tax along the chain of production.  Some see VAT as a disadvantage because it would be a source of revenue to fund a large, intrusive government.  Western Europe is a case in point, says Mankiw. 

  • Many nations there have large governments financed in part by value-added taxes.
  • Europeans also typically work less than Americans and, as a result, have lower income per person. 

While sorting out cause-and-effect among these international differences is hard, many conservatives agree with Edward C. Prescott, a Nobel laureate in economics whose research suggests that Europe's lower income is largely attributable to its higher tax rates.  On the other hand, says Mankiw, conservatives have long argued: 

  • The American tax system is grossly inefficient and impedes the economy's ability to reach its full potential.
  • Taxing consumption is better than taxing income, and a value-added tax does exactly that.  

Source: N. Gregory Mankiw, "Much to Love, and Hate, in a VAT," New York Times, May 2, 2010. 

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