An analysis of the European community VAT: Implications for U.S. tax policy

Abstract

In recent years, several proposals have been introduced to implement a value added tax (VAT) in the United States as well as other forms of consumption-based or flat-taxes. Most proposals are pitched as being fairer, simpler, and more amenable to encouraging personal savings and business investment than the federal income tax. However, consumption taxes such as the VAT have often been criticized for three main reasons. First, consumption taxes such as the VAT, are accused of being money machines in government hands. Second, consumption taxes are said to be regressive. Third, consumption taxes are said to pre-empt the state tax base. Revenue Statistics from the Organisation for Economic Cooperation and Development for nine European Union (EU) countries are used to determine whether the VAT became a “money machine” in the nine EU countries. Results indicate that VATs can be implemented without becoming money machines for the government. EU countries used the VAT to replace a number of indirect taxes and not to increase the overall tax burden. Disparate findings from prior studies are reconciled for the same years studied by prior authors. One possibility for disparate findings may be that prior studies used too few years of data in their analysis.