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Monday, October 18, 2010

VAT - Economic Effects of More Investment and Less Consumption

The National Retail Federation released a study on October 14 on the likely effects of a VAT in the US. The VAT used in the study was modeled on the European VAT which is a credit invoice VAT with a narrow base that excludes rent paid by consumers and purchases of homes, groceries, medicine, health care, financial services and education. The rate used in the study was 10.3%.

The report, prepared by Ernst and Young and Tax Policy Advisers, concluded that such a VAT could result in the loss of 850,000 jobs in retail and other industries, reduce GDP for three years and cause retail spending to decline by $2.5 trillion over ten years. Per the NRF, the drop in jobs would be 850,000 in the first year and "would remain down by 700,000 jobs for decades to come."

The NRF plans to submit the report to President Obama's Deficit Commission which is to issue its report and recommendation in early December 2010.

I think this is an interesting report. Proponents of a consumption tax at the national level usually argue that it will increase investment - meaning that if spending on consumption drops from taxing it at a higher rate, people will instead save more money. I've often wondered when I hear of proposals for a 23% national sales tax or even a VAT of 5% or more, what does happen to our economy when people buy less goods? While as a whole, we are likely buying more goods than we need (do people really need to buy clothes for their pets? more clothes than they can wear in a week? gadgets?), what does happen to the economy when this and other spending drops? I would think the economy realigns. Is that an economy we can live with? I think a lot of that depends on where the lost jobs fall among various income groups.

I'm glad to see the study because I don't think there has been near enough discussion of what our economy with a VAT - even as an add on to the income tax rather than a replacement, looks like.

The report is 72 pages long, but certainly worth the read.

What do you think?


Mark Houtzager said...

Hi - Thanks for the posting. The report is interesting, but not very objective. The idea of an add-on VAT is unreasonable, and has never been suggested by anyone, except the NRF to generate arguments against VAT. I would be more interested in a report that reviews a potential VAT combined with a lower corporate tax rate, and a slightly lower income tax.

Professor Nellen said...

There have been proposals to add a VAT at the federal level, such as to help pay down the debt. Here is some background in an April 13, 2010 Tax Policy Center blog post - Paul Volcker also suggested it for deficit reduction - see April 6, 2010 Reuters article -

It has also been suggested to reduce existing taxes or to replace the corporate tax although a business activity tax - a different form of consumption tax has also been suggested as a replacement business tax.

Unknown said...

Given the importance of "retail therapy" for so many Americans, a reduction in spending (and borrowing to spend) and increase in savings is possibly the best positive outcome of implementing VAT!

It is no longer viable to "spend our way out of a recession". With the collapse of public finances such as what happened in Greece, deficits cannot be addressed with more spending. As Geithner bluntly puts it, "US consumers cannot be relied on to propel the global economy". See

We should not continue to spend on borrowed money today, and then fallback on the government to provide for entitlement benefits from more borrowed money. The cycle ends at the point we loose credibility to borrow. Then what?

The fact that NRF have conducted a thorough study on the negative impact of reduced retail spending (due to VAT) is applaudable, but I seem to get away from a nagging feeling that the retailers just cannot stomach any more tightening of US consumer wallets.