Academic journal article Journal of Accountancy

The Value-Added Tax

Academic journal article Journal of Accountancy

The Value-Added Tax

Article excerpt

Is it a reasonable alternative to raise federal revenue ?

The value-added tax (VAT) is viewed widely as a panacea for much-needed deficit reduction and revenue generation in the United States. The popular argument is the VAT is a relatively painless tax, since consumers may not know the amount of tax they actually are paying. The VAT also is viewed as

* A tax that does not affect business profits.

* A tremendous revenue raiser with relatively low rates.

* A self-enforcing collection process.

* An encouragement to save.

* A textbook answer to the nation's balance-of-payments problem.

In addition to raising revenue, tax policy also must satisfy a nation's social, economic and political aims. The pros and cons of a VAT can be debated at length in these terms. In his landmark work, The Wealth of Nations, Adam Smith outlined five characteristics of a "good tax": equity, neutrality, certainty, economy and simplicity (see the sidebar on page 47 for more complete definitions). For a tax to be "good" it should meet one or more of Smith's five characteristics or be desirable in terms of one of the three aims listed above.

Should the United States adopt a VAT? Within the framework of these eight characteristics and aims, this article will examine this question to determine if a VAT is a logical solution to the nation's economic and budget woes.

COMPUTING THE VAT

As the name implies, a VAT is a tax on the value added at each stage of a product's production, distribution or retail sale. In its most common form, it simply is the tax on a company's sales minus the tax paid on the company's purchases. This is the credit (invoice) method of computing the VAT. (See the exhibit on page 48, for a Treasury Department description of three methods of computing VAT.)

The subtraction method VAT creates fewer administrative burdens for both government and taxpayers since information to compute it already is available on businesses' federal income tax returns. This method, however, would be difficult to administer if Congress created many different tax rates and exempted or zero-rated goods or businesses.

Under the addition method, a company's VAT base is primarily untaxed inputs (wages, salaries, depreciation, profit and interest). The base is simply multiplied by the tax rate. Most countries do not consider this method as an alternative; the European Community (E C) requires use of the invoice method.

Given the need for flexibility in administering any tax, some experts consider the credit method the best for the United States.

There are three methods of treating VAT paid on capital purchases:

* Consumption method. Gross purchases are added to all other inputs.

* Income method. The VAT paid is amortized.

* Gross product method. No deduction is permitted for VAT paid.

The consumption method is most common and also considered best for the United States.

VAT-HISTORY AND CURRENT STATUS

The VAT is a multistage tax; the retail sales tax is a single-stage tax. Many European countries have had one of these taxes for many years. Even before the first VAT (in France in 1954) European countries had a "turnover tax" on each stage of a product's production. In the late 1960s, other countries joined the VAT movement: Denmark, 1967; Germany, 1968; and the Netherlands, Belgium and Sweden, 1969. Today all 12 members have a VAT as part of their tax system.

The Organization for Economic Coordination and Development (OECD) includes 17 European countries, Japan, Turkey, New Zealand, Australia, Canada and the United States. Of these 23 nations, at least 19 use a form of VAT. The latest countries to join the ranks were Japan in 1989 and Canada in 1990. The credit method currently is used by 18 of the 19 OECD nations that have a VAT.

In the United States, the VAT has been discussed at the national level since President Richard Nixon's Task Force on Business Taxation proposed a VAT as a corporate income tax alternative. …

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