The economic effects of introducing a value-added tax are, for the most part, not very interesting. True, imposition of a VAT would probably cause a one-time increase in prices, and the tax would be regressive unless explicit steps were taken to reduce its regressivity. But the tax would have relatively little effect on the allocation of economic resources or on the competitiveness of U.S. industry in world markets, except to the extent that it reduced the deficit and caused the dollar to weaken. That the economic effects of the VAT are rather bland—we might call it a vanilla tax—is one of its chief advantages. After all, the primary purpose of taxation is (or at least should be) to raise revenue, not to change economic behavior; certainly unintended changes in behavior induced by taxation are not likely to be desirable.
That the VAT does not have very interesting economic effects does not mean that the effects of substituting it for part of the present tax system would not be significant. If a relatively neutral VAT were substituted for part of the highly distortionary income tax system, the allocation of resources might be greatly improved. Moreover, the VAT can be expected to be more conducive to saving than the income tax. But, strictly speaking, most of any such effects should be attributed to reduction of the income tax, not to imposition of the VAT. Analogous statements can be made about using the relatively neutral VAT, rather than the income tax, to raise additional revenue.
In this chapter I examine the economic effects of introducing a VAT. For the most part I focus on the likely effects of the VAT, since it is novel and relatively unknown in the United States.But in several instances—most notably in the discussion of international aspects—I explicitly discuss the consequences of substituting the VAT for part of the existing corporate income tax.
Purists might argue that the entire discussion should be cast in terms of substituting the VAT for other taxes, even if the VAT is being