The value-added tax is essentially an administrative technique for implementing a sales tax. Rather than collecting tax only at the retail stage, as under the sales taxes levied by most states, the VAT technique allows tax to be collected as goods and services move through the production-distribution process and value is added to them. The VAT and the retail sales tax have similar economic effects if their tax bases are comparable.
The United States is one of only a few major developed countries of the free world that do not have national sales taxes. Over the next few years interest in introducing a VAT or some other form of national sales tax will probably increase substantially as the Gramm-Rudman‐ Hollings targets for deficit reduction become increasingly difficult to meet. Already several proposals for federal VATs have been advanced, though not in the context of deficit reduction. These include the proposal by Senator William Roth of Delaware for a business transfer tax (BTT), the low-rate manufacturing-stage VAT proposed as a method of financing the Superfund, and the personal-exemption VAT proposed by Robert Hall and Alvin Rabushka in the context of income tax reform. Notably, none of these proposals would employ the credit method of implementing the VAT that is—for very good reasons—used in virtually all countries (currently almost forty) that levy VATs.
Under the credit method a registered taxpayer calculates tax liability by applying the tax rate to sales and then taking credit for taxes paid on purchased inputs. Under the subtraction method envisaged in the three proposals described, the taxpayer would apply the tax rate to value added, which is calculated by subtracting purchased inputs from sales. The mechanics of implementing a VAT in these two ways are described in chapter 3.
If tax is levied at a single rate on all goods and services (that is, with no exceptions or differential rates), the credit and subtraction methods produce identical results, and the subtraction method may