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Implementation of VAT would represent huge tax change
A couple months ago, I commented that the U.S. is the only major industrialized nation without a value-added tax or national sales tax on goods and services. Well, earlier this month, House of Representatives Speaker Nancy Pelosi commented on “The Charlie Rose Show” that a VAT may be part of a larger reform of the Internal Revenue Code.
Most states (and some cities) impose sales taxes on transactions involving sale of tangible property. A number of them also impose a sales tax on certain services. Many of us in Michigan recall that, just two years ago, Michigan enacted a sales tax to be levied on services, only to repeal it hours after it came into effect. There was much controversy on exactly how the tax would be levied and accompanying issues regarding administration and compliance with the tax provisions. The repeal resulted in the additional surtax on the Michigan Business Tax.
A national VAT may create controversy similar to the Michigan services tax debate. If there is a serious attempt to enact VAT legislation, you can rest assured that Washington lobbyists will come out in force to try to exempt certain transactions. The issues of what rate at which to administer the tax and whether to piggyback the administration with state sales taxes will be hot topics. Part of the debate will be about the promise not to raise income taxes on the 90-percent-plus of Americans who make less than $250,000, and how the VAT is not an income tax and the promise didn’t necessarily cover other taxes. There may be something to this position, but many of us recall the promise by former President George H.W. Bush of “Read my lips: No new taxes,” and how voters were upset when income tax rates were, in fact, adjusted during his tenure.
Canada was one of the last countries to introduce a VAT type of tax when it instituted its goods and services tax in 1991. The GST is a national levy in addition to any provincial sales tax. Any U.S.-based business conducting business transactions in Canada has its own story to tell with regard to the issues surrounding whether to register for the GST and the issues with compliance. Many of us who have traveled to Canada have witnessed the tax levied on most of our purchases of goods and services. The same goes for Europe, where VAT rates are generally in the range of 15-20 percent on those transactions subject to VAT — which are most transactions of goods and services. There are some exemptions or tax rate reductions for purchases of food or certain other items.
The biggest change for businesses in the movement to a VAT will be similar to the controversy in Michigan regarding the expansion of the sales tax to certain services. That change is the cost of implementing infrastructure and mechanisms to handle the collection, remittance and filing of returns. Given the state of employment losses in the U.S., the imposition of a VAT create many new jobs in both the private and public sector merely to handle the collection, remittance, reporting, administration, and auditing the businesses required to file, collect and remit the VAT.
In her appearance on “Charlie Rose,” Speaker Pelosi did not go into much detail about at what tax rate a VAT should be assessed or what exemptions may be available. Many opponents to a VAT may argue that any national sales tax or VAT type of tax is likely to be regressive, in that many individuals and families or businesses that pay no or modest income tax amounts may see their tax burden increase dramatically. For example, a 6 percent VAT (significantly lower than most of Western Europe) on a purchase of a $25,000 automobile will cost $1,500. Just imagine the amount that might apply to a rent payment or a purchase of a home (if such items are subject to a VAT regime). The imposition of VAT may significantly change the tax landscape in the U.S.
Most VAT regimes exempt export transactions, so any similar treatment in a U.S. VAT regime, if enacted, will be friendly to U.S.-produced goods that are sold to customers outside the U.S. Imported goods, however, are subject to the reach of VAT, so many may see the imposition of VAT as part of a strategy to help create or maintain U.S. jobs that produce product for use outside the U.S. It may be interesting to review what studies have been done in the past 18 or so years since Canada implemented its version of a VAT and the impact on export-related jobs. It may be difficult to make specific conclusions, as the NAFTA trade agreement came into force in the same relative time period as the Canadian GST regime.
The actual mechanics of a VAT are more complicated that assessing a sales tax on a consumer. The use of a VAT mechanism results in the application of a tax at each stage of the production of a good or service. Thus, the seller of the raw material to a factory assesses VAT on its sale. The factory then assesses a VAT on its price of the product to a distributor, and then the distributor to its customer, and so on. Then, each party files a monthly return where it remits the gross tax collected or required to be collected, and then deducts any credits for any VAT it paid on transactions in the chain of producing or acquiring the product or service it sold. These credits, often referred to as “input” credits, reflect the tax paid on items input into the product or services that are ultimately sold to a customer. The tracking of the input credits can become burdensome for businesses. The need to obtain proper documentation for these “input” credits will likely require a major overhaul of the accounts payable system of a business, as well as other information-gathering capabilities.
As mentioned above, the changes and requirements to administer such a tax will likely increase employment in both the private and government sectors of the economy. The imposition of such a tax at a national level may also result in many state and local jurisdictions that currently assess a sales tax to piggyback and expand their respective tax base to include items not currently subject to sales tax. Given that states are experiencing tight financial difficulties, the chance to piggyback on a national VAT tax base may be very tempting.
With the large federal government operating deficits and the impact of the various initiatives being considered in Washington, the debate over a national sales tax may increase over time, given the recent comments of Speaker Pelosi that perhaps it may be appropriate to consider a VAT in any discussion on tax reform. We will need to sit tight and see whether others in Congress share the Speaker’s views.
The change to a national sales tax or VAT may be the biggest tax change since the major overhaul in 1986 of the Internal Revenue Code.
William F. Roth is a tax partner with BDO Seidman. The views expressed above are those solely of the author and not necessarily those of BDO Seidman LLP.