VATs are popular throughout Europe, but they have nothing to do
with making wine - or beer for that matter. A VAT, or value-added tax, is a levy on goods and services at each stage of the production process.
The United States is one of the few industrial countries that has yet to adopt a VAT, and it is the only one with neither a VAT nor a national sales tax. More than 50 countries have adopted the VAT in place of income taxes, including all the countries of Europe except Iceland, plus Canada and Japan.
Replacing the income tax with a VAT would mean a period of disruption for consumers and businesses alike, and whether it is worth the effort is debatable. Critics and supporters alike point to the VAT's track record in Europe, which has the longest experience with the tax.
“The VAT has the virtue of eliminating the headache of an income tax for everyone,” Senate Finance Committee Chairman William V. Roth Jr. said earlier this year. “But, as our European trading partners who use the VAT tell us, it is no panacea.”
First introduced in France in 1954, the VAT was adopted in Denmark, the Netherlands and West Germany in the 1960s. By 1973, various forms of the VAT had taken hold in the United Kingdom, Italy, Belgium, Ireland and Luxembourg. A major impetus behind the VAT's broad reach in Europe was the desire to integrate the European Community (now the European Union). A common tax system was seen as the key to facilitating the free movement of goods and services across Europe's many national borders.
Before the VAT, each country in Europe taxed goods and services in a variety of ways. On top of that, import and export duties in each country also varied widely. This highly individualistic system persisted over the years because member states were reluctant to relinquish sovereignty in fiscal and trade matters.
Passage of the 1986 Single European Act, removing barriers to trade within the then 12-member federation, overcame much of this resistance. By next year, the 15 current union members will be required to eliminate any remaining sales taxes and replace them with a communitywide VAT.
Under the new VAT system, businesses will pay taxes on the full value of their sales and then claim a credit for the taxes they have already paid on raw materials and other goods purchased. In addition, all taxes previously collected at national borders are to be abolished.
As in Europe, the VAT would offer disadvantages as well as benefits to Americans. Unlike the current U.S. tax system, which taxes the income of both individuals and businesses, a VAT would be paid by businesses alone. The VAT offers the advantage of making it harder to evade taxation because a paper trail of invoices follows everything that is sold. The VAT also would relieve individual taxpayers of the task of filing income tax forms each April.
For Americans, the downside of a VAT is that businesses could be expected to pass on at least part of the tax burden to consumers. Indeed, a major objection to the VAT is its regressivity. Because it taxes consumption, it falls more heavily on the shoulders of the poor, who must spend more of their income for essential goods than the better-off.
Europeans have tried to solve this problem by setting the VAT at different rates for different goods, typically exempting food, housing and medical care from taxation. This enables governments to encourage sales of certain goods as well as reduce the burden of taxation on the poor.
Adopting a VAT in the United States, as proposed by Sen. Sam Nunn, D-Ga., and Sen. Pete V. Domenici, R-N.M., would entail a far more wrenching change for Americans than it has in Europe. The problem is that income taxes alone have long accounted for the bulk of government revenues in this country, while most European countries traditionally have relied on a mix of income and sales taxes.
The Nunn-Domenici proposal, dubbed USA Tax, combines a flat tax on individuals' incomes with a VAT on business. Combining a VAT with the income tax would mean less of a change for individual taxpayers. But such a hybrid system would be costlier than simply replacing one system with the other.
Because it combines features of two popular taxation approaches - the VAT and flat tax - USA Tax could find widespread support. But skeptics note it's the worst of both worlds: Two tax systems instead of one.