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Value Added Tax: Government Spends More, You Pay More?

Posted on 22 October 2010

On December 1st, the President’s Commission on Fiscal Responsibility and Reform will deliver their recommendations on how to reduce the US national debt. The Commission is said to be considering not only spending cuts, but also new revenue sources. According to one recent Reuter’s article, a value added tax (VAT) is likely to be in the mix.

So how exactly does a VAT work, and what does it mean for your wallet?

Think of it like this: unless you live in a state like Delaware or Alaska with no sales tax, you’re probably accustomed to paying a bit extra on most retail and grocery purchases you make. With a five percent sales tax, you buy a hamburger for $1, but the final price you pay for that burger is $1.05. The restaurant then passes that extra 5 cents on to the state government.

As a consumer, you’re still paying extra for a VAT, but it’s much stealthier than your state’s sales tax. With a VAT, the restaurant will pay a tax to the federal government on the ingredients they purchase to make your burger. Since a ten percent VAT means that a burger is ten percent more expensive for a restaurant to sell, the restaurant responds by charging you more for your burger (with full pass-through of the tax, the price you pay rises to $1.10).

You don’t see this tax as a line-item on your receipt, but you’re still paying more money for many of the items you’re purchasing. It’s a stealth tax—and that’s the point.

Congress risks political backlash if they make significant cuts to entitlement programs where we’ve promised more than we can afford. Raising income taxes is similarly unpopular. Instead, our elected representatives can use the VAT to raise the price of most products that the middle class purchases—and collect hundreds of billions in additional government revenue that spares them from reining in excessive spending.

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