There’s been much ado about the potential for the dreaded Value Added Tax (VAT) of late since the economic reality of America’s borrow and spend mantra is starting to hit home.

What is the VAT?

A value added tax is not much different than a sales tax, which is why Americans are so suspicious of it.  It’s a tax that gets levied at each stage along the supply chain and in the end, you the consumer, pay the final tally.  It’s a rather “invisible” tax that ends up rearing its ugly head in everyday purchases, so it’s not quite as obvious to the discerning consumer that your government is taxing and spending your income more than it was prior to the implementation of the tax.  The way it works for businesses is that they can recover the tax paid on inputs to their supply chain so that it’s virtually invisible to them and solely passed along to consumers.  Services though, do not escape the VAT even for businesses.

For and Against the VAT

Because the VAT is a consumption tax, opponents argue that it disproportionately targets the poor and middle class while the higher income citizens wouldn’t really notice it.  For instance, if a given rich household and middle income household both consume roughly the same amount of food, gasoline and other goods, while the upper income home may not feel any pain from a VAT, a middle income household would be disproportionately affected.

The VAT was initially started to avoid cheating and smuggling, though as is typical with any new legislation, enactment of a VAT here would likely result in other means to escape its grasp.  For instance, would everyone start up a “small business” and use their business designation to avoid paying the consumer VAT?  Additionally, just like we’ve seen with the massive health care bill and now, the Financial Reform bill, there are new massive layers of regulation, oversight, paperwork and bureaucrats being added to police the new legislation and any net growth of government with expenses borne by the taxpayer is often bad for the economy as a whole (i.e. adding payroll and getting nothing in return).  So, this obviously flies in the face of “small government”.

Now, proponents argue that 139 different countries (including most of the developed economies we associate ourselves with) have a VAT in some form or another.  Additionally, it can’t be ignored that the US is facing a fiscal crisis at some point in the future, and unless we reverse course and cut spending (which is unlikely), there will need to be some form of new, higher taxation.  To ignore the burgeoning debt would put the sanctity of the US dollar as the world’s reserve currency at risk which would mean higher interest rates, inflation and a lower standard of living in the U.S.

While the opponents argue against the regressive nature of the tax, proponents cite that it’s actually not the case, since affluent consumers tend to just buy more “stuff”, and more expensive stuff at that, so at the end of the day, it would be more of a linear impact to society, as opposed to a regressive tax hurting the poor.

Surprisingly, even some key business leaders seem open to the idea of a VAT – but with a catch: lower corporate income taxes.  In that vein, they must be looking at the total impact and view lower corporate taxes as a net positive.

Regardless of what the naysayers and the supporters say, given the direction the economy is headed and the continued deficits projected in the coming years, you can expect to hear more about the VAT and we may even see one proposed under the current administration.