A value-added tax raises a ton of money. The base (the total amount of goods that would be subject to tax) would range from one-third to one-half of gross domestic product. U.S. tax revenue, meanwhile, is running well below the long-term trend — by about 3 percent of GDP. A 10 percent VAT with a relatively broad base could raise $750 billion a year, enough to pay for about a fifth of the federal budget. This would make room for cuts in other taxes.
A VAT is much less visible than an income tax –individuals don’t have to file an annual return for it — so a tax that is paired with income-tax cuts might be surprisingly palatable, especially if it is phased in.
The VAT offers an opportunity to expand the tax base. Politically, it may not be feasible to abolish the most expensive and popular income-tax deductions, such as those for mortgage interest and health care. But the VAT starts fresh with a new base. Taxing home construction (as many countries, such as Canada, do) would help offset the distortion of the mortgage deduction. Ideally, this should even apply to health-care services…
The rates need not spiral upward. In European Union countries, rates are in the teens or 20s, because EU rules force all members to levy a VAT of at least 15 percent. The U.S. does not have to follow suit. Non-European VATs have tended to stay at reasonable levels. The Australian value-added tax is 10 percent, and Japan’s is 5 percent. Canada introduced a 7 percent VAT in 1991; the rate has since been cut twice and stands at 5 percent.