How a VAT would affect growth

October 14, 2010

Just how would tacking a 10 percent value-added tax onto the current tax system affect the economy? Well, an Ernst & Young study commissioned by the National Retail Federation came up with this result:

1. An add-on VAT would reduce retail spending by $2.5 trillion over the next decade. Retail spending would decline by almost $260 billion or 5.0 percent in the first year after enactment of the VAT.

2. An add-on VAT would cause GDP to fall for several years. The economy would lose 850,000 jobs in the first year, and there would be 700,000 fewer jobs ten years later. By comparison, a comparable reduction in the deficit through reduced government spending would have less adverse effects on the economy, and could have positive effects for economic growth.

3. Although lower deficits and debt would have positive long-run effects for the economy, most Americans over 21 years of age when the VAT is enacted would be worse off due to enactment of an add-on VAT. A VAT would have significant redistributional effects across generations, reducing real incomes and employment for current workers.

Me: Even though this is sponsored by a retailing trade group, the results are hardly shocking since an add-on VAT is a massive tax increase.  Replacing the current tax system with a consumption tax is one thing, but this would  take the US tax burden to record levels. And those levels would likely rise with time given the international experience with the VAT:

vat

3 comments

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Having lived in London for a year and a half now, I can attest to the fact that the VAT reduces retail spending. I still experience sticker shock every time I go into a store. I have not bought nearly as many new clothes or shoes here as I did when I lived in the US.

For the doubters out there, imagine tacking on 17.5% to everything you buy. It mounts up over time. Instead of buying 3-4 new shirts, you decide to buy 1-2 or none. Multiply that reduced level of buying throughout the economy and it has significant consequences.

Although the study focused on the retail industry, I have found my bahavior has changed the most with respect to dining out. Again, add 17.5% on to each dinner bill, and suddenly you are eating out a lot less. Going out to dinner was a fun hobby for me and my husband in DC, but here in London, it’s just too expensive to do as frequently.

After my experience with living in London, I have no doubt that adding on a VAT would be disasterous for the US economy.

Posted by LizzieC | Report as abusive

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That’s an interesting graph and, in the case of Canada, quite wrong. Canada’s GST was introduced at 7% in 1990 and stayed there until 2007, I think it was, when the ruling Conservatives cut it to 5%. The 15% rate shown in the graph is likely a combination of both GST and provincial sales taxes which, in some cases, can easily exceed a combined rate of 15%. Here in Ontario the combined rate is 13%; in Alberta with no provincial sales tax, the combined rate is 5%; Newfoundland I think is around 20%. And Alberta is Canada’s most dynamic economy! Go figure.

Posted by Gotthardbahn | Report as abusive

I don’t think the combined HST rates in Canada run as high as 20%, even in the “hold-out” provinces, there is no provincial retail sales tax rates higher than 10.5%. The highest combined rate is actually in two harmonized provinces of Nova Scotia + P.E.I where the rate is 15 + 15.5% respectively. Compared to other GST / VAT countries this seems on the low side (NZ – 15%, Ireland 21(+1+1), UK 20…And don’t forget Canada will soon have a corporate tax rate of 15%, one of the lowest in the OECD.

Posted by CanuckinKL | Report as abusive