By Rose Moore, CPA and Anita Anand, JD
This article is the first in an ongoing series of articles focusing on changes in international taxation that could affect businesses. We hope you find it educational and encourage you to keep an eye out for further articles.
The Value Added Tax (VAT) has been a divisive subject for many decades in the US, but has become increasingly significant as the world shifts to a global economy. At present, more than 160 countries have implemented VAT systems. While the United States has not passed a similar tax, with both India and China implementing a comprehensive national VAT in the last 5 years, it is becoming increasingly difficult to ignore.
What is a Value Added Tax?
A value added tax is a consumption tax on both goods and services. Many countries often use it as a replacement for sales tax and a revenue raiser. The structure of these tax systems often results in about the same amount of tax paid on goods, both by individuals and businesses but raises revenue on services. Businesses receive a refund of VAT paid for goods sold in country.
Exports are exempt from VAT and any tax paid will be refunded when the export occurs. Imports are assessed VAT when the import arrives in country.
The current structure of the VAT was implemented in the early 1990s, beginning in Europe. The United Kingdom passed the Value Added Tax Act of 1994, which aligned the previously assessed consumption tax with other European Union systems. Since then, the VAT has become one of the largest revenue sources for the country. The below chart shows the revenue generated by individual income taxes, corporate income taxes, and the VAT systems. Using a VAT, the U.K. has been able to keep corporate tax rates relatively low.
Since the 1990s, VAT has accounted for 30-35% of Denmark’s total GDP (per the Denmark Ministry of Taxation website). Like other European Union members, the country’s corporate tax rate is relatively low, making it attractive in a global economy.
Canada implemented its Goods & Services Tax (GST) in 1991 as a replacement to a hidden sales tax. Provincial sales taxes have remained in place. Recently Canada has integrated the VAT and sales tax into a Harmonized Sales Tax (HST) to simplify administration. The tax has been increased and reduced multiple times since it’s inception, as evidenced in the below graph. Unlike European countries with similar taxes, Canada’s VAT (GST) is a relatively low rate of 5%. At last check, HST has been implemented in all but 3 Canadian provinces.
How the U.S. can benefit
The U.S. has been wary about committing to a VAT system as it can be viewed as an additional and regressive tax, one that leads to an increase in product price which will affect lower income people the most. Another criticism is that a VAT will be paid by individual purchasers.
The US exports about $1 trillion a year and imports about $2.3 trillion dollars a year. It is a little difficult to be precise because the US has many multinational corporations and a significant amount of both are between related parties. What is easy to understand is that all US exports are hit with VAT when landed in another country. Additionally, all imports to the US have their home country VAT refunded upon departure from that other country. VAT tax rates run from 5% to as high as 23% depending on the country of origin. Over the past 30 years, many US jobs have been lost due to manufacturing operations being transferred offshore. Instituting a VAT tax could tend to level the playing field. The U.S. currently offers a tax deduction (2 to 3% reduced corporate tax rate based on complicated rules) for domestically manufacturing products. The U.S. has attempted to mitigate the disadvantage to exporters by imposing tariffs on certain goods and creating an export credit, but this legislation was considered unfair by the European Union. The tariffs were considered an illegal border adjustment tax (BAT) and the U.S. withdrew.
One way to implement a VAT without raising any costs on US manufacturers would be to implement a VAT on imports only and at the rate of the country exporting to the US. This could level the playing field between US exports and imports. Large importers of less expensive goods would most likely view this unfavorably as imported products would be a bit more expensive and could impact consumers spending patterns. However, ignoring the problem puts US business at a distinct disadvantage to the rest of the world and objectively viewed is an unfair subsidy on imports.
VAT could also generate substantial revenues for the US government and help fund reductions in corporate tax rates to make US businesses more competitive with the rest of the world. The total amount of VAT paid would not change, only which government receives the money. More competitive US exports could create significant numbers of US jobs.