And, 10 percent VAT eliminates cost of UBI with trillions leftover! – exempts small businesses and UBI offsets impacts on middle and low-income households

[William, “How a VAT could tax the rich and pay for universal basic income,” Brookings Institute, January 30, 2020, https://www.brookings.edu/articles/how-a-vat-could-tax-the-rich-and-pay-for-universal-basic-income/, accessed July 1, 2023, GDS-LL]

The plan would raise substantial net revenue, be very progressive, and be as conducive to economic growth as any other new tax. The VAT would complement, not replace, any new direct taxes on affluent households, such as a wealth tax or capital gains reforms.

A VAT is a national consumption tax—like a retail sales tax but collected in small bits at each stage of production. It raises a lot of revenue without distorting economic choices like saving, investment, or the organizational form of businesses. And it can be easier to administer than retail sales taxes.

An American VAT

The structure of an American VAT should mirror those of the most effective existing VATs around the world. It should be built on a broad consumption base. It should adjust (impose or rebate) taxes at the border so it applies only to goods and services purchased in the US no matter where they are produced. Small businesses should be exempt, though they should be able to choose to join the VAT system. Social Security and means-tested government programs, such as Temporary Assistance to Needy Families, should be adjusted to reflect the after-VAT price of relevant purchases.

Border adjustments are ubiquitous in VATs around the world and do not constitute tariffs. And almost all VAT countries exempt small businesses (somehow defined). Limiting the VAT to firms with more than $200,000 in gross receipts would exempt 43 million small businesses.

Finally, the UBI payment would eliminate the burden of the VAT and give additional resources to low- and moderate-income households. My version would set the UBI at the federal poverty line times the VAT rate (10 percent) times two. For example, a family of four would receive about $5,200 per year. My UBI proposal is similar to, but smaller than, the version proposed by Democratic presidential candidate Andrew Yang.

Effects

A 10 percent VAT would raise about $2.9 trillion over 10 years, or 1.1 percent of Gross Domestic Product, even after covering the cost of the UBI.

As with any tax, its effects on the economy would depend on how government uses the revenue. But all else equal, it would be better for the economy (that is, less distortionary) than hiking income tax rates.

To avoid disrupting the economy in the short run, the VAT proceeds should be used in the early years to stimulate the economy, and the Fed should accommodate the VAT by letting the consumer price level rise.

The Tax Policy Center estimates that the VAT in conjunction with a UBI would be extremely progressive. It would increase after-tax income of the lowest-income 20 percent of households by 17 percent. The tax burden for middle-income people would be unchanged while incomes of the top 1 percent of households would fall by 5.5 percent.

It may seem counter-intuitive, but the VAT functions as a 10 percent tax on existing wealth because future consumption can be financed only with existing wealth or future wages. Unlike a tax imposed on accumulated assets, the VAT’s implicit wealth tax is very difficult to avoid or evade and does not require the valuation of assets.

A VAT also could benefit states. While states would not have to conform to the new federal law, doing so could improve the structure of their consumption taxes, which tend to exempt services and necessities and often tax businesses. Canada’s provinces provide an example of how national and sub-national VATs can “harmonize.”