US VAT Pitch Raises $12.2 Trillion but Risks a Fiscal Trap

A value-added tax pitched to close America's fiscal gap could raise $12.2 trillion over a decade, yet risk locking in a permanent expansion of federal revenue to European levels, according to a Wall Street Journal analysis.

"The purpose of a VAT would be to achieve a step-change toward the European level of nearly 30 percent of GDP," Joseph C. Sternberg, a member of the Journal's editorial board and its Political Economics columnist, wrote.

The Congressional Budget Office estimates a 5 percent VAT would generate $3.38 trillion over 10 years, while the Peter G. Peterson Foundation calculates an 18 percent rate would yield $12.2 trillion. VATs already supply 15 percent to 20 percent of government revenue in Britain, France and Germany, and comparable economies including Canada, Japan, the Netherlands and Switzerland collect about 5 percent of GDP from the tax at rates up to around 20 percent.

The stakes are high for U.S. taxpayers and businesses. A VAT would add compliance costs of 1 percent to 2 percent of revenue for U.K. companies, and the smallest firms — those under £90,000 in annual revenue — cannot claim refunds on inputs as larger competitors can. If lawmakers adopt a VAT without cutting income or corporate taxes, federal revenue as a share of GDP could climb from its historical ceiling of about 18 percent toward Europe's near 30 percent.

The VAT's appeal rests on its simplicity. Levied at every stage of production on the value added in that step, it lets businesses deduct or refund the tax paid on raw materials, so the end consumer bears the full burden. That contrasts with U.S. state sales taxes, which stack on top of business inputs.

The Compliance and Small-Business Catch

The convenience is partly illusory. Businesses must pay a refundable tax on materials, collect a tax from customers, subtract the refundable portion, then remit the adjusted amount — a process that costs 1 percent to 2 percent of a company's revenue in the U.K. While Britain exempts microbusinesses with annual revenue under £90,000, that carve-out means delicate startups and side hustles cannot claim VAT refunds on inputs the way larger competitors can. The tax is pitched as a consumption levy, but in some cases it functions as a small-business tax.

A Revenue Bonanza That Never Shrinks

The deeper problem is political. Supply-side economists have long argued the ideal system taxes consumption rather than work and investment, but America's code does the opposite. With federal spending running ahead of current revenue, the only realistic outcome would be a new consumption tax layered on top of existing income and corporate taxes rather than replacing them. Sternberg notes that however lawmakers set rates, U.S. revenue always maxes out at around 18 percent of GDP; the purpose of a VAT would be to push that toward Europe's near 30 percent.

Europe's experience offers a cautionary tale. Despite VATs that enabled the expansion of welfare states, Britain, France and Germany now face fiscal crises in some ways worse than America's. If Congress cannot match spending to current tax revenues, there is little reason to think lawmakers would be more restrained once a new consumption tax up-rated revenue collection. The national-debt problem, Sternberg argues, is a spending problem, not a revenue problem — and Republicans in particular should be wary of trading permanent tax hikes for illusory budget stability.

The debate is set to intensify as the next budget fight brings the debt into sharper focus. Sternberg warns that the coming wave of "solutions" from Washington wonks will include the VAT, and that lawmakers should weigh the compliance burden on small business and the risk of a permanent revenue expansion before embracing it. For investors, the implication is that a consumption tax — if adopted — would hit consumer discretionary spending and corporate margins, while bond markets would watch whether any new revenue actually narrows the deficit or simply funds higher outlays.

This article is for informational purposes only and does not constitute investment advice.