The Macroeconomic Implications of Replacing the U.S. Federal Tax System With a Value-Added Tax

This paper analyzes the potential implications of instituting a value-added tax (VAT) as the sole source of revenue for the United States Federal Government. A credit-invoice, broad-based VAT would fundamentally tax consumption, whereas the current system employed by the U.S. taxes production. A VAT system would allow firms to make decisions based on the most efficient allocation of capital and labor inputs, leading to a greater level of efficiency and productivity for U.S. firms in the long run. While the VAT would initially reduce the amount of consumption spending within the United States due to it raising the price of consumable goods, workers have the potential to earn higher after-tax income as a result of eliminating the payroll and individual income tax. This shift would provide incentives toward savings, investment, and work that would augment the nation’s capital stock and lead to higher levels of real gross domestic product (GDP) in the long run. This paper concludes that the macroeconomic effects of replacing the current tax system with a broad-based VAT are positive despite the drawbacks of such a mechanism. A flat, broad-based VAT is a simple, efficient tax mechanism that could provide a better revenue source for achieving higher levels of economic growth in the United States.