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Considering the value added tax alternative.

In January, 1996, the National Commission on Economic Growth and Tax Reform released its much awaited report, "Unleashing America's Potential: A Pro-Growth, Pro-Family Tax System for the 21st Century." According to Internal Revenue Service estimates, businesses will spend about 3,400,000,000 hours and individuals an additional 1,700,000,000 hours in tax-related paperwork, at a cost of $200,000,000,000 a year. Mobil Corp. testified to the Commission that it took the firm the equivalent of 57 full-time employees working for a year and cost the company about $10,000,000 to do its taxes.

There has to be a better way. However, while the Commission was clear and definitive with respect to what had to go, it could not come up with a recommended replacement. The Commission laid out the universe of ideas, ranging from a retail sales tax to a flat tax to a cash flow tax, but left the weighing of the benefits and burdens of the proposed alternatives to the reader.

One proposed alternative is a value-added tax (VAT) imposed and collected on the "value added" at every stage in the production and distribution process of a good or service. Although there are several ways to compute the taxable base for a VAT, the amount of value added can be thought of as the difference between the value of sales (outputs) and purchases (inputs) of an enterprise.

The amount of value added may be determined under a VAT in a number of ways. The two most common are the credit invoice and subtraction methods. The credit invoice method is the system of choice in nearly all of the countries that have adopted a VAT, while the subtraction method, sometimes referred to as a business transfer tax, has been used in New Hampshire and Michigan.

Credit invoice method

Under the credit invoice method, a tax is imposed on the seller for all sales. It is calculated by applying the tax rate to the sales price of the goods or services, and the amount of tax generally is disclosed on the sales invoice. A business credit is provided for all VAT paid on purchases of taxable goods and services used in the seller's business (inputs). The ultimate consumer (a non-business purchaser) does not receive a credit with respect to his or her purchases. The VAT credit for inputs prevents the imposition of multiple layers of tax with respect to the total final purchase price. As a result, the net tax paid at every individual stage of production or distribution is based on the value added by that taxpayer at that stage of production or distribution. In theory, the total amount of tax paid with respect to a good or service from all levels of production and distribution should equal the sales price of the good or service to the ultimate consumer multiplied by the VAT rate.

Subtraction method

Under the subtraction method, value added is measured as the difference between an enterprise's taxable sales and its purchases of taxable goods and services from other enterprises. At the end of the reporting period, the VAT rate is applied to this difference to determine the tax liability. The subtraction method differs from the credit invoice method principally in that the tax rate is applied to a net amount of value added (sales less purchases), rather than to the gross sales, with credits for tax paid on gross purchases.

The credit invoice method relies upon an enterprise's sales records and purchase invoices, while the subtraction method may rely on records a taxpayer maintains for income tax or financial accounting purposes. In both cases, the same amount of total tax is paid at the same levels of production.

Goods, services, or classes of taxpayers may be excluded from a VAT by providing either a "zero rating" or an exemption. Sellers of zero-rated goods or services do not collect or remit any VAT on the sales of those items, though they would be allowed to claim credits and potential refunds for the VAT they pay on purchased goods and services.

Is a VAT a good idea? Many have claimed that the real question is not whether it will be adopted, but when--and with what exemptions. In its simplest form, it is nothing more than a national sales tax imposed in incremental stages. It clearly could and would be a major revenue raiser. My concern, however, is that it most likely would not replace the current income tax, but supplement it. Rather than simplify, it would add one more layer of taxation on Americans' current burden. The Tax Reform Act of 1986 was supposed to create two tax rates, at lower levels, in exchange for giving up certain allowable deductions. The deductions disappeared and still are gone, while the tax rates have multiplied and have been increased on several occasions.

Beware of new tax systems. They rarely accomplish what they are advertised to do and usually end up doing what they are advertised to cure--complicate your paperwork and invade your pocketbooks.
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Article Details
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Author:Schnepper, Jeff A.
Publication:USA Today (Magazine)
Article Type:Cover Story
Date:Sep 1, 1996
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