The Beauty of Value-Added Tax for the United States – More Revenue with Least Impact

June 21, 2025. This site is overdue for another opinion on the current US tax and tariff debate as it continues into the summer.

A concern of the new administration has been the imposition of high rates of value added tax (VAT) by importing countries on goods imported from the United States.  This is seen as an additional and unnecessary tax on US exporters that is not levied by the US Government on imports into the United States.  VAT rates are relatively high among OECD members, averaging 19%, and generate a significant share of total fiscal revenue for governments. 

VAT applies to imports of both goods and services – whereas tariffs only apply to imports of goods.  Services represented 35% of total US exports to the EU in 2024.  In the EU, VAT rates vary from 17% to 28% depending on the importing EU country and the product.  Clearly then, VAT represents a significant addition to the landed cost of US exports to the EU.  The administration sees these rates as an unfair non-tariff barrier that should be eliminated on the import of goods and services from the United States.  This led President Trump on April 2 to propose a 20% reciprocal tariff on all imports from the EU – to counter its 2.7% average trade-weighted tariff and its average VAT rate of 21.6%.

What is VAT and why is it imposed on the imports of goods and services in the EU?  VAT was first implemented by France in the 1950s and has now been adopted by 175 countries – almost all nation states except the United States impose VAT on imports of goods and services.  Firstly, VAT is a tax on consumption rather than income.  While the assessment and payment of income tax relies to a large degree on self-declaration by taxpayers, VAT payments rely on third-party vendors to collect and remit the tax revenue.  As we shall see, the design of VAT ensures vendors are unlikely to evade payment of VAT to the government whereas individuals and companies have every incentive to minimize their income tax payments.

Secondly, VAT is levied on the sale and purchase of a good or service at every stage along its value chain – from sourcing raw materials and other inputs, through production and distribution to the final consumer.  In comparison, the US retail consumption tax (sales tax) applied by most US states is levied only once and targets the end consumer at the final stage of consumption.  If the tax is not collected at the final retail sale for any reason, then no revenue is collected at all from the consumption of the product.

To avoid the cascading effect of applying taxes upon taxes at each stage of the value chain, all VAT paid by an enterprise on the purchase of their inputs are credited against the VAT collected on the sale of their outputs at each stage of the value chain.  Therefore, only the net value added of the final good or service is subject to tax.  The magic of VAT is that every enterprise is incentivized to collect and remit VAT on their sales in order that they can receive a credit for all the VAT they have paid on all their goods and services inputs.

The discretionary area of the design of a VAT regime is in deciding which goods and services to tax.  The larger the number of goods and services subject to VAT the lower the administrative and compliance costs and the lower the rate of VAT necessary to achieve a given level of revenue.  However, most countries exempt basic goods and services (e.g. fresh fruit and vegetables and household utilities) from VAT in order to reduce its burden on low-income households.  Housing and labor services are also excluded.

The question arises as to where and when consumption actually occurs and thus where and when it should be taxed.  VAT is levied on the consumption of applicable goods and services within the territory of the taxing country.  Therefore, anyone in the country, resident or visitor, shall pay VAT on their consumption within the country.  However, goods or services produced in the country but consumed outside the country are not taxed.  This is fair because such extra-territorial consumption is likely taxed by the country where consumption takes place.  This means that exporters do not charge their foreign customers VAT.  Furthermore, in order not to disadvantage exporters, all VAT paid on their inputs is refunded to the exporter by their national tax authority.  Therefore, exporters around the world are competing on a level playing field when it comes to VAT.

Just because the United States does not have a VAT regime does not mean that US exporters are being unfairly treated by countries with VAT regimes.  European consumers pay VAT on all their relevant purchases whether imported or produced domestically.  European car manufacturers are subject to the same rate of VAT on their domestic sales as their competing US car manufacturers exporting to the EU.  US policy makers have chosen to keep tariffs relatively low – thereby encouraging greater competition and efficiency among auto makers.  The average US tariff on car imports is 2.5% compared to the EU’s 10%.  It is no wonder that foreign car manufacturers eye the US market so closely.  It is a large affluent market subject to much lower consumption taxation on car purchases than their own domestic markets.

The US sales tax system, no matter how efficiently administered, can never raise the same amount of revenue as a VAT system using the same nominal rate of tax.  There are too many opportunities for evasion and underreporting and too many grey areas as to whether the transaction is a final sale or not or is exempt or not.  Furthermore, if sales tax is levied at points along the value chain in addition to the final sale then the earlier tax is built into the cost of the good and subject to further sales tax thus artificially inflating its cost to the end consumer.  Some US exporters may even have sales tax embedded in the cost structure of their exports and so reducing their pricing competitiveness – something much less likely under a VAT regime.

Many years ago, I was the policy analyst responsible for maintaining and updating New Zealand’s Good and Services Tax (GST) regime at the New Zealand Treasury Department.  I mention this because New Zealand’s GST regime is a broad-based, low-single rate, value added tax regime that significantly enhanced the efficiency and value of revenue collection for the New Zealand Government.  New Zealand’s model has been adopted by many countries, including Australia and Canada and now India.

Like the United States, India is a federation of states.  Each Indian state each applied its own sales tax regime to goods in addition to a range of other state and central government consumption taxes.  State sales tax rates averaged between 8% and 10%.  States began to replace their retail sales taxes with VAT on goods in 2003.  In addition, the central government applied its own sales tax to a number of services.  Except for import duties and a few excise taxes, all state and central government consumption taxes were replaced with a national unified GST regime in 2017.  The most common rates of GST today are 12% and 18% on most goods and services. 

Even with a doubling of tax rates on the consumption of goods, the increase in consumption tax revenue collected during this transition has been significant.  While India’s GDP grew by 334% between 2003 and 2018, replacing sales taxes and other consumption taxes with a unified GST regime increased consumption tax revenue by 2,795% over the same period (ignoring all tariff revenue).  This growth in GST revenue was driven by the broader base and the incentive for all businesses to collect and remit VAT on their sales in order to receive credit for VAT paid on their inputs.  Incidentally, revenue data from VAT records provides a useful audit check against business underreporting their assessable income.

Congress and others have considered a national VAT system for the United States from time to time.  To date the complexity of the current sales tax system and the resistance of local taxing authorities have combined to defy reform – up to 12,000 different tax jurisdictions apply sales tax in the United States.  However, it would seem quite possible to develop a unified national system using existing enterprise Employer Identification Numbers and administered by Agentic AI.  The additional revenue generated should encourage individual states to negotiate a revenue sharing agreement with the federal government.  The average state and local sales tax across all US states is 6.6% – in fact, fifteen states have combined state and local sales tax rates greater than 8%.  Replacing these sales taxes with a modest 5% rate of national VAT may neutralize any tax impact on households but raise significant revenue.

In conclusion, it would behoove the US administration to seriously consider a national VAT regime to efficiently generate further revenue for national and state budgets.  VAT could be administered nationally by the IRS and revenue distributed to states based on their population or some other metric.  Apart from the fiscal efficiency and revenue impact of a VAT regime, the US would then be able to fairly apply its national rate of VAT to imports of European automobiles.

Geoff Wright

TradeSmart Strategy LLC