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The Dedicated VAT Solution

Aug 2010
Policy Brief
By  Victor Fuchs, John Shoven
The National Commission on Fiscal Responsibility and Reform, co-chaired by former Clinton White House Chief of Staff Erskine Bowles and former Republican Senate Whip Alan Simpson, faces two over-riding problems. First, it must find a new source of revenue for the federal government, a source that is relatively stable, produces substantial proceeds, and does not create large disincentives for employment, saving, and investment. Second, it must bring the rate of growth of health care spending closer to the rate of growth of the rest of the economy. The gap over the last 30 years, 2.8 percent per annum, is unsustainable. As Alice Rivlin, a member of the new commission, has said, “Long-run fiscal policy is health policy.”1 Control of health expenditures will require comprehensive change in the way the country finances and delivers health care. A value-added tax (VAT) dedicated to funding basic health care for all through enrollment in accountable care organizations would help solve the revenue and health spending problems at the same time. A VAT, by itself, has much to recommend it. Unlike a payroll tax, it does not discriminate against employment. Unlike the income tax, it taxes only consumption, not saving. The base (consumer expenditures) is more stable than payroll or income over the business cycle and is large enough to provide a substantial yield at a relatively modest rate. While it is not immune to evasion or avoidance, a VAT is not as vulnerable to these problems as the income tax.