The American Exception: Why the US Has No VAT System?
As one of the world's largest and most powerful economies, the United States stands out in many ways. However, when it comes to its tax system, the US is unique in a surprising way: it is the only developed country in the world that does not have a value-added tax (VAT) system in place. In this article, we will explore the reasons behind this absence and the challenges of implementing a VAT system in the US.
While VAT is a popular form of indirect taxation in over 170 countries, it is not implemented in the United States. The US has no federal tax system; it relies on a sales tax system that is administered by the states and has a different approach to raising revenue than many other countries.
There have been tax reform discussions about implementing a national consumption tax system in the US, but so far, no concrete plans have been put into action. Introducing VAT in the US would be a significant challenge, requiring coordination between the federal government, states, and localities and considerable investment in technology and personnel. While some argue that VAT could be fairer, more efficient, and simplify the tax system (and reduce the number of tax rates), others believe it would be too complex and burdensome, and the implementation challenges may outweigh the benefits.
What is Value Added Tax?
VAT is a consumption tax that is levied on the value added to goods and services at each stage of production and distribution: from the manufacturer to the wholesaler, to the retailer, and ultimately to the end consumer. VAT is collected by taxpayers (businesses) on behalf of the government and is remitted to the tax authorities at regular intervals.
The VAT system is a popular form of taxation worldwide: more than 170 countries implemented VAT. It is the primary form of indirect taxation with various VAT rates among the OECD countries and in the European Union. Hungary has a 27% standard rate, the highest standard rate in the EU countries; Belgium has 21%, while Luxembourg generally has 17% (with a temporary reduction to 16% in 2023). Most countries have reduced rates in addition to the standard rate. VAT is also used in countries like New Zealand, Australia, and Canada, where it is known as the Goods and Services Tax (GST).
VAT rules impose the tax at each stage of the supply chain while allowing businesses for VAT deduction on their purchases, except for the final consumer. This design ensures that VAT is an economically neutral tax for businesses: it flows through them, regardless of the product's nature or the distribution chain's structure, effectively taxing supplies made to final consumers who ultimately bear the tax's cost. Furthermore, since it is collected at each stage of production and distribution, it has another essential advantage: it creates a consistent and stable source of revenue for the governments throughout the supply chain's entire lifecycle.
Sales Taxes in the US: A Brief Overview
Sales taxes are a type of consumption tax that is imposed on retail sales of tangible personal property and services. The sales tax system in the United States is unique in comparison to other developed countries, as there is no national-level sales tax. Instead, US states have the authority to levy their own sales tax. Currently, there are sales and use taxes in place in 45 of the 50 US states, plus in the District of Columbia and Puerto Rico. Alaska, Delaware, Montana, New Hampshire, and Oregon are the only states that do not impose sales and use tax (however, Alaska allows localities to impose their own sales taxes).
Sales tax rates vary widely across the US, ranging from zero in some states to over 10% in others. In addition to state-level sales taxes, some local governments also levy their own sales taxes, resulting in a complex patchwork of tax rates across the country.
Unlike the VAT system, sales tax is not applied at each supply chain step but only at the end when the product or service is sold to the end consumer. This means that before the final sale to the end consumer, who can be either a business or an individual, no sales tax is added to the price of the goods or services.
One of the advantages of the sales tax system is that it allows for more control at the state and local levels, which also means that they can be tailored to the region's specific needs. However, the lack of uniformity in sales tax rates, scope, and definitions across states and localities can create confusion and enormous compliance challenges for businesses operating in multiple US jurisdictions.
Roadblocks and Challenges to Implementing a VAT System in the US
Despite the widespread use of VAT systems across the world, the United States remains a notable exception. Implementing such an indirect tax in the US would face numerous roadblocks and challenges.
- One of the primary reasons why the US has not adopted a VAT system is the federal system of government. Due to that, the US has a more decentralized tax system than many other countries, with the US Constitution granting significant powers to individual states. US states have their own tax laws, and they collect sales and use taxes (sometimes not just states, but local governments, too), which are an essential source of revenue for states and localities. In light of these differences in the tax foundations on a state level, many of them would likely resist attempts to harmonize their state tax systems with a national VAT, not to mention the substantial political challenges it may bring.
- Introducing a VAT system in the US would be a significant undertaking. The country's complex sales tax system currently has different scopes, tax rates, definitions, and exemptions in each state. Harmonizing these systems would require extensive coordination between the federal government, states, counties, and cities. However, there are initiatives to reach some degree of uniformization, like the Streamlined Sales Tax Project.
- Moreover, the US has a large and intricate economy. Implementing a VAT system would require significant changes to the tax infrastructure, which would involve high costs and could take long years to implement. The US would also need to establish a system for administering and collecting VAT, requiring a significant investment in technology and personnel.
- Another challenge would be the impact on businesses. While the VAT system is designed to be neutral to businesses, transitioning to a new tax system would bring some challenges. Since VAT is applied at every stage of the supply chain, VAT would place a more significant burden on some businesses than sales tax, as it requires them to collect and remit VAT correctly, keep detailed records, and comply with all the potential VAT obligations (VAT registrations, VAT reporting, new types of tax returns, etc.). Small businesses, in particular, may need help to adjust to the new system, which could lead to increased administrative costs and reduced profitability.
- Introducing VAT would likely mean higher tax rates for the final consumers than the current sales tax system, as VAT is generally applied at a higher rate than sales tax. Furthermore, VAT is levied at each production stage, which may increase costs for businesses and, in turn, lead to higher consumer prices.
- Lastly, enforcement is another challenge to implementing a VAT system in the US. While VAT is designed to be self-policing, with businesses responsible for collecting and remitting VAT payments, enforcement can be difficult. Tax audits and investigations are necessary to ensure compliance and deter fraud and tax evasion, but this requires additional resources and personnel.
Could the US Benefit from a VAT System?
Despite these challenges, some proponents of VAT argue that it could provide a more stable source of tax revenue for the US government, even broaden the tax base and generate additional revenue for the federal government. Unlike sales tax, VAT is applied at every stage of the supply chain, which means it captures a larger portion of economic activity. This could provide a more reliable source of revenue than sales tax.
In addition, VAT could provide an opportunity to simplify the US tax system. By harmonizing the sales tax systems of the states, the US could reduce the overall compliance costs for businesses and create a more efficient tax system. It could also provide an opportunity to address some of the issues with the current sales tax system, such as the complex web of rates and exemptions, that cause the sales tax base to be much smaller than consumption.
Ultimately, the decision to introduce VAT or maintain sales tax would depend on a variety of factors, including revenue goals, administrative feasibility, impact on businesses and consumers, and the willingness of policymakers to pursue potentially controversial tax policy changes. While the idea of federal consumption taxation is on the agenda from time to time, it is unlikely that any significant progress will be made toward implementing a VAT system in the near future in the US.
How can Fonoa help with US Sales Tax?
When managing sales and use tax in the USA, we recommend you consider the following:
- How do you keep track of sales and use tax rates in over 11.000 US jurisdictions?
- Can you react quickly enough when there is a law change in any jurisdictions requiring that you charge tax (or allowing you to stop charging tax)?
- Can you easily manage new products or business lines in the US?