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Choosing the Nation’s Fiscal Future
Current Tax Structure
One way to raise more revenue is simply to increase the statutory tax rates under the current tax structure, which now range from 10 to 35 percent. In the “high spending and revenues” scenario that approach pushes income tax rates so high that the committee has concluded that current levels of tax avoidance and negative economic effects would reach unacceptable levels. “Unacceptable” is defined differently by different experts, but the committee concluded that to avoid damaging effects on growth, the top income tax rate should not exceed 50 percent for people with the highest incomes.19 With the revenue required for the “high” scenario, that level would be reached by about 2020 under the current tax structure. At that time, we assume that policy makers would add to the current income tax a VAT similar to that in Europe. Thereafter, because we assume that personal and corporate income taxes cannot rise further, we assume for purposes of illustration that the VAT’s rate would rise to supply whatever additional revenues are needed.20
The economic burden imposed by a VAT could be minimized if it were imposed on a very broad base of all consumption. Nevertheless, in most countries, the VAT has a narrower base that excludes significant categories of consumption (such as food), for both technical and political reasons. In the 15 core countries of the European Union (EU), the average VAT tax base is about 40 percent of GDP.21 We assume that a VAT in the United States would have the same breadth as this European average.
Overall, the tax levels and structures in the United States and the EU countries are noticeably different. In 2006, the tax-to-GDP ratio in the United States was 28 percent, compared with 39.8 percent in the 15 core nations of the EU (Organisation for Economic Co-operation and Development, 2008b:96). Taxes on “general consumption” were 7.9 percent in the United States and 19.2 percent in the 15 EU countries. Thus, in a rough sense, Europe’s higher social spending and larger governments are funded by higher general consumption taxes, the VAT.
One way to view the typical European approach is as using relatively regressive VATs, with burdens falling disproportionately on lower-income people, to pay for more redistributive social spending than in the United States, such as larger child allowances and higher unemployment benefits. Following this reasoning, if the United States adopted a VAT, it might be seen as taking only half of the European social bargain.
For simplicity, we do not assume an explicit period of transition to a VAT—that is, a slow phase-in of increasing tax rates—but rather propose a VAT rate to provide the revenue needed at any given time. The committee recognizes that adding a VAT would impose disparate combined tax burdens on different age groups. For instance, middle-aged and elderly people