The US is the world’s 12th-worst tax system, because we have a value added tax (VAT) without refunds for individuals

Unbeknownst to many, the US has a Value-Added Tax (VAT). We just call it something else, and our version is structured so that it is the worst VAT of any developed country. According to the Tax Foundation, our VAT is currently the 12th-worst in the world. Only France, Belgium, Italy, and eight other countries have a worse VAT than the US. The US VAT is called the income tax. For the past 100 years, the US has structured the income tax as a European-style VAT. This VAT has many of the same characteristics as the VATs used in Europe and elsewhere. We have the standard European VAT exemption for households and small business. Just like Europe, the US exempts small households and small businesses from paying the VAT, which is called the income tax in the US. Europe exempts small households and small businesses from paying the VAT because they are not really in the business of producing goods and services. They are not really adding value in the production process. They don’t have the economies of scale or the organization to sell goods and services. They are not the primary consumers of the goods and services they produce, and they don’t primarily produce goods and services for sale. Like Europe, the US does not tax the wages households and small businesses earn from producing goods and services because those households and businesses are not really adding value in the production process. They are not really in the business of producing goods and services, they just do it for fun. If households and small businesses are not really producing goods and services in any event, why does it matter if they are exempt from paying the VAT? It doesn’t. But then why does anyone pay the VAT in the US? They don’t. They pay something called the “income tax.” In the US, the income tax has two parts: (i) the business portion of the income tax, and (ii) the individual portion of the income tax. The first part, the business portion, is actually a VAT, and it is exactly like the VATs used in Europe. The business portion of the income tax is called the “corporate income tax” and is imposed on corporations, which are businesses that are large enough to be in the business of producing goods and services for sale. In contrast, the second part of the income tax, the individual portion of the income tax, is not a VAT. It is a tax on “consumption” as defined below. I won’t get too deep into the weeds here, but the US has a VAT with no refunds for individuals. Instead of giving you a refund for taxes you already paid on your groceries, the US income tax allows you to deduct the cost of your groceries. So if you earn $1,000 and pay $800 in groceries (which is an 80% marginal tax rate), you only pay taxes on the $200 you didn’t spend on groceries ($1,000 - $800 in groceries = $200 in income). The rest of this post is just a deep dive into the details of how the US income tax is structured like the European VATs. It might be boring to read. You can stop reading here if you want. The OECD has identified several “ Characteristics” that define a VAT, and the US meets all of them. (i) *Based on the destination principle* The US applies the destination principle, meaning that goods and services are taxed in the country where they are consumed, not where they are produced. The business portion of the income tax has a destination-based cash flow tax (DBCFT) component that applies to goods and services consumed in the US. This is in addition to the traditional origin-based VAT component that applies to goods and services produced in the US. (ii) *Multi-stage tax* The US income tax is a multi-stage tax. The business portion of the income tax taxes the production of goods and services at every stage of production. (iii) *Consumed tax* The US income tax is a consumed tax. The individual portion of the income tax taxes individuals on their consumption of goods and services. (iv) *No tax cascading* The US has no tax cascading. Businesses are able to deduct the cost of goods and services and claim a credit or refund for taxes previously paid. (v) *Defined tax base* The US has a defined tax base. The business portion of the income tax taxes the production of business goods and services. The individual portion of the income tax taxes the consumption of individuals and non-businesses. (vi) *Single tax rate applied on broad tax base* The US has moved towards having a single tax rate applied on a broad tax base. The Tax Cuts and Jobs Act (TCJA) of 2017 reduced the tax rate on the business portion of the income tax and broadened the tax base. The US income tax meets all of the OECD’s Characteristics of a VAT. It is a VAT. The US business income tax is a VAT because it is based on the destination principle, is a multi-stage tax, is a consumed tax, has no tax cascading, has a defined tax base, and has a single tax rate applied on a broad tax base. The US income tax is structured as a VAT, but we just call it something else. *The US has all of the same VAT exemptions as Europe* Like Europe, the US exempts many goods and services from the VAT. The US income tax has many of the same exemptions as the European VAT system. (i) *Basic necessities* The US exempts basic necessities from the VAT. The US income tax allows individuals to deduct the cost of basic necessities like food, clothing, and shelter. (ii) *Health* The US exempts healthcare from the VAT. The US income tax allows individuals to deduct the cost of medical expenses, and the Affordable Care Act (ACA) exempts health insurance premiums from taxation. (iii) *Education* The US exempts education from the VAT. The US income tax allows individuals to deduct the cost of education expenses, and the TCJA exempted graduate student tuition waivers from taxation. (iv) *Charity* The US exempts charitable donations from the VAT. The US income tax allows individuals and businesses to deduct charitable donations. (v) *Financial services* The US exempts financial services from the VAT. The US income tax exempts interest on bank deposits and other financial instruments from taxation. (vi) *Public services* The US exempts public services from the VAT. The US income tax exempts government services from taxation. The US income tax has many of the same exemptions as the European VAT system. *The US has all of the same VAT treatments as Europe* The US income tax is structured as a VAT and has many of the same exemptions as the European VAT system. Like Europe, the US taxes goods and services at every stage of production. The business portion of the income tax is levied at every stage of production. The business portion of the income tax taxes the production of goods and services, and businesses are able to deduct the cost of goods and services and claim a credit or refund for taxes previously paid. Like Europe, the US taxes goods and services at every stage of production. But then why is the US VAT so different from the European VATs? It isn’t. The reason the US VAT is so much worse than the European VATs is that the US has no VAT refund mechanism for individuals. Europe exempts small households and small businesses from paying the VAT because they are not really in the business of producing goods and services. But then Europe also refunds the VAT to small households and small businesses, because they are consumers and the VAT is a consumption tax. In contrast, the US has no VAT refund mechanism for individuals. The US income tax has no refund mechanism for individuals. Businesses are able to deduct the cost of goods and services and claim a credit or refund for taxes previously paid, but individuals are not. Instead, the US income tax allows individuals to deduct the cost of goods and services, which is basically just a non-refundable tax credit. That is why the US has the worst VAT of any developed country. The US has a VAT with no refund mechanism for individuals. Businesses are able to deduct the cost of goods and services and claim a credit or refund for taxes previously paid, but individuals are not. Individuals are required to pay the VAT, but they are not able to deduct the cost of goods and services or claim a credit or refund for taxes previously paid. Instead, the US income tax allows individuals to deduct the cost of goods and services, which is basically just a non-refundable tax credit. This is not the same as a VAT refund, because a VAT refund is a refund of taxes previously paid. In contrast, the US income tax deduction for the cost of goods and services is not a refund of taxes previously paid. It is simply a non-refundable tax credit. The US lacks a VAT refund mechanism for individuals. The Tax Policy Center estimates that it would cost about $175 billion each year to provide a VAT refund to individuals for the taxes they incur on groceries alone. This is a small fraction compared to the cost of other social programs in the US, such as Social Security and Medicare. The US Social Security program alone costs well over $1 trillion each year. *The US is the worst VAT of any developed country, because the US has a VAT without a refund mechanism for individuals* According to the Tax Foundation, the US has the worst VAT of any developed country because the US lacks a VAT refund mechanism for individuals. The Tax Foundation has identified several “ Characteristics” that define a good VAT, and the US fails to meet several of them. (i) *A broad tax base with few exemptions* The US has a narrow tax base and too many exemptions. The US income tax has many exemptions, including exemptions for basic

The US is the world’s 12th-worst tax system, because we have a value added tax (VAT) without refunds for individuals

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