Value-Added Taxes aren't a bad idea for small businesses

Value-added taxes (VATs) have been attracting growing attention in the United States. There are many benefits to such a tax, and new research shows that it should not be a burden for small businesses, either.

Jens Meyer/AP/File
Daniel Mudaci works in the distribution center of Amazon in Bad Hersfeld, Germany (April 21, 2016). Research indicates that small businesses should not be burdened by a value-added tax.

Value-added taxes (VATs) have been attracting growing attention in the United States. GOP presidential hopeful Ted Cruz has proposed a VAT as part of a sweeping tax reform plan. The idea has also been backed by House Speaker Paul Ryan (R-WI), Senator Ben Cardin (D-MD), and others.

There are many benefits to such a tax. It could replace the revenue lost from reducing and simplifying the income tax, it could shore up the nation’s long-term fiscal situation, and a well-designed VAT could be more efficient than today’s messy income tax. But VATs also generate criticism, including from those who argue that it would be a burden to small business.

However, new Tax Policy Center research finds that most firms ought to be able to handle the tax, especially if very small businesses are exempted from collecting the levy.  (This complements other recent TPC work that explores the effects of a VAT on state and local budgets.) A VAT is applied to the difference between a business’s sale of goods and services to other businesses or consumers and its purchases from other businesses. Under the credit-invoice method used by most developed countries, businesses levy a tax on their sales and claim a credit on the taxes they paid on their input purchases. In the usual case, the sum of these remittances is the total value of the tax levied on consumers. Thus, a VAT replicates the effect of a retail sales tax.

A critical policy design question is whether to exempt small businesses and, if so, at what size. For very small firms, the government’s administrative costs and the business’s collections and compliance costs may be high relative to the amount of tax revenue they generate. As a result, most countries exempt some small businesses from their VATs, though nearly all allow small businesses to register for the VAT if they would like. Evidence from countries with a VAT, as well as theoretical models of the trade-off between compliance saving and revenue loss, suggests that firms adjust their size to receive favorable tax treatment.  A recent study by Treasury economists suggests that the optimal exemption is about $200,000 in sales for a 10 percent VAT.

While we can’t directly estimate the effects of a VAT in the U.S. since one has never existed, we can learn how a VAT would affect small businesses by studying the variation of existing state taxes.

In new research, Hilary Gelfond, Aaron Krupkin, and I estimated the effects of state-level income and sales taxes on the number of small firms and on their employment. We adapted a model from research by W. Robert Reed  in 2008 and a paper Aaron Krupkin, TPC’s Kim Rueben, and I published last year. Both papers examine the role of taxes on growth, controlling for other factors.  Overall, we found that increases in state sales tax rates have little or no effect on the number of firms or the employment within those firms. This implies that a VAT should not be a major hurdle for small businesses, especially if it is paired with a reasonably-sized exemption.

Whatever else you think of a VAT, it does not have to be a burden on small businesses.

This article first appeared at TaxVox.

You've read  of  free articles. Subscribe to continue.

Dear Reader,

About a year ago, I happened upon this statement about the Monitor in the Harvard Business Review – under the charming heading of “do things that don’t interest you”:

“Many things that end up” being meaningful, writes social scientist Joseph Grenny, “have come from conference workshops, articles, or online videos that began as a chore and ended with an insight. My work in Kenya, for example, was heavily influenced by a Christian Science Monitor article I had forced myself to read 10 years earlier. Sometimes, we call things ‘boring’ simply because they lie outside the box we are currently in.”

If you were to come up with a punchline to a joke about the Monitor, that would probably be it. We’re seen as being global, fair, insightful, and perhaps a bit too earnest. We’re the bran muffin of journalism.

But you know what? We change lives. And I’m going to argue that we change lives precisely because we force open that too-small box that most human beings think they live in.

The Monitor is a peculiar little publication that’s hard for the world to figure out. We’re run by a church, but we’re not only for church members and we’re not about converting people. We’re known as being fair even as the world becomes as polarized as at any time since the newspaper’s founding in 1908.

We have a mission beyond circulation, we want to bridge divides. We’re about kicking down the door of thought everywhere and saying, “You are bigger and more capable than you realize. And we can prove it.”

If you’re looking for bran muffin journalism, you can subscribe to the Monitor for $15. You’ll get the Monitor Weekly magazine, the Monitor Daily email, and unlimited access to