Viewpoint March 5, 2010, 10:30PM EST

Why a VAT Tax Is Where It's At

Adoption of a value-added tax in the U.S. would be a fair, efficient way to help restore the country's financial health, argues Bloomberg BusinessWeek columnist Chris Farrell

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The U.S. government's debt is triple-A rated, and with good reason. Could the adoption of a value-added tax help keep it that way for generations to come? Simply put: yes.

The U.S., as both the world's wealthiest economy and a vibrant democracy, remains the investing safe haven of choice in times of financial and political turmoil. Witness the flight of capital into U.S. Treasury securities from investors around the world during the Great Recession, a remarkable measure of trust considering the epicenter of the financial crisis was the U.S. housing market. Treasury securities are the gold standard of the global capital markets. The embrace of the full faith and credit of the American taxpayer and the federal government are worth honoring.

Now, there's no shortage of folks worried about the federal government's budget deficit and soaring debt levels. The concern is misplaced in the short-run. Much of the current fiscal situation largely reflects the cost of combating the Great Recession, the worst downturn since the 1930s. But long-term, the budget deficit and steep government debts are an ominous combination. The underlying budgetary issue is the Holy Trinity of entitlement programs: Social Security, Medicare, and Medicaid, with the primary emphasis on health care. Spending on those three programs alone accounts for about half of the government's noninterest spending. It is only going to go up with an aging population.

Lines That Go Straight Up

The Woodstock Generation, aka the roughly 76 million baby boomers born between 1946 and 1964, is getting ready to retire. The oldest boomers were eligible to start collecting Social Security at age 62 in 2008. They'll be eligible for Medicare next year. Eventually, over the next half-century or so, if the nation's total tax burden stays around its current 18% of gross domestic product, Uncle Sam will end up borrowing to pay interest on the interest, according to Rudolph G. Penner, economist at the nonpartisan Urban Institute. "At that point, total spending, the deficit, and the national debt begin to go straight up," he writes.

Clearly, the long-term fiscal numbers are unsustainable. Something has to give long before the fiscal disaster strikes, Yet any solution will take years to come into law, so now is a good time to get started. It's long past time to lay to rest such deficit solutions as "starve the beast." Mantras such as "tax cuts pay for themselves" aren't true no matter how often repeated. Social Security, Medicare, and Medicaid are popular programs that aren't going to fade away. The government may take on even greater obligations with health-care reform. Indeed, between the aftermath of 9/11 and the Great Recession, the government has taken on enormous responsibilities, from waging war on two fronts and boosting domestic security to expanding Medicare and bailing out the banks. Any viable solution will have to involve both the spending and the tax side of the fiscal ledger.

That means it's time to consider a value-added tax, or VAT. Unlike a sales tax, which is levied by 45 states and many municipalities only on the retail consumption of a good or service, a VAT is collected at each stage of production and distribution rather than just from retailers. A VAT is a highly efficient tax from an economic point of view. It's essentially a flat consumption tax, and the way it's collected minimizes compliance problems. More than 100 countries use a VAT to help fill their coffers. New Zealand, for instance, has a 12.5% VAT, and Denmark's is 25%.