Economic Report of the President

would have to differ from state taxes by not taxing such sales. A relatedproblem is that it is sometimes difficult to distinguish final sales for consumptionfrom sales for use in production. For example, how would a store sellinga computer know for certain whether it is being purchased for resale(exempt), for use in another business (exempt), or for home entertainment(taxable)? This issue would arise with many dual-use products and services.To replace a significant portion of Federal tax revenues, tax rates for anational retail sales tax would have to be much higher than current state andlocal rates. The exact rate would depend on which Federal taxes were to bereplaced and on whether education expenses, prescription drugs, medicalexpenses, and other necessary goods and services would be taxed. Some recentresearch suggests that to replace revenues from the individual and corporateincome taxes, a national sales tax rate would have to be at least 30 percent ifthe tax base were that of a “typical state” and business-to-business sales wereexempt. Such high rates could create strong incentives for tax evasion andavoidance. Some tax economists believe that sales tax rates over 10 percentcould be problematic because of the incentive for evasion and avoidance.Concerns about the impact of sales taxes on lower-income householdscould be addressed by exempting certain necessary goods and services or byproviding a refundable tax credit sufficient to cover a certain amount of tax.Exemptions and preferential rates to address equity concerns, however,increase the complexity of sales taxes and lead to uneven taxation of consumption.Refundable credits could require the filing of some type of tax return bylower income households. However, this would defeat one of the main goalsof the retail sales tax, which is reducing administrative burdens on households.In any case, both solutions would require higher tax rates to achieve agiven amount of revenue. Uneven taxation and high tax rates would underminea principal potential benefit of this type of reform: reducing economicdistortions and promoting growth.Value Added Tax (VAT)Value added taxes are used in all European Union countries and in morethan 100 countries around the world. European countries, which generallyadopted VATs in the 1960s or early 1970s, typically impose a standard rate of16 to 20 percent and a lower 5 to 10 percent or zero rate on products such asfood and drugs. It is important to note that countries adopting VATs have notused them to replace income taxes; they are in addition to individual andcorporate income taxes.VATs avoid the problem of cascading taxes by allowing credit for the VATpaid on purchases. European VATs also create a paper trail that is believed toimprove compliance. In spite of these advantages, VATs have not receivedserious consideration in the United States. Similar to the sales tax, VATs areChapter 3 | 85