The value added tax (VAT) is consumption tax levied on goods and services in the country while revenue refers to taxes on income from labor or capital. Consumption taxes are not regressive and closely relates to sales tax despite the two being fundamentally different. The shift from income tax to a VAT would raise the nation’s savings.
VAT tends to discourage consumption leading to more savings. Moreover, VAT does not decrease the returns to savings. It follows that it does not affect choices between future and current consumption by changing their relative prices (Congressional Budget Office, 1992 p. 51). Fundamentally, when the government imposes VAT on the products and services, the prices tend to increase. In the process, the customers react by reducing their spending and, as a consequence saves money. For instance, a VAT of 1% would yield a reduction of 1% in aggregate consumption. The cumulative effect would an upsurge of the total savings in the country in the long term, but greatest immediately.
Because VAT excludes one’s savings during deductions, i.e. all savings are not taxed, consumers tend to save more. In income tax, the tax is paid before one can save and, as a result, one has little money to keep aside for future use. However, VAT would only be on the services and products consumed by individuals exempting the saving from the cuts. The cumulative effect would be a rise in national savings. It is essential to note that the savings would not be entirely free from taxes only that it would be at a future date. However, the future tax would have some deductions as explained bellow.
The Federal Reserve Bank of Kansa City noted that a consumption tax does not penalize consumers giving them a chance to save and invest (Garner, n.d. p.10). Exempting the current consumption from tax cuts, the people feel relieved and would set aside a significantly large amount for future use. Income tax burdens the consumers with no deduction on new savings in that any capital or income one gets from the new savings would be taxed as current capital in the future. As a result, income tax places a heavy burden on the savers.
The above situation does not arise in VAT because despite deferred consumption attracting the VAT, the amount accrued from investing the saving is exempted from the taxation. Arguing from this point of view, VAT would lead to the creation of more wealth than income tax. When the people gain more wealth, they have excess money to save as opposed to the poorer citizenry. At the same time, they would have the capacity to create new business frontiers and innovations at a faster pace that would lead to more people earning a living. In this respect, more people would have the ability to save money that in turn boost the national savings.
References
Congressional Budget Office. (1992). Effect of Adopting Vale Added Tax. Retrieved on April 28, 2016 from https://www.cbo.gov/sites/default/files/102nd-congress-1991- 1992/reports/1992_02_effectsofadloptingavat.pdf
Garner, Alan (n.d.). Consumption Taxes: Macroeconomic Effects and Policy Issues. The Federal Reserve Bank of Kansas City. Pdf file. Retrieved on April 28, 2016 from https://www.kansascityfed.org/publicat/econrev/pdf/2q05garn.pdf
