Replace the Corporate Income Tax with a 5 Percent Value-Added Tax

This option repeals the current corporate income tax, with its attendant complexities in defining domestic and foreign income, and replaces it with a 5 percent value-added tax (VAT), which is a broad-based tax on consumption. The corporate income tax raises the cost of capital, discouraging investment, wages, and economic output. Replacing it with a VAT, which allows businesses to immediately deduct the cost of their investments, would reduce the cost of capital, increase investment, and expand economic output. It would also increase the tax burden on labor, leading to a reduction in hours worked.

This option raises substantial revenue because the VAT has a broader base than the corporate income tax, covering approximately 72 percent of US GDP. Exempting sectors of the economy from the VAT would reduce its revenue-raising potential.

Replacing the corporate income tax with a VAT would be regressive. Over the long term, some of the reduction in after-tax income would be offset by the increase in economic output, but because this swap raises substantial revenue, most taxpayers would still see reductions in after-tax income. Imposing the VAT at a lower rate would raise less revenue, creating a smaller decrease in after-tax incomes and a larger growth effect from this option.

On a conventional basis, this option would decrease the primary deficit by $4,013.5 billion over the budget window. Long-run GDP would rise by 0.2 percent, while long-run GNP would rise by 0.4 percent. On a dynamic basis, the primary deficit would decrease by $3,753.6 billion from 2027 through 2036, $259.9 billion less than the conventional estimate. Incorporating changes in interest costs, the publicly held debt-to-GDP ratio would be lower than baseline, reaching 144.4 percent by 2056.

On average, in 2036, taxpayers would see decreases in their after-tax incomes of 2.0 percent. The top quintile of taxpayers would experience a 1.6 percent decrease, whereas the bottom quintile would experience a 2.4 percent decrease. On a long-run dynamic basis, taxpayers would see a 1.9 percent decrease on average.