Leviathan Unbound: The VAT?

The value-added tax (VAT) has emerged as a central feature of the debate over the future of U.S. federal tax policy. In addition to its attributes from the perspective of economic efficiency, fairness, and administrative burden, a key aspect of this debate is its political-economic consequences. Specifically, critics argue that the VAT is a “money pump” that causes government to grow too large. Defenders argue that any correlation between a VAT and the size of government is spurious.

We examine these claims in a parsimonious empirical framework with two key results found using data from the OECD:

• A strong, indisputable, positive relationship between use of a VAT and government spending as a fraction of GDP; both across countries and within the same country over time; and

• Statistical evidence that an increase in the current VAT tax rate causes government spending (as a fraction of GDP) to grow larger in the future, even after controlling for the existing size of government, cultural factors, and worldwide economic trends.

These results suggest that concerns over links between a VAT and growth of government are not easily dismissed, if not conclusively proven.

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