A Technical Note on Revenue Estimation for an Add-On VAT: The Fixed GDP Convention, Relative Prices, Income Offsets and Monetary Policy

Abstract

Revenue estimates for tax policy changes are typically made under the convention of a fixed set of economic assumptions, with a given level of nominal GDP and aggregate income. For a tax policy change as large and significant as an add-on value-added tax (VAT) or other consumption tax that applies to a large share of consumption expenditures, the fixed GDP assumption requires careful calculation of the changes in relative prices and other relationships that result from the imposition of a VAT. This paper provides a technical analysis for issues associated with revenue estimation of an add-on VAT, notably relative price relationships, the role of compliance, income and revenue offsets, issues regarding assumptions about monetary policy, and total Federal budget effects.