What are the behavioral implications of a value added tax?

Establishing a value added tax (VAT) in the United States is a topic of considerable debate and controversy. Such a tax, which would add a fixed percentage to every product or service, is standard in many European countries. There has been discussion about whether to add a VAT on top of existing taxes, or whether to reduce income taxes and offset the revenue losses with a VAT. Ted Gayer, Co-Director of Brooking’s Economic Studies, wonders what the behavioral implications of such a tax would be.

Traditionally, economists view the structure and application of a tax as unimportant. All that matters is the change in relative prices. But (economists Raj Chetty, Adam) Looney, and (Kory) Kroft find that structure and application do matter. For example, they find that consumers are less likely to buy an item if a sales tax is explicitly listed on the product than if the same tax is instead added at check-out.

The economists’ argument stems from a recent American Economic Review paper of a field experiment in a grocery store that varied the displayed prices of alcohol (gated copy here). The VAT raises interesting questions for policymakers who might be able to manipulate the salience of taxes in ways that would bring in more tax revenue, but potentially harm consumers. Check out the link to Brookings (Hat tip: Amol Agrawal).


  • Eva

    I don’t think this is about the structure of the tax exactly. People may simply be less aware of the full price of an item when the tax isn’t listed on the product.

    After living in Europe all my life, where VAT is pretty much a fact of life (and usually included in the price shown but listed separately), I found shopping in Canada quite difficult. Prices in the shop did not include tax and wasn’t displayed anywhere, so I had to keep track of the total price of my shopping to be able to add the tax and make sure I had enough cash at the checkout.

    My point is that not displaying the tax makes it marginally more difficult for consumers to figure out the full price of an item, which probably leads to the “irrationality” described in the example.