How Should the United States Treat Government Entities, Nonprofit Organizations, and Other Tax Exempt Bodies Under a VAT?

Goods and services supplied by government entities, public sector bodies, nonprofit organizations, charitable organizations, and similar tax-exempt bodies (the PNC sector) are usually exempt under VAT. While there are very few conceptual arguments against the full taxation of such supplies under VAT, concerns around social objectives and income distributions are often mentioned in defense of the exemption. This article reviews the case for exemption as well as its economic effects. Lessons for the United States include: (i) the case for full taxation of the PNC sector under VAT is strong; (ii) the Australian-New Zealand model would offer the best practical method to apply VAT to the sector; and (iii) to address the issue of states as taxable persons, a US federal VAT should provide states and local governments with a voluntary option to collect tax. The suggested design would result in the lowest efficiency costs, and likely the lowest compliance and administrative costs as well