The United States faces a fiscal outlook that is commonly and correctly understood to be unsustainable under current policy. Federal debt held by the public has climbed to historically elevated levels relative to GDP and is expected to continue rising indefinitely. If we don’t rein in the debt, and even if the debt does not cause or exacerbate a crisis, it will slowly but surely make it harder to grow our economy, boost our living standards, respond to wars or recessions, address social needs, and maintain our role as a global leader.

Part of the fiscal problem arises from the fact that population aging is increasing expenditures on Social Security, Medicare, and other health programs. But the challenge we face is not just “a spending problem.”

Ever since the Bush Administration tax cuts in 2001 and 2003, taxes have been low relative to post-war averages as a share of GDP. The 2017 tax cuts made the situation worse. The cuts created by the Trump Administration’s One Big Beautiful Bill Act (OBBBA) in 2025 are even more substantial. In recent work, University of California, Berkeley economist Alan Auerbach and I find that, under plausible circumstances, the OBBBA could raise the debt-to-GDP ratio by a whopping 79 percentage points over the next 30 years. That increase is larger, relative to GDP, than the entire level of U.S. debt before the 2008 global financial crisis. Indeed, the resources spent on OBBBA would have been sufficient to solve the entire Social Security problem.

The bottom line is that we will need to curtail spending as well as boost revenues. Politically, compromise will be necessary. Economically, the magnitude of the changes needed to solve the fiscal problem with just spending or just tax increases would be quite large. It takes two sides of the scissors to do the cutting.

Raising revenue via existing taxes is a target-rich environment, including reforming corporate taxes, taxing unrealized gains at death, converting the estate tax to a broad-based inheritance tax, and repealing the section 199A deduction for pass-through businesses, which has been shown to be utterly ineffective. Still, even if all these changes were to occur—which seems unlikely—it would not raise enough revenue to adequately address the fiscal shortfall. As a result, policymakers will need to consider new taxes.

The most promising new levy would be a consumption tax. Consumption levies collect revenue from what people spend or alternatively, the difference between their income and their saving. A consumption tax can take many forms: a retail sales tax, a “consumed income” tax, and a value-added tax are the most commonly discussed alternatives. Historically, the discussion has focused on whether we should replace the income tax with a consumption tax. Today, given the fiscal outlook, we need to consider consumption taxes as a supplement to the income tax.

Consumption Tax: It’s Complicated

Consumption taxes have a lot to offer. First, what may seem like a narrow factor currently could well become the biggest selling point in the next decade. The diffusion of artificial intelligence and automation technologies strengthens the case for adding a consumption tax. The U.S. federal tax system currently relies heavily on taxing labor income. Payroll taxes finance Social Security and Medicare, and the individual income tax derives a substantial portion of its revenue from wages and salaries. If AI and automation technologies hollow out the work force, revenues from labor income would fall, even if overall economic output continues to grow. Adding a consumption tax makes the tax system more resilient to change.

More generally, consumption represents the largest component of GDP, making it an attractive tax base for governments seeking to raise significant revenue. As the bank robber Willie Sutton reportedly said when asked why he robbed banks, “Because that’s where the money is.” Consumption is where the money is, especially given the already-heavy reliance on income taxes in the United States.

Consumption taxes can also be economically efficient. By taxing spending rather than income, they generally avoid discouraging saving and investment. Over time, this can promote capital formation, productivity growth, and higher living standards. In contrast, income taxes can impose additional tax burdens on saving because individuals are taxed both when they earn income and when they earn returns on saved income.

Consumption taxes have the potential to be much simpler than the current system, if they are designed with a broad base—that is, with no exemptions—and uniform rates. Consumption taxes also tend to be relatively stable sources of revenue over the business cycle, during which consumption typically fluctuates less than individuals’ income or corporate profits. This stability can enhance fiscal planning and reduce revenue volatility.

Despite these advantages, consumption taxes raise several legitimate concerns. The most frequently cited objection is that they are regressive. Lower-income households tend to spend a larger share of their income on consumption than higher-income households, meaning that a uniform consumption tax can impose a proportionally larger burden on low- and moderate-income families. Without offsetting policies, a consumption tax could increase after-tax income inequality.

Another concern is potential complexity. Although consumption taxes can be simple in theory, real-world systems sometimes become complicated due to exemptions, multiple rates, and special industry provisions. In many countries, the value-added tax (VAT) includes numerous reduced rates and exemptions for specific goods and services, which complicates administration and compliance while reducing revenue. A third concern is that introducing a new consumption tax too abruptly could temporarily yet substantially reduce consumer spending. Because consumption is a major component of aggregate demand, a sudden increase in consumption taxation could risk triggering or exacerbating a recession if not carefully managed.

These concerns are real but can be addressed through thoughtful policy design. Fortunately, existing experience in other countries provides clear guidance on how to mitigate these risks.

The Right Kind of Consumption Tax

The United States stands alone among advanced countries in not having a VAT as a major revenue source. Instead, the United States raises relatively little revenue from broad-based consumption taxes, relying on subnational retail sales taxes that are typically narrow, complex, and economically inefficient.

The United States should adopt a subtraction-method VAT. In this system, businesses calculate their tax liability by subtracting purchases from other businesses from their total sales and applying the tax rate to the resulting value added. Because the sum of value added by each firm equals the retail sale price of the good, the VAT is a consumption tax. Relative to other consumption taxes, the subtraction-method VAT offers several administrative and economic advantages.

First, it reduces opportunities for complexity. Unlike the credit-invoice VAT used in most countries, which requires tracking tax credits across each transaction, the subtraction method operates through business-level accounting, which can simplify compliance and administration. It also avoids many of the complexities associated with consumed income taxes, which require detailed tracking of household-level savings and investment flows. Having few exemptions matters because by increasing the tax base, we can reduce the tax rate required to meet a given revenue target.

A subtraction-method VAT is easier to enforce than a retail sales tax. Retail sales taxes rely heavily on compliance at the final point of sale, which creates significant evasion risks. VAT systems, by contrast, collect revenue throughout the production chain, reducing opportunities for evasion and improving compliance.

Concerns about short-term macroeconomic effects can be addressed by phasing the policy in gradually and through offsetting policies, such as using a portion of the revenue to support incomes and aggregate demand through targeted transfers, tax credits, or temporary fiscal stimulus measures.

Long-run distributional concerns can be addressed by using a portion of VAT revenue to support vulnerable populations. One promising option is a universal basic income (UBI), which would provide an equal per capita payment to every adult, or similar broad-based transfer programs that help low- and moderate-income households. Although the term “UBI” sometimes generates political resistance, the underlying concept enjoys bipartisan support in other contexts. For example, policymakers have proposed returning revenues from carbon taxes or tariffs to households through uniform rebates, which function similarly to UBI-style transfers. Using a portion of VAT revenues to finance such transfers can offset regressivity and can make the overall tax-and-transfer system more progressive.

The VAT and State Sales Taxes

One source of resistance to VAT adoption in the United States is simple unfamiliarity. VAT systems typically incorporate border adjustments that exempt exports from taxation while taxing imports. These adjustments ensure that the tax applies to domestic consumption rather than domestic production. Although border adjustments can seem unusual to Americans, they are standard features of consumption taxes worldwide. Indeed, state retail sales taxes already operate with implicit border adjustments. Goods produced in state A and sold in state B are subject only to the sales tax in state B. That is, the sales tax in state A exempts “exports” to state B; the sales tax in state B taxes “imports” from state A.

Political concerns about VATs often focus on the fear that they could become “money machines” that allow governments to expand spending unchecked. While this concern is generally unfounded empirically, it is also worth emphasizing that, if implemented as part of a fiscal consolidation package, a VAT would be associated with reductions in spending, not increases.

Notably, policymakers from both major political parties have proposed VAT-like taxes at various points, including Republican ex-Speaker Paul Ryan and former Democratic Senator Ben Cardin. These proposals have differed in structure and purpose, but they demonstrate that consumption taxes are not inherently partisan.

The introduction of a federal VAT would interact with existing state sales taxes, many of which are poorly designed. State sales taxes often exclude services, include numerous exemptions, and impose significant compliance burdens. A federal VAT could provide an opportunity for states to harmonize their tax bases, improving efficiency and compliance while preserving state fiscal autonomy. States could choose to conform to the federal VAT base or maintain independent systems, much as they currently do with the federal income tax.

International experience provides reassurance that VAT systems can operate effectively. Canada offers a particularly relevant example. The Canadian federal government replaced its manufacturer’s sales tax with a value-added tax in the early 1990s. Although the reform initially faced political resistance from the provinces, which already had their own sales taxes, it ultimately improved economic efficiency, enhanced revenue stability, and allowed provinces to coordinate their tax systems, if they chose to do so. (Some did. Some did not.) Similar issues would arise here in the United States, where most states have retail sales taxes. A federal VAT would allow states to conform their consumption tax base with the federal definition, thus making taxes more efficient and simpler to comply with and administer.

Conclusion: Stable, Progressive, and Efficient

The United States faces a fiscal challenge that demands serious and forward-looking policy responses. Demographic trends, rising healthcare costs, and growing interest obligations require policymakers to identify sustainable sources of additional revenue. Relying exclusively on existing tax instruments is unlikely to be sufficient or economically efficient.

The bottom line is that a 10 percent national consumption tax—preferably in the form of a VAT—could raise about 4 percent of GDP in gross revenue and about half of that on net if funds are used to offset the impact on low- and moderate-income families. The tax—with a broad base and virtually no exemptions, since product exemptions do not effectively target the needy—would add a stable, progressive, efficient, and simple source of much-needed revenue.

The United States is unique among advanced economies in lacking a national consumption tax. International experience demonstrates that a VAT is consistent with higher revenues and robust growth. Coupled with offsetting policies like a UBI, that VAT would be progressive as well. Adding a consumption tax would also make revenues more stable and more resilient to technological change.

Concerns about regressivity, complexity, and macroeconomic effects are real but manageable. Through careful policy design, including broad tax bases, progressive transfer mechanisms, and thoughtful implementation strategies, policymakers can address these challenges effectively.

Importantly, adopting a consumption tax does not preclude additional taxes on affluent households. The policy choice is not between taxing consumption and taxing the rich; rather, it is about expanding the range of tax instruments to create a revenue system that raises more revenue and is simpler, fairer, more efficient, more sustainable, and more resilient.