On August 19, 2026, the U.S. national debt exceeded 40 trillion dollars for the first time, amounting to approximately 125 percent of the projected 2026 nominal GDP. The debt surpassed 30 trillion in 2022, post-COVID pandemic, 20 trillion dollars in 2017, and 10 trillion dollars in 2008, following the financial crisis. The pace of debt accumulation has not slowed down in recent years even as the U.S. economy recorded a solid growth averaging 2.6 percent in 2022-25. Coincidentally, the date before the debt reached 40 trillion, 30-year government bond yield reached multi-year height, prompting the U.S. Treasury to announce an increase in the buyback of long-term bonds to keep yield lower.
Crossing the new debt milestone will likely further stimulate the debate about how to arrest and reverse the perilous fiscal trend. The scale of the fiscal deficit indicates that only a combination of revenue-enhancing measures and spending reforms can restore fiscal health. On the revenue side, there is one tool that should deserve particular attention: value added tax (VAT).
Out of the 38 OECD countries, the United States is the only OECD that does not have VAT. Including developing countries, VAT is as of January 2026 in place in 176 countries. According to the IMF, VAT revenue brings on average around 4 percent of GDP in lower income countries, and more than 7 percent of GDP in advanced countries. The popularity of VAT is evidenced by the increasing number of countries that have adopted it, as well as by the fact that no country abandoned the VAT after adopting it.
The revenue potential of VAT is measured by ‘C-efficiency,’ a ratio reflecting actual VAT revenue relative to potential maximum revenue. If all final consumption would be subject to VAT tax, the ratio would be 1. In practice, the ratio is well below 1, reflecting loss of VAT revenues due to exemptions, reduced VAT rates, fraud, and evasion/avoidance. For OECD countries, the average ratio is close to 0.6, with wide dispersion from 0.3 (Mexico) to over 0.8 (New Zealand). In the United States, consumption represents close to 70 percent of GDP. Assuming the OECD average VAT tax rate of 19 percent and average C-efficiency 0.6 percent, VAT revenues would yield about 8 percent of GDP, more than the federal deficit in recent years.
To be sure, such a large tax increase would hit the economy hard, and would not be politically feasible. But a phased VAT introduction at a lower rate would reduce the adverse impact of VAT introduction on growth, particularly if it would be a part of the package to bring public finance back to health that would increase investors and consumers’ confidence, reduce borrowing costs, and boost investment.
If one accepts that revenue measures must be integral to the fiscal consolidation strategy, there are compelling arguments for preferring VAT over other revenue sources. The U.S. economy is consumption-oriented, and household consumption represents a high share of GDP – almost 70 percent compared to the OECD average of about 60 percent. Thus, revenue potential even with relatively low VAT rate is high. Moreover, taxing consumption is preferable to increasing taxation of labor or capital that would adversely affect economic activity. While the United States already has a consumption tax in the form of sales tax at the state level, this tax brings little revenue and is different from that VAT. It is collected only at the final sale stage, while VAT is collected at each stage of the supply chain and could be less distortive to businesses.
One objection to VAT is that it disproportionately impacts lower-income households, who allocate a larger share of their income to consumption. This problem could be mitigated by providing exemptions and/or reduced rates to certain items (foodstuffs, medicine) that represent a large share of purchases by lower income households. But it should be also kept in mind that not addressing the fiscal problem would adversely impact lower income households as well, through different channels.
Another objection to VAT introduction is that bringing additional revenues to the Treasury would only provide funding for even more budget spending. This line of thinking has been known as “starve the beast” argument, whereby limiting government revenues will force spending cuts, and vice versa. To address the risk that higher revenues would boost spending rather than reduce the deficit, tight spending control, preferably in the form of expenditure fiscal rule, would ideally need to complement VAT introduction.
Featured Author:
Jiri Jonas, is a former senior economist at the IMF with 40 years of experience in economic policy, country operations, and analytical work.
All views expressed by members are their own and not reflective of the views of the Bretton Woods Committee.