A value-added tax has been the subject of much debate in recent years as a tax to use to help reduce the deficit. Various forms of value-added taxes are used throughout Europe, Canada, and in many other countries. To acquaint yourself with the basic operation of a value-added tax, read the following article:

Peter Chin and Joel G. Siegel, ‘‘What the Value-Added Tax Is All About,’’ TAXES— The Tax Magazine, January 1989, pp. 3-13.

After reading the article, consider the following circumstances:

Joe is married and has 2 children. A brain surgeon, he earns about $300,000 annually from his medical practice and averages about $250,000 in investment income. Jane, Joe’s wife, spends most of her time doing volunteer work for charitable organizations.

Tom is also married and has 5 children. He earns $40,000 per year working as a maintenance man for Joe.

While Joe was working late one night, he and Tom had a serious disagreement about two new tax bills recently introduced to help reduce the deficit. The first bill would levy a 10% value-added tax on all goods and services. A second bill introduced at the same time would add an additional 10% tax to each of the six current tax rate brackets (i.e., 10%would become 20%, 15%would become 25%, 25%would become 35%, 28% would become 38%, 33% would become 43%, and 35% would become 45%).

Joe is concerned that the imposition of a value-added tax would mean that fewer people could afford medical treatment. Both his patients and his practice would suffer from the tax. Tom strongly disagrees with Joe. He thinks that Joe does not want to pay his fair share of taxes. Tom charges that Joe can afford to hire tax accountants to help him avoid paying higher income taxes, even with the higher tax rates. By enacting a value-added tax, Tom believes, high-income taxpayers like Joe will have to pay up.

He thinks it is the only fair way to raise taxes to bring down the deficit.

After several hours of arguing, neither could convince the other that he was

wrong. Joe finally ended the discussion by saying that he would get an independent person knowledgeable in tax law to decide who is right.

You work for the firm that prepares Joe’s tax return and advises him on managing his finances. The tax partner of your firm asks you to prepare a memorandum discussing the merits and deficiencies of the two proposals as they apply to Joe and Tom. In your memorandum, you are directed to specifically consider the following and provide a response:

a. What is a value-added tax, and how does it work?

b. Evaluate the rate structures of the two proposed taxes. Are they proportional, progressive, or regressive?

c. What, if anything, is wrong with Tom’s and/or Joe’s point of view? Be sure to explain this part in depth.