A big reason Europeans adopted a value-added tax (VAT) was to raise enormous sums to underwrite their social welfare state, but another was that the VAT was supposed to be much more difficult to evade than most other taxes. Europeans have a well-deserved reputation for tax evasion and so their governments need a tight, reliable, auditable, mighty revenue source and the VAT seemed to fit the bill. Well, maybe not.

According to a recent study commissioned by the European Union, Member States lose more than $150 billion annually to fraud. This represents about 12 percent of total VAT revenues. This is a startling large figure when one considers the decades of experience Europeans have in auditing and enforcement of their VATs.

The design of the VAT imposes enormous paperwork burdens on businesses specifically to facilitate auditing and enforcement. Every business levies VAT on its sales, but it also pays VAT on its purchases. It then tallies up the VAT paid as shown on its purchase invoices and subtracts the total from VAT owed on its own sales; hence the name the “credit-invoice VAT”. The benefit that is supposed to flow from this crediting mechanism is a paper trail to prevent evasion. A 12 percent evasion rate suggests it’s not worth the effort.

By way of comparison, the federal income tax raised $2.155 trillion in 2005. It was supposed to raise $2.445 trillion. The difference of $290 billion is called the “net tax gap” as estimated by the Treasury Department and represents just under 12 percent of total collections. For all its complications and flaws, the clumsy and inefficient federal income tax administered by the IRS does about as well as the vaunted VAT. The VAT has few virtues. It now has one less.