THE RADICALS ARE ALL ON THE RIGHT:

A New Money Machine for the U.S.: The old ways can't keep up. We need a value-added tax to meet revenue demands. (Bruce Bartlett, August 29, 2004, LA Times)

The United States needs to adopt a value-added tax. [...]

The tax was originally adopted as part of European integration in order to avoid double taxation by national sales taxes. Its key feature is refundability at the border. This requires tax authorities to know exactly how much tax is embedded in the prices of all exports. The VAT provided that paper trail. In its classic form, the tax is paid at each stage of production and distribution, with a credit for taxes paid at earlier stages. Because producers and retailers need to show that they paid the tax to be credited for the taxes included in the prices of the goods they purchased, the system is largely self-enforcing. And the invoice trail allows governments to refund the entire tax on exports at the border.

From the point of view of consumers, a value-added tax is embedded in prices, which tends to make it less transparent than the state and local sales taxes Americans pay. And because a VAT falls only on consumption, it doesn't burden saving or investment. This makes it a highly efficient tax in the sense it discourages less economic output — what economists call the "deadweight" cost of taxation — than income taxes of similar magnitude.

The lack of transparency and the low economic cost of a value-added tax make it possible for this tax to raise substantial revenues relatively easily, both politically and economically. The average VAT in Europe is 20%, and European governments raise about one-third of their total revenue from consumption taxes, including excise taxes on gasoline, tobacco and other items. The U.S. raises about half that, including sales taxes at the state and local levels.

This suggests there is substantial room for raising broad-based consumption taxes in the U.S. without overburdening the economy. A very broad value-added tax levied on virtually all personal consumption could raise about half a percent of GDP in revenue for each 1% tax rate. But this sort of value-added tax is highly unlikely, though it would be best to treat all consumption equally. In practice, it is unlikely that more than 30% of GDP would be taxed, meaning that a 10% VAT would raise revenues equal to 3% of GDP — about $350 billion this year. We could raise twice that at a rate no higher than now exists in most European countries.

The great bugaboo of a value-added tax is its regressive feature — taking more from the poor than the rich. In the short run that's true, because the lower one's income, the higher one's consumption is as a share of income. Over a lifetime, however, consumption is roughly proportional to income, so a VAT would also be proportional — taking about the same from rich and poor alike in percentage terms.

It's kind of amusing to watch the Right debate what kind of fundamental tax reform it should undertake next year while Senator Kerry's only proposal is tax hikes under the old system.

Posted by Orrin Judd at August 29, 2004 5:22 PM