March 8, 2005

MAKE IT HURT:

The VAT (Bruce Bartlett, March 8, 2005, Townhall)

Federal Reserve Chairman Alan Greenspan's comments last week before the tax reform commission regarding the desirability of a consumption-based tax system are fueling new interest in the value-added tax (VAT), a type of consumption tax used in virtually every major country except the United States. House Ways and Means Committee Chairman Bill Thomas has also hinted that the time may have come for serious debate on this topic.

The VAT was invented in Europe mainly to facilitate trade. It needed a tax that could be applied at the border on imports and rebated at the border on exports. This was necessary to prevent taxes from being levied on top of taxes every time a good passed through a country. The VAT solved this problem by being applied incrementally at each stage of production or distribution, with an invoice trail showing precisely how much tax was embedded in the prices of all goods.

Economists have always liked the VAT because it is a highly efficient tax. That is, it discourages less output per dollar of tax than any other major tax in existence. Some taxes are estimated to discourage $1 of output for every $1 raised. Overall, the U.S. tax system has what economists call a "deadweight cost" of about 20 cents per tax dollar, meaning that every tax dollar costs the economy $1.20. The VAT, however, has a deadweight cost of just a few cents per dollar.

Economic theory tells us that the more efficient a tax system is, the more revenue it will raise. Thus, many people have fought introduction of a VAT here on the grounds that it would be a "money machine" that would fuel the growth of government. The Wall Street Journal routinely rails against the VAT on these grounds. As President Reagan put it in a Feb 21, 1985, press conference, "A value-added tax actually gives a government a chance to blindfold the people and grow in stature and size."


That's nonsense of course, by driving up the prices we pay out of pocket it is far more visible than the income taxes we have withheld and never feel the pain of paying out. History is rife with uprisings fueled by the rising costs of bread and such. Indeed, Ronald Reagan became president in no small part because of the costs of our daily purchases.

One sensible precaution to take though is to only pass the VAT in conjunction with repeal of the 16th Amendment.

Posted by Orrin Judd at March 8, 2005 12:00 AM
Comments

It really scares me when you and I are in 100% agreement.

BRAVO!

Posted by: Bart at March 8, 2005 7:10 AM

An invisible VAT is far less preferable to a highly visible sales tax, for the reasons Bartlett cites.

You don't especially notice how much you're paying in taxes when you purchase gasoline (Orrin wants to make you notice by taxing it more ridiculously, but that's neither here nor there). You do notice when you buy other consumer goods and there's that useful subtotal followed by the tax line.

Besides, we WANT to add value to goods, not discourage the same. The very notion of a tax on adding values to goods ought to set off alarm bells.

Posted by: kevin whited at March 8, 2005 11:00 AM

I'd much prefer a Sales Tax or VAT. But, if Oregon's any indicator (not at all a sound premise) the ONLY way a VAT or Sales Tax will get support is if Income Tax is drastically reduced or eliminated altogether. Voters here consistently reject a sales tax because every iteration of the idea has done NOTHING to reduce the 9% state income tax we pay. Even in this bastion of Blue, those measures are soundly defeated each time.

Posted by: John Resnick at March 8, 2005 11:32 AM

Keep in mind the greatest advantage of consumption taxation: it cannot be evaded. Everyone pays it--pimps, drug dealers, Arkansas governors, everybody.

Posted by: Lou Gots at March 8, 2005 1:46 PM

Except when they buy black market goods.

Posted by: AML at March 8, 2005 2:55 PM

It's much easier to police vendors than it is 300 million taxpayers. The money from those 'black market goods' has to surface sometime. How many people evade the cigarette tax? Not many and not for long.

Posted by: Bart at March 8, 2005 8:44 PM

OJ,

Repeal of the 16th abolishes the FICA tax as well, does it not? This is OK with me, but it scotches both SSec AND SSec reform. Guess which loses that battle.

Kevin,

Who cares if a tax is visible or invisible as long as it is low & broadbased. We live in an age when any attempt to raise it would create an slew of econometric analyses, so does it matter?

Others..

The size of the Uground Economy is way oversold.

I did the math, and our tax bill [AGI

The only answer is a slam on the lower & middle class, who now pay low taxes (EITC & exemptions).

Do the math & tell me where it's made up. Spare me the "drug dealer" canard.

BTW - I support the idea, I'm just not a FairTax ditto head.

Posted by: BB at March 9, 2005 12:12 AM

First, a repeal of the 16th amendment would not get you where you want to go OJ. As we all know the Supreme Court believes that any decision made before the current members got alzheimer's is not precedent. Repeal of the 16th would not get rid of the income tax since the 19th century decision that voided a previous income tax law would not apply to the current tax. That old decsion was probably wrong.

Second, one of the main reasons for favoring a VAT is that under WTO rules it is not counted as an import duty. A VAT is charged on imports at full rate and rebated on exports. One way to make US manufactuers more competitive would be to adopt a VAT and repeal the corporate income tax, state franchise taxes and personal property taxes on manufacturers' PPE.

Third. if we impose a VAT, the revenue should be shared with the states and sales taxes repealed.

Fourth: a VAT in the percentage range of the EU Contries, Canada and Japan, if shared with the states to replace their sales, PP and franchise taxes probably would still require a personal income tax to fund the Federal Government. That is OK. It is better to have more small taxes that are less tempting to cheat than one big one that is a constant target.

Fifth: The Wall Street Journal is wrong, they wrote an editorial last Friday (2/26/05) that said that the VAT made European Governments spendthrifts. The truth is that they were socialist long before they adopted the VAT. The way to control government spending is to get rid of programs not to mess with the tax system.

Posted by: Robert Schwartz at March 9, 2005 12:33 AM
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