StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between



The VAT and the Money-Machine Argument

10 Apr 2010
Posted by Bruce Bartlett

It is an article of faith among conservatives that the value-added tax is a money-machine that must be fought to the death. The Wall Street Journal, for example, continually argues against the VAT on the grounds that if we were ever to adopt such an insidious form of taxation we would very quickly become just like Europe, as if the entire continent is one big Gulag instead of someplace where by and large the people are just as free and prosperous as Americans.

Today I just want to make two points about the money-machine argument. First, it is often implied that the trend of the VAT is continuously upward. This is factually wrong. According to the OECD, 7 of the 29 countries with a VAT have lower rates today than they had in the past: Canada, the Czech Republic, France, Hungary, Ireland, the Netherlands, and the Slovak Republic. And a number of countries have never increased their VAT rates: Australia, Finland, Korea, and Poland. Indeed, the average VAT rate in OECD countries is actually lower today than it was in 1984: 17.79 percent then versus 17.61 percent today.
 
In this respect it should also be noted that the VAT rates commonly referred to are statutory rates that don’t necessarily tell us anything about the effective tax rate. Conservatives just assume that the VAT covers everything and has the same structure in every country. In fact, every country with a VAT exempts many items, imposes lower rates on some things and higher rates on others. The rates one tends to see, such as those I use below, are the basic rates that apply to most things that a VAT covers. But the share of GDP covered by the VAT varies enormously from one country to another. I will post data on this point later.
 
Another problem with the money-machine argument is that it fails to note the critical impact of inflation on fueling higher VAT rates in the 1970s. At that time it was absurdly easy for governments to raise VAT rates because they were hardly noticed—what was another one percent rise in the inflation rate when the general price level was rising at double-digit rates? Furthermore, to the extent that inflation was a function of budget deficits, higher taxes were a plausible means of reducing it. And in the Keynesian model, higher taxes are inherently anti-inflationary because they reduce purchasing power.
 
Therefore, I think it is critical that any money-machine analysis distinguish between those countries that adopted VATs before the great inflation of the 1970s and those adopting VATs in the era of relative price stability that we have seen since that time. I have done so in the two tables below. They show that to the extent that there is a valid money-machine argument it is only in the countries that were able to piggyback on inflation to ratchet up their rates in the 1970s. VAT rates show much less evidence of a ratchet effect during the era of price stability.
 
VAT Rates in OECD Countries Establishing VATs Before 1975
(Ranked by Year of Inception)
 
 
Country
Initial Rate
Year
2009 Rate
% Increase
1
Denmark
10
1967
25
150
2
France
16.66
1968
19.6
17.6
3
Germany
10
1968
19
90
4
Netherlands
12
1969
19
58.3
5
Sweden
11.11
1969
25
125
6
Luxembourg
8
1970
15
87.5
7
Norway
20
1970
25
25
8
Belgium
18
1971
21
16.7
9
Ireland
16.37
1972
21.5
31.3
10
Austria
16
1973
20
25
11
Italy
12
1973
20
66.7
12
U.K.
10
1973
15
50
 
Average
13.3
 
20.425
53.6
 
VAT Rates in OECD Countries Establishing VATs After 1975
                       
 
Country
Initial Rate
Year
2009 Rate
% Increase
13
Korea
10
1977
10
0
14
Mexico
10
1980
15
50
15
Turkey
10
1985
18
80
16
New Zealand
10
1986
12.5
25
17
Portugal
17
1986
21
23.5
18
Spain
12
1986
16
33.3
19
Greece
16
1987
19
18.75
20
Hungary
25
1988
20
(20)
21
Iceland
22
1989
24.5
11.4
22
Japan
3
1989
5
66.7
23
Canada
7
1991
5
(28.6)
24
Czech Rep.
23
1993
19
(17.4)
25
Poland
22
1993
22
0
26
Slovak Rep.
25
1993
19
(24)
27
Finland
22
1994
22
0
28
Switzerland
6.5
1995
7.6
16.9
29
Australia
10
2000
10
0
 
Average
14.7
 
15.6
6.1
 
Note: There are 30 nations in the OECD and 29 have VATs, only the U.S. does not.
 
Sources: EU, IMF, PricewaterhouseCoopers, and national sources.
 

X-Tax question

Somewhat off topic, but I was wondering what opinion you have on the "X-Tax" -- a flat tax-like consumption tax with progressive rates. I read "Taxing Ourselves" a few years ago, and although I've forgotten most of what was in it, I remember the authors' preference for the X-Tax. The problem, of course, was transitioning from an income tax to a consumption tax.


X-tax

I haven't thought much about fundamental tax reform in a while because I think time has passed it by. The need for additional revenue has assumed paramount importance. Undoubtedly a VAT could be used for tax reform purposes, but I don't see it as a replacement for the income tax, payroll tax or corporate tax. Initially, the revenue could be used to permanently fix things like the AMT. But in the longer run it will have to be a supplementary revenue source, not an alternative to the sources we have now.


The VAT (GST) reduction in

The VAT (GST) reduction in Canada is a little more complicated than you present.

First off, the 2% reduction in the GST was for political grand-standing purposes (taxes were quietly raised elsewhere and the 'loophole' in income trusts slammed shut, destroying some $38 Billion in the wealth of retired folk)

Secondly the provinces in Canada also charge sales tax (in Ontario it's currently 8% - was 7% in the 80s)

Two of the larger provinces - Ontario and BC - are introducing 'harmonized sales taxes' which will actually expand taxation on items that are currently exempt from provincial sales taxes.

That's outside of sales taxes being one of the more regressive forms of taxation, disproportionately hitting the middle and lower classes.


A Different Perspective on the Canadian GST reduction

It is correct that many provinces have hamonized their sales taxes with the federal Goods and Services tax. The reduction of the GST rate from 7 to 5% has provided greater tax room for the provinces to increase their portions of the Harmonized Sales Tax. Nova Scotia and Quebec have both announced HST tax increases. The HST is collected by the federal government and the provincial portion remitted by the Canada Revenue Agency.

It should be noted that with the GST VAT, it is the final customer who pays, and that from a business perspective there is effectively no tax burden - though there is paperwork.


average VAT rates

Your argument is interesting. However, you've used a simple mean to calculate average VAT rates. You should have used the harmonic mean, as this is a better representation of mean rates.

Info: http://en.wikipedia.org/wiki/Harmonic_mean


I forget where I read it but

I forget where I read it but someone commented the VAT isn't liked because republicans fear it will be a vast money making machine and the democrats don't like it because it is regressive. As such, the VAT will become law once the Republicans realize it is a regressive tax and the Democrats realize it is a vast money making machine.


Summers

 Larry Summers said that about 20 years ago. 


Getting WSJ to favor the VAT

Bruce,

Reserve almost all income tax collection for the States and let the Federal government run on a VAT.

Adopt a constitutional amendment with a 10-yr. transition period that lowers federal income tax to maximum of 1%. Abolish federal estate taxes too. Retain 1% just so we force people to file returns from which we can still collect good data about incomes.

Competition between the States will place a brake upon ability to utilize income tax for redistribution purposes. VAT at federal level is broad based and not easily used for social engineering and vote buying.

This is the kind of compromise the WSJ and Republicans could favor.


Compromise?

DebtLimitReferendum,
You might have proposed a fine compromise between the WSJ and Republicans. But I don't think that anybody else would want to sign up for it.

Democrats view "competition between the states" as a race to the bottom, and a competition to inflict externalities on neighbors. They also like progressivity. What's in your proposal for them?


What's in it for them?

What's in it for the Democrats is a way to pay for all the programs they want (Social Security, Medicare, obamacare). What they give up is the ability to discriminate on basis of income AT THE FEDERAL LEVEL. Leave the social engineering to the states.

Part of the bargain would involve the devolution of programs from federal to state level. Agriculture, education, housing, transportation, etc. are not core federal functions. They can be moved to the state level where balanced budgets are the norm, not the exception. Give states the revenue source to pay for the additional responsibilities by reserving the income tax for them.

I don't see a "race to the bottom" when it comes to public school district expenditures. People support government spending where they see results. If there's value, then support for taxation will appear.


Regressive taxation exempting the wealthy

I am fine with a VAT, provided it applies to ALL purchases--including buying shares of stock, treasuries, real estate and other investments of the "liesure class". Oh, well we CAN'T do that, it would depress investment in the private sector you say? Use the funds to increase public sector investment--which would at least stay in the US rather than fund Asian wages and profits. This at least ameliorates the regressive nature of the tax. As John Belushi would say "But NO!" Capital is sacrosanct, and labor should be free to move to the lowest cost providers. The hypocrisy of freshwater economics is just atrocious.


Consumption/Saving

 Apparently you are unclear about the difference between consumption and saving.


the eternal struggle between corporations and the State

would thrift stores apply VAT on used merchandise as well?

VAT is regressive. Another tax on the poor who are forced to consume (spend) the greatest proportions of their income on necessities. All because, the Government can't really do anything about (ie tax further) global multinational corporations that are rivalling the power of the government itself: lobbying, choosing domiciles with favorable tax rules/environmental rules/labor costs, working every loophole with synthetic leases structured finance whatnot.

A typically Obamanian solution. Can't do anything about real reform, smile broadly and hit the silent middle class and lower. DONE. Full steam to the next. what a faker.




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