The Case Against the VAT
In my Forbes column this morning I respond to various arguments against a value-added tax. BB
In a previous column, I explained why I think it would be desirable for the United States to adopt a value-added tax. In a nutshell, I think it's impossible to cut spending enough to forestall a fiscal crisis, that taxes will eventually be raised a lot, that it would be economically debilitating to raise income tax rates as high as would be necessary to get the necessary revenue, and that a broad-based consumption tax such as a VAT would be much less damaging to the economy than very large budget deficits.
Today I want to look at some of the arguments against my view. Some are serious, but many are not; they're just straw men created solely to obfuscate the issue. I will try to deal with them in order of seriousness, from least to most.
We must repeal the 16th Amendment first in order to avoid having both a VAT and an income tax. Columnist George Will made this the centerpiece of his case against the VAT in a recent column. It's a silly argument because, contrary to popular belief, Congress was not prohibited from taxing incomes prior to the 16th Amendment. As historian David Levenstam explains in the libertarian magazine Reason, the Supreme Court struck down an income tax enacted in 1894 on narrow grounds and did not find the taxation of incomes to be unconstitutional.
While it is reasonable to say that it might be a bad idea to tax both consumption and incomes, repealing the 16th Amendment would provide no guarantee against this happening. We would not only have to get rid of that amendment, but enact another one that clearly, unambiguously prohibits--immune from court challenge--the federal government from taxing incomes. This is impossible, if only because the definition of income is so elastic.
The VAT is a hidden tax. This is also a silly argument. The VAT is no more hidden than any other tax. Ask yourself, do you really know what the sales tax rate is in your state or the property tax rate in your community or even what your effective federal income tax rate was last year? (Guess and then check; more than likely you overestimated all of them quite a lot.). According to polls, most people have no idea. The chances are far better that those who pay the VAT in other countries can tell you precisely what the rate is because it covers such a wide array of goods and services and is the same throughout the country.
Even if the VAT were an especially hidden tax, is there any reason to believe that hidden taxes are more easily increased than more visible taxes? Indeed, there is none. Economist Casey Mulligan, a VAT opponent, recently looked for evidence and could find none. He concluded that "tax visibility is empirically unrelated to the amount of taxation and government spending."
The VAT is too complicated and will be riddled with exemptions. This is a weak argument because all taxes are complicated. They're complicated because people don't like paying them, which then requires governments to continually plug new loopholes and evasion tactics that people are always discovering, and because Congress is continually meddling with the tax code to buy votes and redress legitimate grievances.
While a VAT would indeed be tricky to implement, once in place it is not especially complicated, certainly no more than the retail sales taxes that exist in almost every state. One reason I support a VAT is because so many other countries have one that we could learn from their experience and avoid making our VAT unnecessarily complicated.
The VAT is inflationary. While it is true that imposition of a VAT will more than likely raise the price level by about the amount of the tax, this is not what economists normally think of as inflation. That would be a continuing rise in the price level year after year resulting primarily from excessive money creation by the central bank. Any rise in prices resulting from imposition of a VAT would be a one-time event that would have no effect on the general trend of inflation.
The VAT is a money machine. This is probably the biggest problem most conservatives have with the VAT. In their minds, its primary virtue--the ability to raise large amounts of revenue at low deadweight cost (the output lost to taxation over and above the tax itself)--is also its primary vice. If taxes are insufficiently burdensome, conservatives reckon, then they will be too easy to raise. To keep taxes low, they believe we should raise them in the most painful and burdensome manner possible.
In response, I would make three points. First, we will only enact a VAT if we really, really need a lot of new revenue; i.e., a money machine. If by some miracle Congress enacts massive spending cuts that significantly reduce benefits for the largest, most politically powerful and fastest-growing voting bloc in the country--the elderly--thus preventing the need for higher taxes to avoid a financial crisis, then there is no need to consider a VAT. But that's not going to happen except in a libertarian fantasy world.
Second, it's not true that VATs always rise once implemented. Of the 29 members of the Organization for Economic Cooperation and Development with a VAT--the U.S. is the only country without one--four have never increased their VAT rates and seven others have reduced theirs over time. The average VAT rate in the OECD is actually lower today than it was in 1984: 17.61% today vs. 17.79% then.
Third, it is critical to differentiate between those countries enacting VATs before the great inflation of the 1970s and those not initiating one until after. The first group did raise their VAT rates a lot by piggybacking on inflation. But in the era of relative price stability since the 1980s, there is little evidence that the VAT is a money machine. In the 17 countries enacting VATs since 1977 the average rate increase is less than a percentage point.
The VAT is regressive, taking more out of the pockets of the poor. This is probably the strongest argument against the VAT. Since the poor consume a higher percentage of their income than the well-to-do, they are necessarily going to pay more VAT as a percentage of their income than the well-to-do. There just isn't any getting around that fact, and it is something that would have to be addressed if we were to adopt a VAT.
That said, one important benefit of a VAT insofar as those with low incomes is concerned is that they would be contributing something to the general cost of government. Everyone benefits from things like national defense, and everyone ought to pay something for it. But as it is, 47% of those filing federal income tax returns have either a zero or negative tax liability; that is, they pay nothing but still get a tax "refund."
When this fact is brought up, liberals always point to all the payroll taxes low-income workers pay. But they never note that the negative income tax liability many of them have comes from something called the Earned Income Tax Credit, which was established precisely for the purpose of indirectly offsetting the payroll tax for such people. Furthermore, the payroll tax does not support the government's general operations; it funds specific benefit programs, Social Security and Medicare, from which the vast majority of beneficiaries get back far more than they ever pay in.
The odd thing is that conservatives are the ones most likely to complain that the poor aren't pulling their weight, yet they fail to see that a VAT is probably the only way of getting them to help finance the general cost of government. It's extremely unrealistic to think we are ever going to impose income taxes on very many of those now paying nothing.
Of course, there are any number of other reasons why people oppose a federal VAT. One key constituency is state governments, which view consumption as a tax base that belongs exclusively to them. But they could easily piggyback on a federal VAT, which would also be able to tax things like Internet and mail order sales that the states have great difficulty collecting sales taxes on.
Lastly, it goes without saying that we would never impose a VAT until well after the economy has returned to reasonable health. And it also goes without saying that a VAT would have a heavy economic cost even if that cost would be far less than that from an equivalent income tax rate increase. But, as noted earlier, a VAT is never going to be seriously considered unless the need is overwhelming. That will be when large deficits are imposing costs on the American people that are even worse in the form of inflation, high interest rates and economic instability.
If, as former Vice President Dick Cheney used to say, deficits don't matter, then we have nothing to worry about. But anyone who believes that deficits have economic costs has to accept that at some point those costs may be greater than the cost of raising taxes to reduce them if, as I believe, spending will never be cut enough to keep deficits from rising to economically disastrous levels.
Addendum
David Graham comments in Newsweek.
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Am I conservative or liberal?
Thanks for a great essay, Bruce.
I would add to your counterargument about the so-called regressive nature of payroll taxes. Social Security benefits are taxed above a baseline level. Thus, not only do low-income people receive more in benefits than they pay in taxes for these programs, but also they are not taxed as heavily on those benefits.
I am troubled by your belief that "spending will never be cut enough to keep deficits from rising to economically disastrous levels". I am troubled because your belief might well be correct.
I still consider myself a liberal. Given my perspectives above, I'm just not sure what that means.
Best regards,
Jim
Re: Am I Conservative or Liberal?
In the anti-matter world created by George W. Bush, there is a real problem regarding definition of terms.
You cannot be a legitimate Conservative and support much of anything George W. Bush did -- foreign or domestic.
Perhaps that will help you.
I agree Please keep
I agree
Please keep blogging!!
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"Furthermore, the payroll tax
"Furthermore, the payroll tax does not support the government's general operations; it funds specific benefit programs, Social Security and Medicare, from which the vast majority of beneficiaries get back far more than they ever pay in."
If you can get conservatives to concede this point and agree that the Social Security Trust Fund is loaded with assets, then you may have a point. Until then your critique on this subject is flawed.
VAT and Sustainability
Would a VAT have the inadvertent effect of driving our consumption patterns toward a more sustainable level? Would repairing items - or even designing items for a long life that can be repaired over and over to extend their life - be more cost effective than buying new ones? Would this affect where goods are manufactured?
There could be some potentially beneficial side effects of a VAT that move us away from our dead end resource extraction to dump economy.
Bruce, what about trade
Bruce, what about trade tariffs instead of a VAT?
The advantage of such a tax from a conservative point of view would be that its revenue potential would be limited. If you want to raise 4% gdp, equivalant to 12% VAT, then a 50% rate applied to imports of 8% gdp - half that of today - should do. Some of the money raised could be used to reduce other taxes.
What do you think of the merits of such a tax, and what do you think Republicans would prefer?
You have a wild imagination
You have a wild imagination if you believe that the revenues derived from a VAT will reduce the deficit. Like the Social Security trust fund, our brain damaged legislators will find new ways to spend the added revenue.
Increasing taxes does reduce the deficit
Experience shows that legislators don't find new ways to spend the added revenue, because the only reason that tax increases get passed in the first place is that legislators want to reduce the deficit. I suspect that the reason the previous commentator claimed otherwise is that he'd rather have lower taxes than lower deficits, but doesn't what to come out squarely in favor of higher deficits.
I agree with the post above i
I agree with the post above i cannot believe that the revenue from VAT will reduce the deficit. We need some serious cut in spending and responsibility with our funds
VAT is easy
VAT is the easiest tax imaginable to calculate, implement and audit. I ran a small business in France for 25 years, and it never posed any problem. All you do is pay a percentage of your sales, less a percentage of your purchases. Even the smallest business person knows these two numbers. And why would it be a problem for the IRS to eyeball these two additional figures, when reviewing tax returns? Only a very minor upgrade to business accounting and invoicing programs is necessary.
Definition of Income is Elastic
Bruce was correct to write that you cannot write prohibitions against the taxation of income. However, there is another approach. For example, you could write a restriction that income tax rates may not exceed 1% and must be levied on no less than 90% of persons who earn income.
This is a better approach to effectively disabling the income tax. Assume that future legislators will try to play games with the definition of income and you'll never be able to anticipate what they'll come up with. However, whatever the come up with will then be contained.
What if we ONLY kept VAT ?
I think there are several reasons to like VAT a lot:
1- no loopholes. We all know rich people actually pay less in taxes, thanks to arcane tax exemptions, good accountants and tax-motivated relocation. VAT is quite impervious to that.
2- cheap to collect and administer. Once you're set up to do it, VAT is fairly painless to asses and collect.
3- No more social dumping. Replacing taxes on companies and workers by taxes on consumers lowers the cost of doing business. Instead of penalizing companies that produce in highly-taxed US, it levels the playing field.
4- more freedom. Instead of just having to pay taxes, you can choose to pay less, by buying less or resorting to home-made stuff and barter.
5- flexibility. several rates can be used to take "soft" factors into account: luxury vs necessity, social value, environment, health value...
Re: Point 4
Just out of curiosity, would a VAT be applied to resale of goods?
For example, assuming I buy a copy of Bruce's book and a VAT was applied, would VAT be charged again if I sold it to a used book shop and/or when the shop sells it to someone else? I know a state sales tax gets charged when the shop resells the book, but wondering if a VAT would be applied the same way.
Similarly, what about garage sales?
Genuinely curious. I do think a VAT (or a consumption-based tax in general) is better on the grounds of possibly moving us to a more sustainable economy as another commenter posted higher up. Just interested in figuring out how it would be applied.
Just to be clear...
You don't trust the government to use the VAT money to pay off the debt (i.e. refrain from ADDING spending), but you do think that they will possibly CUT existing spending?
This makes no sense. Lawmakers will always be more reluctant to cut programs that already exist than to refuse to add new programs, since their constituents are human beings subject to both loss-aversion and framing biases which make them more angry to lose an existing payment than not get a potential payment. To whatever extent you distrust congress to save the money from a VAT, you should have even less faith that they can balance the budget through cuts alone.
Realistically, Congress will NEVER cut Medicare, Medicaid, Social Security or Defense, and cannot cut debt service. That means if we are ever to get the deficit under control, we MUST raise revenues AND use those increased revenues to pay off the debt. Those of us who are serious about reducing the deficit must focus not on our ideal solution, but on solutions with a realistic chance of happening. We may hope for the best, but should advocate for the possible.
PCT
Why not try Robert Frank's progressive consumption tax in lieu of the crazy complexities brought by a VAT? It's progressive, it encourages savings and work over consumption, it raises lots of revenue...what's not to like?
By the way
The problem is not that the United States is adopting an European level of taxing and spending, but that Europe decided to adopt an American level of deficits and personal consumption.
Book - The New American Economy
I mostly agree with your analysis and recommendation for VAT. However your book still perpetuates myths about the stimulating effect of tax reduction in the 1980's. The real growth rate of the US GDP between 1960 and 1980 averaged 4% per year. From 1980 to 2009 it averaged 2.78%. Even if you remove the last two recession years 2008 and 2009 and the first two years 1980-81 also recession, the growth rate 1982 to 2007 was 3.31%. This same lack of change in overall growth rates is true of the UK economy also where similar policies were pursued.
I have always believed the rise in the rate of inflation in the 1970's was not over stimulation or deficit financing particularly but the rapid rise in oil prices which fed through to all other costs. When the oil price collapsed in the early 1980's so did inflation.
source for groth statistics:
http://www.google.com/publicdata?ds=wb-wdi&met=ny_gdp_mktp_kd_zg&idim=co...
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