When We Will Get a VAT
The recent mini-boomlet for a value-added tax (VAT) that was kicked off a few weeks ago when former Federal Reserve chairman Paul Volcker indicated support for the idea is now officially over. Jackie Calmes of the New York Times quotes him this morning as dismissing the VAT for the time being. "I don't think it's on the political table for now or for the indefinite future, but that's the kind of thing you have to look at," Volcker said.
Volcker is unquestionably correct that the VAT is too politically toxic for it to be considered anytime in the near future. Since his brief comment of support on April 6, the right-wing crazies have been having a field day denouncing it. No doubt, millions of pieces of direct mail have already been dropped to raise money for an all-out war against the VAT. Thousands of little old ladies will be induced to sign over their Social Security checks for dubious campaigns against a tax that has no chance whatsoever of being enacted for many years. In a few months, they will be told that their pitiful contributions are what turned the tide for now, but that the VAT could arise from the ashes at any moment and so even more money must be contributed to ward off this insidious tax and keep it at bay. Since there is nothing to keep at bay, all such contributions will simply go into the pockets of executives at the organizations sponsoring these direct mail campaigns and the companies that do the mailing.
Even though I think we should enact a VAT as soon as possible for reasons I have explained many times here and elsewhere, I am under no illusion that it is remotely feasible under current political and economic conditions. But those conditions will inevitably change if projections of future federal deficits are even close to correct and if economists' beliefs about the impact of deficits are remotely true. They mean that sometime in the not-too-distant future we are going to see significantly higher inflation and interest rates than we have today. At some point--I don't know when--they will pass a political threshold and politicians can start to talk honestly about the sorts of fiscal actions that will be necessary to bring inflation and interest rates down to tolerable levels.
Even then, I don't anticipate that a VAT will be among the first options that will be considered. What I expect is that when there is the inevitable flare-up in financial markets as bond prices crash, the dollar takes an unexpected dip, the price of oil shoots up or whatever that Congress and the White House will solemnly vow to cut the deficit because it will be the one thing that everyone will be able to agree upon that might help and at least won't hurt. Everyone will go out to Andrews Air Force Base and after weeks of intense negotiations announce that a deal has been struck to deal with the crisis.
Republicans will inevitably agree to some modest tax increases, Democrats will agree to trim Medicare and Medicaid, and both sides will promise that discretionary spending will be slashed. But after the low-hanging fruit has been picked clean, deficits continue to rise and financial markets once again suffer some turmoil we will, after perhaps 10 years of unsuccessful efforts to get our finances under control, eventually reach a point where a VAT is politically viable. Republicans will finally be brought around to it by using the revenue to offset many of the ad hoc tax increases that will have been previously enacted, with a little left over for deficit reduction. This way they can rationalize their surrender to the inevitable as a tax reform rather than a tax increase. But in fact it will simply be a retroactive tax increase.
David Ignatius put it well in the Washington Post this morning. Said Ignatius, "By ruling out a VAT when it could keep the federal deficit in check, politicians have all but guaranteed that the debt crisis, when it comes, will be more damaging. But by then, everyone will be clamoring for a VAT, so it will be safe to endorse it."
Personally, I think it's stupid to put up with a decade of unnecessary pain and suffering before we finally bite the bullet and do what has to be done to stabilize our nation's public finances. But I don't see any other path that will get us there. The right-wing, tea party fantasy that we can solve our fiscal problems only by cutting spending has to be proven by experience to be a failure before rational people can finally put real solutions like a VAT on the table without being denounced by Larry Kudlow and the Wall Street Journal editorial page for trying to Europeanize the American economy and turn every American into a tax-slave.
Against the VAT, and I'm a Dem
Hi Bruce, I'm a Democrat, although I do occasionally watch Kudlow. I'm against a VAT because it's regressive, and I do hope that the GOP runs ads against the VAT this fall, so that Dems will have to go on the record against it.
I acknowledge that the US needs to either increase tax receipts or significantly decrease entitlement spending. But, if the Dems decide to increase tax receipts, I want them to champion a wealth tax, primarily impacting households with a worth over 50M.
Yes, Europe has a VAT, but Europe has a far more egalitarian society than the US. Once we get to Europe's Gini Coefficient, we can discuss a VAT.
I read somewhere that
I read somewhere that Liberals have opposed the VAT because it is regressive and Republicans have opposed it because it is a money machine and that a VAT won't be enacted until Republicans realize that it is regressive and Liberals realize that it is a money machine. Is there anything to that?
Larry Summers said that 20 years ago.
"tea party
"tea party fantasy"
Considering that the very existence of a "tea party" would have been a "fantasy" 16 months ago, I would have thought that your conversion to nihilistic liberal statism (I don't know what else to call it) might have been tempered by events.
Apparently not.
Patricia as it wrong. It is
Patricia as it wrong. It is because European countries have a VAT that they can afford the sort of programs that promotes a more egalitarian society. In fact, countries that have high social spendings tend to have fairly regressive tax systems. This is the trade off: high level of taxation for everyone (so even the income tax in Sweden is not especially progressive), but very generous income support programs and social services that largely compensate for poorer citizens.
Patricia as it wrong. It is
yes and the europeans need it because of bad productivity,high unemployment, low job mobility,I could go on but hey go live there a while and try to start a business.
"Bad productivity"?!
What chauvinistic dreamland are you living in? Check for example http://www.nationmaster.com/graph/eco_ove_pro_ppp-economy-overall-produc... -- Luxembourg's productivity trashes the US's, Ireland's in a death heath with it, Italy's and Belgium's are not far...!
There's nothing, and I mean
There's nothing, and I mean nothing, you do better than putting on the mantle of the martyr Bruce. The silly and pointless ad-hominem really undercuts your argument, to the extent you even have one. It's more akin to the global warming doom-mongers. "Enact my preferred policy now or we're all doomed!" Sure thing Bruce. At least you acknowledge that it's not remotely feasible, for various excellent reasons that others have explained to you.
touching faith
Your faith in the Republicans to eventually do the right thing is touching. I wish I shared it.
Time to Hike the LTCG Tax Rate
It's time for a bit of balancing of tax rates. Long term capital gains are taxed at just 15%. The result has been an rise in equity prices that has nothing to do with actual value and everything to do with value "created" by tax policy. Look at the rise of the average P/E ration in the S&P500 over time to see what I mean. Today's lows are yesterday's highs.
When taking wage tax into account, the middle class is paying a marginal rate that is well over double the capital gains rate. It's even worse if you're self-employed. Why do we want a tax policy that discourages work and the creation of new businesses?
Time to flatten taxes a bit.
On pros and cons of wealth taxes and VATs
Doesn't a wealth tax (which one commenter suggested) have constitutional issues? As I understand it, it would arguably be a "direct tax", which couldn't be enacted unless apportioned by state population. That would be difficult to pull off both technically and politically. That's why federal taxes tend to be on transactions (which makes them "indirect" taxes) and property taxes tend to be local.
Also, I still don't see why enacting a VAT is better than simply raising the income tax rate. Is it just that it's considered easier to pass, or is there some other reason?
(I do agree with the suggestion another commenter made to bring taxes on capital gains back into line with taxes on labor gains.)
"Doesn't a wealth tax (which
"Doesn't a wealth tax (which one commenter suggested) have constitutional issues?"
The way to go about it is not by direct tax, but by removing tax shelters and loopholes. Removing the mortgage interest deduction would be a great start, the deduction brings only slight benefits to the middle class but the benefits multiply significantly the higher up the housing chain you buy. Remove favorable treatment of capital gains. Remove every single deduction from our personal income tax system and lower the base rates to compensate. If you leave ANY wiggle room anywhere, it will be abused.
Isn't it easier....
... to sell a VAT for what it obviously is?
I may be wrong, but my understanding of a VAT is it's a sales tax EVERYBODY has to pay, but with deductability: A business (or person maybe? depending on how it's implemented) deducts the sales tax they paid on goods from the tax they collected in sales.
Since almost every state already has a sales tax, wouldn't VAT be the easiest to implement, since the accounting is essentially the same?
It will take a Republican
Just as it took a Democrat in Bill Clinton to enact NAFTA, GATT and welfare reform, it will take a Republican to pass and sign a VAT.
And why not? A properly constructed subtraction-method VAT (by a new name, of course) that replaces the byzantine income tax for most Americans would be the ultimate in tax reform. It could gain support on both the right and left as a pro-jobs bill that forced corporations to "pay their fair share." Above all else, the VAT gives us the opportunity to remove the structural inbalances inherent in 60 years of special interest meddling with the tax code.
Now we just have to get the Fair Tax people to understand they can have their cake and eat it too with a VAT.
I agree
it will take a Republican president and probably a Democratic Congress.
We need a VAT
As a independent that leans to the left, I am against the income tax. It makes the hard earned income you make the sole property of the government before you have a say what you want to do with your money. I am in favor of the Value added tax because it taxes you when you decide to purchase something or have a service provided.
The benefits of a VAT would be that it would encourage Americans to save instead of spend. If you save you are not taxed, if you spend you are taxed. No longer would your house be your golden goose as it had been the last 50 years.
Progressive VAT
Why not have a "progressive VAT?"
With modern high speed computers, it would be easy to have a multi-level VAT, just like we have a progressive tiered income tax.
Wealthy people want a flat VAT.
Lower income people see a VAT as regressive.
Compromise on a 4 tier VAT:
Zero for food and necessities (most state sales taxes do this)
Low Rate for parts in the basic model (i.e. Honda Civic)
Middle Rate for more upscale parts (i.e. Accord-Lexus)
High Rate for luxury model (i.e. S Class Mercedes)
Today's computers can do this easily, especially when staffed by all the income tax CPA's who would need a new job.
VAT increases cost of inventory, lowers ROI?
Bruce,
Although a large retail sales tax obviously would present practical problems regarding compliance and therefore seems undesirable, would it be correct to say that, compared to a retail sales tax (and compared to no sales-related tax at all), a VAT increases inventory carrying cost and thus reduces ROI, ROA, and NPV (and thus value of the enterprise) for parties throughout the supply chain (manufacturers, wholesalers, retailers)? With a retail sales tax the retailer, for example, never needs to expend capital for the purpose of taxation until after that retailer already has it in hand from the consumer (actually, even later) and then passes it on to the government. But with a VAT, the retailer must first expend a portion of the overall sales-related taxation upon purchasing goods for inventory, only recovering it after it sells those goods to the consumer. That means more capital tied up in inventory than there would be under a retail sales tax system, and for the same dollar amount of profit, thus lower return on invested capital.
Correct?
Brooks: wrong again. See my
Brooks: wrong again. See my comment below to Jack. The VAT is recovered when the return is filed, not when the goods are ultimately sold.
states rights and states' obligations
As I recall, the Constitution didn't say what federal taxes there could or couldn't be, and there mainly weren't federal taxes until income taxes (?)
Circumstances change. But shouldn't the burdon of raising the funds to pay for the services the states and their residents share- Coast Guard, NSA, FBI, CIA, FDA, Smithsonian, National Parks, -- be paid by the states rather than by direct national taxation of individual people?
Let states, many of which already have state income taxes and state and local sales taxes, figure out how to tax to pay federal bills. Start with states' obligations and, if they all choose VAT, harmonize rates later.
More on VAT vs. Retail sales tax
Just to reiterate my point above and expand on it...
It seems to me something is being missed in every discussion I've seen of the VAT vs. a retail sales tax: I think a VAT would make a retail firm less valuable than it would be under a retail sales tax by adversely impacting the timing of tax-related cash flows. Under a retail sales tax, the retailer doesn't expend funds for the tax until after it already has those funds in hand from the consumer. By contrast, under a VAT, the retailer must expend funds upon purchasing its inventory, and only later get reimbursed upon the sale to consumers of that inventory. The retailer ends up with the same dollar profit after investing more funds earlier when purchasing the inventory. That means lower NPV and thus lower firm valuation, correct?
And it seems that this dynamic effects every party in the supply chain, for better or worse. The initial supplier -- equivalent to the farmer in your illustration -- is better off (that firm is worth more under the VAT than under an equivalent retail sales tax) because under the VAT it receives an influx of funds from its customers and will later forward those funds to the government, in the interim benefiting in terms of the timing of cash flow (e.g., the float; financing needs and thus cost of capital, etc.). For those between the initial supplier and the retailer it apparently could go either way in terms of net impact on NPV and thus firm value, because on the one hand they must expend funds to acquire inventory that they wouldn't have to expend under a retail sales tax, but on the other hand when they later sell the inventory to their trade customer (e.g., retailer) they get a larger amount than they had to expend earlier, so it's quantity vs. time value of money.
Finance wasn't my focus in B-school nor has it been since, so I may be missing something, but if I'm correct then there is a substantive difference between a VAT and a retail sales tax that is not being discussed, or at least not discussed much.
If anyone can confirm or invalidate my point above, I'd appreciate it.
Mor on VAT versus Retail Sales Tax
Your assumption is wrong. Under the VAT system (at least as it is operated in Europe) a business person files VAT returns quite frequently (possibly each month, depending on revenues and costs). VAT that is incurred is netted against VAT that is collected. The difference is either paid to or refunded from the revenue authorities. Thus, depending on the size of the businesses, the cash flow issue is not significant. The VAT incurred on purchasing inventory is refunded when the return is filed---not when the good is ultimately re-sold.
VAT tax recordkeeping
A VAT adds huge record keeping burden to industry, and small business is less able to cope with burdens than big ones. Therefore, a VAT is a great thing for big corporations. Like the new 1099 legislation, it gives them another competitive advantage over mom and pops.
Bravo, Bruce. Just Bravo.
Why not spend a little more of your intellectual horsepower on something that will make a better difference. Like say, placing higher marginal tax rates on incomes >$500k, busting public employee unions, cutting Federal agencies, and (for once) making genuine changes to immigration policy?
The biggest argument against
The biggest argument against spending cuts as a solution is that it isn't politically feasible. But you are also saying that's the case for a VAT. Do we have any sort of polling figures on which is more politically feasible?
I favor a VAT due to its less distortionary nature, but I don't think it will stop fiscally irresponsible legislators from spending into bankruptcy much further on down the line. The VAT is a band-aid, we need to grab the bull by the horns. Perhaps we should outsource our governance to Canada?
My Small Canadian Business and VAT
Canada has had a VAT (GST) since 1991 and it has been a blessing as a small business operator. By July 2010, most provinces will have switched their RSTs to VAT as well, which is a tremendous help when it comes to effectively reducing tax rates on investment. Combined with lower corporate tax rates, VATs help other countries compete with the USA and its antiquated tax system.
Regarding VAT and inventories: Before VAT, small businesses were disadvantaged relative to larger businesses, because a larger proportion of small business inputs were subject to retail sales tax and other built-in non-flow-through taxes which are replaced by VAT. This vastly outweighs any concerns re VAT on building up inventory, ROI, IRR, valuation etc.
As a rule of thumb, the difference between VAT and RST increases average small business margins by about 25% of whatever the implemented VAT rate is, i.e. 2% margins for an 8% VAT.
Wealth tax rather than VAT
I suggest: forget the VAT, reduce but reform income taxes (eliminating most deductions and adjustments), eliminate regressive sales, property and social security taxes, eliminate capital gains taxes, eliminate estate taxes,and ADD A WEALTH TAX of 1-2% on net worths over about $500,000.
The wealth tax would amount to a 20% tax on investment returns, making it on par with taxes on work income. Right now work is taxed at 5-10-fold rates greater than investment returns. For the very rich (Warren Buffett 2006) investment return are taxed at rates 200-fold less than work income
A Wealth Tax would:
1 -make taxes more proportional to ability to pay
2- make taxes proportion to the extent a household has profited from economic infrastructure provided by governments
3- reverse tax advantages that have resulted in the top 1% owning 40% of the nation's wealth [basic economic fairness and less inequality are associated with reduction of numerous social ills (http://www.equalitytrust.org.uk/why)]
4- reduce recessions caused by bubbles caused by excessive investment caused by favored tax treatment of investment and wealth condensation
5- strengthen the economy
6- create a rising tide that raises all boats
7- simplify the tax system
(A VAT would have the opposite effect on all 7)
See more at http://fairsharetaxes.org