In discussions about changing the U.S. tax system, one topic almost always arises: the possibility of adopting a value-added tax.
After all, most of the industrialized world uses a VAT — which is not to say they all like it.
Unlike a traditional sales tax, a VAT is a levy on consumption that taxes the value added to a product or service by businesses at each point in the chain of production. Businesses along the chain collect the tax and send it to the government, which supporters say is a boon for the efficiency of revenue-collection efforts. But ultimately, it is the consumer who pays the tax, because the final price of the goods and services they buy reflects all of the taxes that have been charged up to that point. The taxes are all baked into the retail price.
In this way, a VAT taxes what people consume rather than how much they earn. But this is also a reason why some consider a VAT to be unfair—because, the critics say, the burden of taxation falls disproportionately on those with lower incomes.
Supporters of a VAT, meanwhile, say it is better for economic growth than an income tax because it doesn’t tax savings or investment. And governments like it because it tends to bring in more revenue, thanks in part to the role that businesses play in its collection. Incentivizing their efforts, businesses receive credits for the VAT they pay.
Arguing that a VAT can be good for governments and for the economy is Michael J. Graetz, a professor of law at Columbia Law School and author of “100 Million Unnecessary Returns: A Simple, Fair, and Competitive Tax Plan for the United States.” Taking the view that a VAT encourages wasteful government spending is David R. Henderson, an economics professor at the Naval Postgraduate School and a research fellow with the Hoover Institution.
Yes: It is fair and simple, and would spur economic growth
By Michael J. Graetz
For decades after World War II, even a horrible tax system (with a top individual income-tax rate of 91% and corporate rates above 50%) could not keep the U.S. from achieving robust economic growth and widespread prosperity.
A generation later, Ronald Reagan’s 1986 tax overhaul lowered income-tax rates. But it didn’t take long before that reform unraveled.
Now, our income tax is badly broken, and astounding complexities abound. In 1987 our tax rates on businesses were among the lowest in the world; today they are the highest. How can anyone remain optimistic about repairing our tax system without radical surgery?
What our nation needs is a fair and simple tax structure that is conducive to economic growth and that better positions U.S. workers and businesses to compete in today’s slow-growth global economy. We are hobbled by our heavy reliance on income taxation. The rest of the world has taken a very different path.
While the U.S. is a low-tax country compared with other nations in the Organization for Economic Cooperation and Development, other developed countries get nearly a third of their take by taxing consumption—through value-added taxes—while we get less than 18%, virtually all from state and local sales taxes.
Serious tax reform needs to replace income taxes on businesses and individuals with a value-added tax on sales of goods and services collected at all stages of production. Today, more than 160 countries have a VAT. The U.S. is the only OECD country that doesn’t.
This would free more than 150 million Americans from ever having to file tax returns or deal with the Internal Revenue Service. And it would enable us to cut our corporate income-tax rate to compete with the lowest in the world without shifting the tax burden away from those who can most afford to pay.
A VAT would also spur economic growth, increasing U.S. GDP by as much as 5% in the long run, compared with proposed income-tax changes that would increase GDP by far less.
Shifting taxes from production to consumption would stimulate jobs and investments and induce companies to base headquarters here rather than abroad. Taking the additional step of taxing imports and exempting exports would yield hundreds of billions of dollars for the U.S. Treasury in the decade ahead.
Unlike the income tax, with its exclusions, deductions and credits, we could apply VAT at a single rate to a broad base of goods and services. Like Canada’s VAT, the amount of tax on each purchase should be stated on customers’ receipts. And for 90% or more of businesses, all small businesses, collection should be optional. Before the retail level, the tax just gets collected at the next stage, based on the higher price. And even if a retailer opts out, the amount of tax forgone is modest compared with the VAT already collected at earlier stages.
Former Treasury Secretary Lawrence Summers said Republicans don’t like value-added taxes because they are a “money machine” and Democrats don’t like them because they are regressive. We will get a VAT, he said, when Democrats realize that it is a money machine and Republicans realize that it is regressive.
To the contrary, we will get a VAT only as part of a major tax reform designed to ensure that it is neither regressive nor a money machine. The potential for regressivity should be addressed for low- and moderate-income households by eliminating payroll taxes and through debit cards which cancel taxes at the cash register.
Done right, a VAT would enable us to restructure our tax system to produce greater economic growth and more jobs, fairly, and at far lower costs. For the vast majority of Americans, April 15 would be just another spring day.
No: It makes it too easy for the government to raise money
By David R. Henderson
Many economists who study tax systems do not concern themselves with the issue of government spending. Focusing simply on how the government collects its revenue, they often argue that a value-added tax, which taxes consumption, is more efficient than the alternatives. One main reason they give is that a consumption tax avoids the multiple taxation of saving that occurs now under our tax system. Our current system taxes interest and dividends that people earn on their savings, and taxes capital gains.
But another efficiency—this one from the revenue collector’s perspective—is that a VAT makes it easier to increase revenue. And that is the part we should balk at.
The evidence is strong that a VAT makes it easier for the government to tax more. The VAT is, in short, a revenue machine for big government. All other things being equal, the higher taxes are, the lower economic growth is. Moreover, higher taxes, even if they didn’t hurt growth, would put more money in the hands of government, which spends more recklessly and wastefully than we spend our own money.
Take Europe, where the VAT is a major source of government revenue. When Belgium, France, Germany, Ireland, Italy and the Netherlands adopted a VAT — all between 1968 and 1971 — their stated revenue goal was neutrality: Gains in revenue from the VAT were to be fully offset by reduced taxes elsewhere. (France already had a VAT but needed to revise it to meet European Economic Community Standards.)
All failed. Government revenues — and spending — rose substantially as a percentage of GDP. In 1967 in France, the year before that country adopted its EEC-compliant VAT, total government revenues were 33.4% of GDP. In 1968, France adopted a VAT rate of 13.6%. By 2014, its VAT rate was 20% and government revenues were a whopping 45.2% of GDP. When Britain adopted a VAT, the government’s stated goal was to reduce revenue. That failed, too. Only one country, Denmark, adopted a VAT to increase revenues. It succeeded.
Why does a VAT make it easier for government to raise revenue?
One possible reason is that a VAT is nearly invisible. When you pay for an item and don’t see the tax itemized on your receipt, you may not be aware of how big the tax is. And VATs tend to be hidden. Ironically, another possible reason VATs have led to government growth is that because VATs are more efficient at raising revenue, governments are tempted to raise VATs. Whichever explanation is correct, the sad truth is that VATs are not an engine of economic growth but, rather, an engine of government growth.
Make it visible
Is there a way not to have the VAT be an engine of government growth? There is only one I can think of: insisting that a VAT or similar consumption tax be highly visible. But then any government that implements a large transparent VAT is likely to be defeated. That’s what happened in Canada. In 1991, Prime Minister Brian Mulroney, head of the Progressive Conservatives, imposed a fully transparent 7% sales (consumption) tax. In the next election, his party lost nearly all of its 151 seats—the biggest rout in Canadian parliamentary history. The hugely unpopular sales tax was a major contributor.
One further problem with a VAT is that it would take a much higher percentage of income from lower-income people than the current tax system does. A way around that is to send checks to lower-income people who apply. The checks would be so large, though, that fraud would be substantial.