A Value-Added Tax Is a Terrible Idea
They claim VAT would be a substitute for income tax, but we know politicians will never get rid of any tax
The misguided valued-added tax seems like a magic money-making bullet to the nation’s deficit problems. The Tax Foundation estimates that Sen. Ted Cruz’s 16% VAT would net $25 trillion over the next decade. Sen. Rand Paul proposes a 14.5% “business activity tax” that would operate much like a European value-added tax or VAT.
“Cruz and Paul have both called our Congress dysfunctional, and one symptom of its dysfunction is that it never considers taxes rationally.”
But once the VAT is put in place, it is practically impossible to get rid of it. In countries that have it, the VAT rises over time incrementally and gives government immense power. Cruz and Paul are in favor of smaller government, but their suggested VATs would expand government clout.
VATs harm consumers through increased prices and broader tax bases. Although Cruz and Paul suggest it as a substitute for other taxes, in advanced countries, parliaments, congresses, and assemblies don’t get rid of other taxes. They add the VAT on top of existing levies.
If enacted in the United States, our Congress would be no exception. Cruz and Paul have both called our Congress dysfunctional, and one symptom of its dysfunction is that it never considers taxes rationally. Despite four years of warning that the Bush tax cuts would expire in 2010, Vice President Joe Biden and Senate Majority Leader Mitch McConnell negotiated the tax cuts’ extension in four days in December 2012.
Unlike state sales taxes, VATs are charged in small amounts along the entire supply chain. The final tax is hidden in the price and borne by consumers, as corporations pass increased costs on to the final user. Due to their hidden nature, VATs tend to grow over time, and 26 of the 33 advanced nations with VATs have raised their rates.
From 1975 to the present, VAT rates have risen in the U.K. from 8% to 20%. In Norway, they increased from 20% to 25%. These taxes are in addition to European income taxes that are relatively high by American standards.
For instance, when imposed in 1967, Denmark’s VAT was 10%; it is now 25%, in addition to a top income tax rate of 56%. In 1968, Germany levied a 10% VAT. Germans are more fortunate; their VAT has risen “only” to 19%, and their highest income tax rate is “only” 48%.
Of the 33 countries in the Organisation for Economic Co-operation and Development with VATs, only Canada, Japan, and Switzerland apply rates under 10%. Thirty have rates of 10% or more, and 21 have rates of 20% or higher. The notion that a VAT will stay at 14% or 16% is not supported by other countries’ experience.
Academics like consumption taxes because they discourage consumption and encourage savings and investment. More savings and investment generally translates into higher economic growth, all other factors being equal.
The problem is that politicians can never resist a tax. They are incapable of substituting a VAT for an income tax. So countries that institute a VAT end up with an additional layer of tax, not a substitution of one tax for another, as Cruz and Paul have planned.
OECD countries, with their VATs, should have higher growth rates than the United States. But since 2009 growth in gross domestic product has averaged 2.2% annually in the United States, compared to an OECD average of 1.8%.
Congress is not going to get rid of income taxes. In its December budget bill, Congress abandoned all fiscal restraint, adding $622 billion to the deficit. It will need income-tax revenue to fund its projects not only now but into the future.
“Politicians can never resist a tax. They are incapable of substituting a VAT for an income tax. So countries that institute a VAT end up with an additional layer of tax.”
Besides, VATs are not a progressive tax, because the poor spend a higher share of their income than the rich. Members of Congress do not want to be accused of exacerbating inequality by substituting a VAT for an income tax.
In an attempt to keep the VAT progressive, OECD countries spend considerable time and energy deciding what goods should be subject to the VAT. In the U.K. children’s clothes are not subject to a VAT, yet adult clothes are. When possible, smaller adults prefer to buy children’s clothes to avoid the VAT.
In most countries food is excluded from the VAT, but certain types of food are included. In Britain, hot food is exempt from tax, so some stores have microwaves to heat the food, which then exempts it from VAT. Plus, people are tempted to purchase services on the black market to avoid VAT. These games occur throughout the OECD countries.
VATs are unpopular with governors because they interfere with states’ sales tax collections, a state staple of revenue generation. Adding a VAT on top of a state sales tax would reduce the revenues that states pull in from sales taxes, as consumption is reduced and economic activity is partly driven into the black market.
After all, with an 8% combined state and local sales tax (as 12 states have, including California, Texas, New York and Illinois) and a 16% VAT, that 24% rate would encourage people to do business out of the government’s sight.
Cruz and Paul make the VAT the centerpiece of their tax-reform plans. But America needs to move away from European policies, not towards them.
This piece originally appeared in WSJ's MarketWatch
This piece originally appeared in WSJ's MarketWatch