What's Cooking on the VAT front?

Bruce Bartlett is about as pure an anti-tax cat as you'll find, so when he writes in The New York Times that he thinks a value-added tax now makes sense for America, you should know something is up.

Bartlett confesses disappointment at the GOP's track-record running Congress since 1994 -- join the club there -- and notes that the Bush administration's indifference to any kind of spending restraint, especially on entitlements, adding new ones even, makes galloping budget deficits almost certain.

After an initial effort at restraining Medicare spending - squelched by President Bill Clinton's veto pen - Republicans in Congress have become almost indistinguishable from Democrats on spending. They have been aided and abetted by President Bush, who not only refuses to veto anything, but also aggressively worked to ram a $23.5 trillion (of which $18.2 trillion must be covered by the general revenue) expansion of Medicare down the throats of the few small government conservatives left in the House.

This behavior has led me and other conservatives to conclude that starving the beast simply doesn't work anymore. Deficits are no longer a barrier to greater government spending. And with the baby-boom generation aging, spending is set to explode in coming years even if no new government programs are enacted.

Bartlett also notes that the lack of inflationary pressures tames a VAT somewhat and that countries which have recently enacted VATs have rarely increased rates, a big worry of anti-VATers over the years.

Personally, I've always been in the anti-VAT camp, but like Bartlett find myself coming around to the idea. For one thing, I think the compliance cost of our wacky tax code is way too high. For another I think the VAT might offer an escape hatch for our current Social Security mess.

Bush erred by running with Social Security reform instead of tax reform for his second term. He should've tried to do both. Lose the payroll tax and the fictional, but distortionary, corporate income tax, replaced by some mandatory savings mechanism into personal accounts and a VAT. Make clear that Social Security will continue to be funded for older workers with VAT proceeds, but that the program is definitely sunsetting.

Far, far from perfect but far, far better than the huge marginal income tax rates we'll face in a few years if the status quo persists.

Comments

[Jamie]

I'd given even odds that any VAT enacted would end up being in addition to, not instead of, an income tax. And try convincing Joe Average that corporate income tax is really the same as a personal income tax. Joe doesn't care, it's not his income. Does anyone thnk it's actually possible to push sweeping reform of Medicare and/or the Tax Code through our congress? Too many oxen would get gored. The GOP is too busy telling Micheal Shiavo how to take care of his wife to actually do their own job.

[MP]

This recent Cato paper on Options for Tax Reform provides a decent overview of the various plans. I've never been a VAT fan, and one thing that this paper pointed out was the potentially high tax rate (maybe greater than 30%) required for a VAT to be revenue neutral.

I don't see Congress ever enacting a VAT and repealing the 16th amendment, and I see a Flat Tax (which includes a tax on Capital Gains) as being much more efficient and effective.

[SPD]

Hasn't Steve Forbes been proposing a flat tax for years? I would like to see if the idea of a national sales tax on all non-essential goods would be viable.

[Mark Denovich]

I've never understood the concept of taxing someone when they buy something... Don't we want to encourage spending? Taxing someone upfront everytime they buy something is a massive disincentive to spend. At least with an income tax that tax pain is water under the bridge by the time you get to the cash register.

[MP]

Most tax policy people would rather encourage saving than spending, particularly in this country where the savings rate is abysmal.

[SPD]

But wouldn't eliminating income tax give people more money to save and spend? At least with the sales tax, you are still getting something tangible in return.

(Please forgive my economic naivete; this is what I get for being an English Lit. major in college.)

[Mark Draughn]

If the VAT is a tax on spending, then the income tax is a tax on production. Neither of these taxes helps the economy, but that's not what taxes are for.

My fears are similar to Jamie's. I don't think anyone will want to risk the shock to our economy of switching from income tax to VAT in one step. So we'll probably phase in the VAT as we phase out the income tax. Which means there will be a time when we have a little bit of both taxes.

I don't think that time will ever end. Once we have everyone paying both taxes, and goverment spending both taxes, and thousands of government workers processing both taxes, I just don't see Congress moving to eliminate the income tax.

[phocion]

Without a constitutional amendment, a flat tax would quickly unflatten. Without repealing the 16th amendment, any sales tax/VAT runs the danger of being eventually supplemented by income taxation, Euro-style. Even just regular tax code "simplification," which has been tried a few times, comes undone in short order.

So, for any kind of radical tax reform, you'd need two-thirds of the US legislature and three-fourths of the states to agree. With most Democrats and lobbyists vociferously opposing, at the least. Good luck with that.

Bush erred by running with Social Security reform instead of tax reform for his second term. He should've tried to do both.

He is trying to do both, just not simultaneously. The plan was to do SS this year and tax reform next year, I believe. Of course, his SS reform blowing up in Hillarycare fashion wasn't part of the plan.

[phocion]

But wouldn't eliminating income tax give people more money to save and spend?

Saving would be tax-free and spending would be taxed. That would hypothetically provide a disincentive to spending. Although the real sales tax partisans would tell you with a straight face that prices won't go up much with their plan. I don't think I believe that, but I also don't think that spending would grind to a halt.

[Mark Draughn]

SPD,

Figuring out where the tax burden lands is not easy. When you tax some economic activity, people try to recover their losses or avoid the tax, and there are often unintended consequences.

For example, say we decide to pass a tax on rental income so that greedy landlords will help cover the cost of caring for the homeless. Well, if one landlord's costs go up, he usually has to eat it. He can't just raise his rents to recover the loss because his tenants are only willing to pay so much. If he increases the rent, they'll go to other landlords who haven't raised the rent.

But if every landlord's costs increase, as would be the case with a landlord tax, then the tenants have nowhere else to go, so the landlords can pass on all of the taxes to the tenants in the form of increased rent. We may be collecting the taxes from landlords, but the burden of the tax falls on the tenants. That's probably not what we had in mind.

There are also distortions of economic activity. For example, some landlords at the fringes may decide to stop renting their property because it's no longer worth it, so we'll get a contraction of the rental market, squeezing some tenants out. Other tenants will do the math and decide that they might as well pay just a little more money and buy a house. Housing prices may increase or decrease, depending on whether former tenants coming in boost the market enough to compensate for landlords getting out.

Weird stuff starts to happen. Landlords who pay for utilities will remodel so that the tenants pay. The market will force them to reduce rents, but the reduced rent will mean reduced rental income tax. They weren't getting the utility money anyway, but now they're not paying taxes on it. Declining rents will force other landlords to do the same thing. Lawyers will get paid to come up with tricky schemes to collect rent from tenants without it meeting the legal definition of rent. Apartment rents will drop, but fees for parking spaces and laundry will increase. Tenants will get hit with special surcharges that aren't covered by the law. Millions of dollars that could have been used for other purposes will flow to electricians and plumbers and lawyers for no other reason than to avoid the tax. All of this is very wasteful.

Even broad taxes like the income tax and the VAT have effects like these. However, many economists believe that the VAT's effects are less destructive.

[dead_elvis]

George Will had a good article a couple of days ago espousing ditching the income tax in favor of a national sales tax.

I'm 100% in favor because

1)as is often discussed, compliance with the current law is nearly impossible, and makes everything I do the governments business and
2) with every purchase, people will be faced with the huge cost of government. Right now, the average joe doesn't notice because it's automatically deducted from each check, and then once a year he fills out a form. When you see your every purchase go up 25%, you'll sure as heck notice, and perhaps demand a little more accountability.

[William]

I'm suspicious of the VAT because it can act as a stealth tax. With income tax, at the end of the year you know how badly you've been fleeced, but with a VAT, it just gets added into daily spending. Whats worse, small raises in the tax can go relatively unnoticed. The county I live in has one of the highest sales taxes in the country (which applies even to essential spending) and most people just take it for granted. A .25% increase is so small that no one really notices it when they buy their lunch, but by the end of the year that .25% adds up, especially when its on top of last years .25% and the year before that and the year before that.

I worry about the VAT because it looks to me alot like the gouging gasoline taxes we pay. Were complaining about the price of oil pushing our per gallon cost up to $2.48 when somewhere around 50 cents of that is tax we don't even notice. I mean, honestly, can anyone here say they actually trust congress not to push the VAT rate up every single year?

[NCDan]

The big problem with a VAT is that Republicans will immediately begin using it to disadvantage classes of businesses whose owners are thought to mostly vote for or contribute to Democrats. Democrats, meanwhile will immediately begin using it to disadvantage classes of businesses whose owners are thought to mostly vote for or contribute to Republicans.
As always with tax schemes, the devil is in the details. The details of a VAT can be devilish indeed.

[Dan H.]

Also, don't forget that all changes by fiat, even ones that we consider to be overall beneficial, carry transition costs and unintended consequences.

For example, what would elimination of the income tax do to real-estate prices? Currently, mortgage interest is tax deductible. That pushes people into home purchases that otherwise might not choose to do so. Eliminate the mortgage interest deduction, and you'll lower demand for real estate and perhaps cause price crashes in some areas.

The same can be said for any other tax-sheltered activity. Vehicle leases for small business, for example. It may be overall an economic benefit to get rid of activities that are done for tax sheltering reasons and not because they are the most economically efficient things to do, but there will still be transition costs.

[Jamie]

Great post Mark, In reply to phocion I would point out that a consumption tax discourages individual spending by making saving tax free. However, that money ends up being out into saving accounts and lent out to businesses or put into stock and provided to the capital markets directly. What do those companies do with it? Buy new equiptment, buildings, and capital goods. If these are taxed under a consumption tax, this gets passed along to the saver in the form of decreased appreciation in the stock, or lower interest rate returns.

Even if corporations were allowed to buy Capital goods without paying VAT and there were no indirect tax on savings, as long as all corporations had the same advantages, the reduced tax burden would probably be passed on to the consumer in the form of cheaper consumer goods and services. This would tend to offset some of the disincentive to spend. At the end of the day, money has to be consumed - you can't take it with you. Even if you try to hoard it, unless you put it in your mattress, someone else gets the use of it for a fair rate of return.

[SPD]

Mark,

Thank you very much for the detailed and insightful explanation, which helped me to understand that there is much more to this issue than meets the eye.

[David T]

It's' not going to happen--period.

Can't you just see the Democrats' campaign ads: "THE GOP's NEW SALES TAX--WHAT YOU WILL PAY." (And I think most people will be very skeptical of the idea that the income tax will be permanently abolished. )

[Shawn Smith]

Let's assume that unprepared food (out of a market but not a restaurant) and prescription medicine is not taxed. I use those because that's the way NV's sales tax is structured. What else would be exempt?

Would primary residence homes also fall under this tax? If you're in a cheap market for housing, it should "only" be a few extra thousand dollars. If you're in a not so cheap area, it could be a couple tens of thousands of dollars, probably paid up front. Maybe you could finance it, but that's not very pleasant, either. In other words, don't move. Ugggh.

How about buying stocks, bonds, or other securities? If you buy some stocks one month, sell them the next, and then buy them back the next month, I suppose you'll be taxed twice. It seems to me that would discourage free-wheeling buying and selling in the stock, bond, and commodities markets. Bleahh.

[M. Simon]

The real advantage of a VAT is that you can't start a legal business without permission.

[Mo]

The reason why the VAT will have major politcal problems being implemented is it's unfairness on people who have saved significantly or those populations, such as the elderly that live almost entirely on accumulated wealth. The guy that saved and invested (and paid taxes on this money) until his retirement finds that he's paying taxes on the money a second time. Not to mention studies that have shown that tax cheats on sales tax go up drastically as the rate goes up. The black market is going to be ginormous. I'm more sympathetic to a hybrid system or better yet, flat income tax.

[Mo]

If you're in a not so cheap area, it could be a couple tens of thousands of dollars, probably paid up front. Maybe you could finance it, but that's not very pleasant, either. In other words, don't move. Ugggh.
Or if you live in California, a hundred thou plus. Housing prices will take a huge hit up front.

[M. Simon]

All Federal Taxes on US Citizens engaged in US commerce only must be apportioned among the states.

The 16th Amdmt. didn't change that.

You can look up the Supreme Court cases on the matter. Brushaber I believe is the name of one.

It is a question of jurisdiction. The 16th Amdmt did not change Federal jurisdiction. It merely said that where the Feds have jurisdiction an income tax is legal.

The sudden interest in VAT is due to the fact that Americans are getting educated on tax law.

Here migh be a good place to start.

[M. Simon]

Did i mention that excise taxes need not be apportioned?

Of course the only taxable items in that case would be imports.

Federal jurisdiction due to foreign commerce.

[thoreau]

I don't know much about the VAT, but I just want to thank Mo for making sure that my story was heard yesterday.

Thanks, Mo.

[William]

I know that this is only tangentially relevant to the thread, but why on earth is everyone so afraid of black markets? Sure with things like drugs where the only outlet is a black market crime goes up, but when its just people dodging taxes? Whats really wrong with citizens find a way to outsmart government pick-pockets?

[MP]

Because legally, they are all criminals, which means that the power of the state can be used to persecute them. Criminalization of voluntary interactions undermines the foundation of a free society.

[Ayatollah Usoe]

Just to reiterate what Mo said. A VAT could be good, an income tax could be good, but the transition from income to VAT will be bad for anyone who has accumulated wealth.

I would expect we would need vouchers for the rich to make this fair. Prove your wealth, and get food stamp-type vouchers exempting you from a second tax on that wealth. But why expect fairness?

[Mo]

William,
Tax evasion would also lead to higher taxes for those who actually paid them. How? Sales tax is set to n% in order to cover current tax flow (lets assume it?s adjusted for reduced consumption). Due to high sales taxes, x% of all sales are conducted on the black market, unexpectedly reducing tax receipts to levels lower than projected. After raising taxes to the new level, law abiding citizens get screwed by paying taxes for those operating on the black market. I prefer the flat tax with a high standard deductible. Keeps transactions above the board, it?s super simple to enforce and pay (reducing administrative costs) and it?s the most fair.

Usoe,
You forgot: The VAT will be DOA because the AARP will strangle it in the crib.

[Isaac Bartram]

Tax evasion would also lead to higher taxes for those who actually paid them.

Conversely higher taxes lead to greater levels of evasion. Tax dodging is Italy's national pastime.

And while we're on AARP, I wish someone would pull their feeding tube (mixing threads here).

[Anon]

Sure with things like drugs where the only outlet is a black market crime goes up, but when its just people dodging taxes?

All black markets create violence. There are a number of reasons for this, but the big one is that black markets have no legal means for resolving disputes. If you pay someone $100 for two dozen cartons of untaxed cigarettes, what exactly are you going to do if he just takes your money and tells you to go fuck yourself?

[William]

At the risk of sounding like both a cowboy and an asshole, its not really my concern if some people aren't bright/brave enough to dodge over-reaching taxes. As for settling disputes on the black market, It has been my experiance that black market buisnessmen tend to be slightly more honest than above the board buisnessmen. In a market where everything is based on reputation and word of mouth, the guy who takes your money and doesn't provide the good/service you paid for doesn't stay in buisness too long. Either the market sorts itself out and people stop trusting the fraud, or the fraud cheats the wrong person and is removed from the market. I know we like to talk about being civilized, but the threat of violence as a consequence for violating the rights of others is a powerful incentive for people to not violate others rights. It works so well that our governemnt was built around a similar concept: if a redress of greviances goes ignored, the next step is the militia.