Taxes

Murray Rothbard On the Ingeniously Destructive Power of VAT

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Don't let the bowtie fool you: This man was a sex machine.

Like locust infestations and cicada spawning, the value added tax proposal is something that comes around every few years but is always treated as some surprising new thing. Take the wayback machine to 1972—a remote time when America had a hobbled economy, a lousy president and a war that just kept going on and on—to hear how the late Murray Rothbard viewed the economic solution that President Obama has either never heard of or is seriously considering

The VAT is essentially a national sales tax, levied in proportion to the goods and services produced and sold. But its delightful concealment comes from the fact that the VAT is levied at each step of the way in the production process: on farmer, manufacturer, jobber and wholesaler, and only slightly on the retailer.

The difference is that when a consumer pays a 7 percent sales tax on every purchase, his indignation rises and he points the finger of resentment at the politicians in charge of government; but if the 7 percent tax is hidden and paid by every firm rather than just at retail, the inevitably higher prices will be charged, not to the government where it belongs, but to grasping businessmen and avaricious trade unions.

While consumers, businessmen, and unions all blame each other for inflation like Kilkenny cats, Papa government is able to preserve its lofty moral purity, and to join in denouncing all of these groups for "causing inflation."

It is now easy to see the enthusiasm of the federal government and its economic advisers for the new scheme for a VAT. It allows the government to extract many more funds from the public — to bring about higher prices, lower production, and lower incomes — and yet totally escape the blame, which can easily be loaded on business, unions, or the consumer as the particular administration sees fit.

[…]

But the VAT is in many ways far worse than a sales tax, apart from its hidden and clandestine nature. In the first place, the VAT advocates claim that since each firm and stage of production will pay in proportion to its "value added" to production, there will be no misallocation effects along the way.

But this ignores the fact that every business firm will be burdened by the cost of innumerable record keeping and collection for the government. The result will be an inexorable push of the business system toward "vertical mergers" and the reduction of competition.

Suppose, for example, that a crude-oil producer adds the value of $1,000, and that an oil refiner adds another $1,000, and suppose for simplicity that the VAT is 10 percent. Theoretically, it should make no difference if the firms are separate or "integrated"; in the former case, each firm would pay $100 to the government; in the latter, the integrated firm would pay $200. But since this comforting theory ignores the substantial costs of record keeping and the collection, in practice if the crude-oil firm and the oil refiner were integrated into one firm, making only one payment, their costs would be lower…

Hence, vertical mergers will be induced by the VAT, after which the Antitrust Division of the Department of Justice would begin to clamor that the free market is producing "monopoly" and that the merger must be broken by government fiat.

The costs of record keeping and payment pose another grave problem for the market economy. Obviously, small firms are less able to bear these costs than big ones, and so the VAT will be a powerful burden on small business, and hamper it gravely in the competitive struggle. It is no wonder that some big businesses look with favor on the VAT!

[…]

A further crucial flaw exists in the VAT, a flaw which will bring much grief to our economic system. Most people assume that such a tax will simply be passed on in higher prices to the consumer. But the process is not that simple. While, in the long run, prices to consumers will undoubtedly rise, there will be two other important effects: a large short-run reduction in business profits, and a long-run fall in wage incomes.

The critical blow to profits, while perhaps only "short-run," will take place at a time of business recession, when many firms and industries are suffering from low profits and even from business losses. The low-profit firms and industries will be severely hit by the imposition of VAT, and the result will be to cripple any possible recovery and plunge us deeper into recession. Furthermore, new and creative firms, which usually begin small and with low profits, will be similarly crippled before they have scarcely begun.

The VAT will also have a severe, and so far unacknowledged, effect in aggravating unemployment, which is already at a high recession rate. The grievous impact on unemployment will be twofold. In the first place, any firm that buys, say, machinery, can deduct the embodied VAT from its own tax liability; but if it hires workers, it can make no such deduction. The result will be to spur over-mechanization and the firing of laborers.

Secondly, part of the long-run effect of VAT will be to lower the demand for labor and wage incomes; but since unions and the minimum-wage laws are able to keep wage rates up indefinitely, the impact will be a rise in unemployment. Thus, from two separate and compounding directions, VAT will aggravate an already serious unemployment problem.

Hence, the American public will pay a high price indeed for the clandestine nature of the VAT. We will be mulcted of a large and increasing amount of funds, extracted in a hidden but no less burdensome manner, just at a time when the government seemed to have reached the limit of the tax burden that the people will allow. It will be funds that will aggravate the burdens on the already long-suffering average middle-class American. And to top it off, the VAT will cripple profits; injure competition, small business, and new creative firms; raise prices; and greatly aggravate unemployment. It will pit consumers against business, and intensify conflicts within society.

This is a big excerpt, but the full article is essential reading.

In the current issue of Newsweek, Robert J. Samuelson shows how little has changed. Dig the comments for more exciting VAT history.

NEXT: Reason Writers Around Town: Matt Welch in Politico on John McCain's "Maverick" Persona

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  1. Casey Mulligan disagrees:
    http://economix.blogs.nytimes……sible-tax/

    1. Of course he doesn’t.

    2. It’s a poor economist who graphs variables against GDP when doing so has no bearing on the question at hand. It would be far more valid to compare the visibility of a tax against the change in the level of taxation over time.

      Further, since this is an issue of perception, payroll/social security taxes are a poor proxy as they are distinct from other taxes (e.g., income tax, VAT) in that they may be viewed as relating to a future direct benefit to the individual.

      And note he doesn’t address any of the other negative unintended consequences of a VAT.

  2. While consumers, businessmen, and unions all blame each other for inflation like Kilkenny cats, Papa government is able to preserve its lofty moral purity, and to join in denouncing all of these groups for “causing inflation.”

    This reminds of the “little less piggy” public service advertisement that the Feds had back in 1970.

    http://news.google.com/newspap…..39,3327446

    The TV version split the screen between a businessman, a union hardhat, and a housewife. It’s message was the that greedy profit-seeking of the businessman, the incessant wage demands of the union man, and the imprudent shopping habits of the housewife were the root causes of inflation. The characters morphed into pigs with the message that inflation could be eliminated if we would just be less piggy.

    1. I don’t get the ad in question from that link. I got sports stories from October 1969.

    2. That is unbelievably insulting.

    3. That isn’t an ad from the government. It was the Council for Economic Education…so, basically, an academically oriented nonprofit that takes funding from corporations and was working with the media industries.

  3. So to summarize: The VAT is a hidden tax purely because people are really stupid.

    Well, can’t argue with him there.

    Also, record-keeping costs will be astronomical.

    If a business is not already tracking its own costs and profits, a VAT would probably be the least of its problems.

    1. Most VATs use a credit-invoice system. You have to keep invoices to show the amount of VAT you paid to a supplier to take a credit for that amount against the VAT you collect from your customers. The difference is what you remit to the government and prevents the “cascading” effect (in other words, taxing an already collected tax). And most VATs have zero-rated or exempt items (meaning VAT isn’t collected from the customer but you may or may not get credit for a VAT paid to the supplier).

      So there’s a lot more to this than just tracking costs and profits.

      1. Well at least it will simplify that shit.

        *rolls eyes*

  4. What about financial firms. Do you pay VAT on interest, dividends, or capital gain?

    How about services? You aren’t buying goods to which you’re adding value.

  5. http://www.cato-at-liberty.org…..overnment/

    Cato on the subject, responding to Tyler Cowen.

  6. mulcted

    Nice word.

    A VAT is the California $5, foot-long Subway sandwich problem on national scale.

    Eating the sandwich in the store is considered added value. Heating the sandwich is considered added value. So asking for a small pleasantry from
    a Subway store employee increases the price of a sandwich by 9.75% (LA sales tax). With a VAT that would be 9.75% on top of the VAT rate. It should be called a VADT: Value Added Deterrence Tax.

    You always have to pay sales tax on a beverage from Subway. I asked the manager of my local store why that was. She said that chilling a beverage was considered value-added and that Subway stores were not permitted to sell beverages that were not either chilled or heated.

    1. Subway sandwiches will soon be invaluable. Because they won’t be allowed to sell them any other way.

    2. Is this serious? Or are you predicting a time when California gets a VAT tax? Because that is nuts, I thought there wasn’t even tax on food.

      1. I’m assuming a cold to-go sandwich is non-taxable, while heating or eating in the store makes it a taxable restaurant meal. Prepared sandwiches are just taxed everywhere I ever go. Some municipalities put extra restaurant taxes over the food sales tax

      2. Every state I’ve ever lived in has had a tax on prepared food. The only foods that don’t have sales tax are plain bread, plain (ie, not chocolate) milk, pure fruit juice, unaltered eggs, veggies, etc. Anything prepared or with sugar added is going to have a tax on it.

        Mind you, all the states I’ve lived in (with the exception of PA) were deep blue vampire-states.

        1. Ditto here. Either McDonalds has been ripping me off all these years, or prepared food is taxed everywhere I go.

  7. Wow Tim, that’s a lot of VAT-esque babble-ease stuff you’ve got there. Let me sum it for you:

    VATs suck.

    1. Which ignores the fact that VATs suck even more than you think they do.

  8. VAT also generates quite a lot of fraud opportunities. Just google ‘VAT carousel’.

  9. I’m sorry to say that Rothbard doesn’t understand how the VAT system works. Everywhere in Europe, *firms recuperate from the government the VAT they paid when buying production goods*. The system is designed such that only the ultimate consumer doesn’t recuperate the VAT. I.e. it is supposed to be a “tax on consumption”. This means that the distortion Rothbard is mentioning (the tendency toward vertical integration) doesn’t exist. (This distortion does exist in case of sales taxes without recuperation – but that’s not VAT.) The distortion produced by VAT is that many employees have their personal things (such as the car) nominally in the property of the firm (such that e.g. they don’t pay VAT on gas).

    1. Are you really that dumb, or is it just the character you’re playing? You don’t “recuperate” the cost of record keeping from the government, just the cost of the tax. If you are talking about the 2 or 3 percent vendor’s fee you’re allowed to keep, those are rapidly going the way of the dodo. I’m the accountant for a small manufacturing company. Currently, paying state and local sales and use tax consumes about 3 hours per month. Adding a vat would easily quadruple that. As I’m the only person in the accounting department and I already work 50 hour weeks, some other more profitable tasks would have to be eliminated or we would have to add staff in the middle of a recession. Additionally, the state recently eliminated the vendor’s fee due to the “budget crisis”. I don’t expect to see it back any time soon.

    2. What’s the goal of taxing something and then recompensating the business? Government waste as usual.

      1. It’s more than just waste. The goal is to hide the tax from the consumer. The tax is built into the price of the item.

      2. Anyone who does any business activity is subject to reporting. In Canada we are required to report subcontractors who charge us GST.

        The rate we pay for GST doesn’t produce vast amounts of revenue for government, but it allows more efficient collection of other taxes.

        Derek

    3. So like, in the future, employees will be “vertically integrated” by becoming the property of the company.

      I mean, if the company owns you, then it doesn’t have to pay taxes on your education until it sells you. Easy.

    4. firms recuperate from the government the VAT they paid when buying production goods

      Quite true, and wholly irrelevant to the point Rothbard was making with respect to the distorting effects of the unaccounted-for cost of record-keeping.

      This means that the distortion Rothbard is mentioning (the tendency toward vertical integration) doesn’t exist.

      Your premise is flawed (see above), thus your conclusion is flawed.

      1. My point would be that if we cannot agree on how the system works here, then a politician will never have a damn clue.

    5. I’m sorry to say that Rothbard doesn’t understand how the VAT system works.

      I’m not sorry when I say that you are an idiot.

      A VAT is as useful to the economy as Sarbanes-Oxley. A whole lot of extra steps to ensure absolutely nothing.

      Only a bureaucrat would think the problem with the economy is that companies don’t have enough bureaucrats.

  10. The VAT carousel bit is interesting. The complaint seems to be not that one of the parties paid a VAT it shouldn’t have, but that, having defrauded that party, they should have remitted the bogus VAT payment to the government. In other words, it is the government being harmed by fraudulent VAT collections, not the parties paying the fraudulent charge.

  11. The VAT will cripple profits; injure competition, small business, and new creative firms; raise prices; and greatly aggravate unemployment. It will pit consumers against business, and intensify conflicts within society.

    You’ll love it when you understand it!

  12. Of course there’s also the risk that whatever regime is in power will write the rules so that those businesses who contribute to their opponents are more hobbled by the VAT than those businesses who support the regime. Of course, the writing of biased rules is already a problem in many (most??) areas of government, but the hidden nature of the VAT will exacerbate this problem. Of course, to the regime in power, this isn’t a bug, it’s a feature.

    1. Regime? Regime?!! You go to war with regimes. Regimes are tyrannies. They’re juntas. They’re military coups. The use of the word ‘regime’ in American political parlance is unacceptable, and someone should tell you to stop using it.

      1. “Regime” is a perfectly acceptable description of an administration that uses extra-Constitutional means to get what it wants. Call it poetic license.

        1. Thank you Ed. I did not intend the word regime to be an emotionally loaded word. My mistake.
          Allow me to edit my last sentence to bring it in line with the first sentence in my 4-25 post. My opinion would have been better expressed if the last sentence had read, “Of course, to whatever regime is in power, this isn’t a bug, it’s a feature.”

  13. Urge to shrug rising…

  14. Wow, that dude is actually making a lot of sense.

    Lou
    http://www.anonymous-vpn.tk

    1. OK, cut out the stealth commercials already!!!

  15. I am *so* looking forward to seeing how many pages the legislation takes to define “value added”. Seriously, just say no.

    Also, FWIW, a Pakistani perspective.

    1. I’m so happy that you are looking forward to it, but first we have to pass the bill so you can find out what is in it.

  16. So why is it so difficult to get a job in Europe? Hmm…::scratches head::

  17. The best (most constitutionally sound, most optimally incentive-structured, simplest) tax system would be a flat tax on corporate income.

    Unlike the income tax, it would be a real example of an exchange for services rendered, since all corporations exist because they are chartered by the state (that’s a service) whereas not all individuals use government services at the same level.

    From an incentive standpoint, it would serve to keep taxes down over the long run, since lobbyists would focus their energy on not hurting their industries further.

    And, it would be simple. What is your gross income as a business? The government gets x percentage of it. Done.

  18. I’m all for a VAT – I’d prefer that to our current tax system that favors the wealthy. And it seems to me much of the complaints about the consequent increase in prices – (the furor over a more expensive $5 footlong?) reinforces the ad from the ’70s that suggests we’re all maybe just a bit spoiled.

    1. I’m all for a VAT – I’d prefer that to our current tax system that favors the wealthy.

      Hahahahah! +100

      That was a joke, right?

    2. It favors the wealthy by making them pay most of the taxes? Huh?

      1. Also, the VAT would somehow not favor the wealthy, how? It’s like an uber-sales-tax, and all sales taxes are regressive.

        1. The “rich people suck” economic policy strikes again!

  19. I HOPE the Democrats keep pushing the VAT.

    What genius decided an election year during a recession would be an excellent time to propose a massive tax increase? It’s like a plan to lose as many seats as possible.

    More please.

    1. It’s like a plan to lose as many seats as possible.

      Assuming the Dems are not the stupid party, but the evil party, why *are* they pursuing this apparently self-destructive course? Are they *that* confident that once The American People? get addicted to the largese they Dems passed rammed through they’ll be voted back in big-time? Any way I parse this “plan” it seems short-sighted. Maybe the powers-that-be really do not care about le d?luge.

    2. The plan is to push it right after Nov 2012 elections. The deficit commission report (old man Simpson and idiot Bowles running the show) will come out with report saying we need to cut spending and raise revenue. naturally, the spending cuts will be deferred until some magical future date.

      If we get a VAT, America will be Europe. Game over. Fed govt will consulme >50% of GDP – only a matter of time.

  20. There are those who say that the VAT represents a massive tax increase in the middle of a recession. But let me be clear: as I promised during my campaign, no one who has an income of less than $150,000 will see their taxes increase by one red cent. If you are one of those folks, just keep your receipts showing how much VAT you paid and we will reimburse you at tax time.

    Now, there are those who will say that you’re paying secret hidden taxes anyway, but just remember, those are the folks who were in charge in Washington during the past eight years, who got us into this mess in the first place. Maybe we should listen to someone else this time around.

  21. I’am from argentina, and the VAT is a business killing machine. The main problems
    1) Record Keeping. You need to keep track of all invoices (AP and AR). The problem is more complicated if you have exempts from VAT or diferent rates. Also on each sale that you do you must check VAT status to see what rate you need to charge. Add to this complication returns, adjusments and you will get the sense.
    2) Services. The vat works as direct tax revenue for services industries, where the main product is based on human labor that is not vat taxable. In those cases the vat is like a direct tax on revenue, because you have very little purchasing VAT to discharge.
    3) Exports, with vat you have the problem that if your main business is for export you only have two options a) Increse you prices to recover the vat that you have paid b) Ask the goverment to return to you all the vat. In both options you loose, specially if you need to go to goverment.
    4) Also you will be affected by when you need to pay the vat, when you emit the invoice or when you actually recieve the money. Here we pay the vat when we emit the invoice. So if you are selling in installments, you need to put the vat money from your own pocket and recover the money from each installment from the customer. The same will happen for example if you buy a machine, you will pay vat upfront, but you will recover that vat from each sale of the product made during a very long period of time.
    5) With VAT you always pay taxes, independently if you make profits or not.
    6) IF you think that it will simplify the current tax code, just wait a couple of years.
    Just a few thoughts from some one that suffers the VAT every day. My advice, stay out of the VAT like hell.

    1. Glad to hear your perspective, dude.

    2. +10

      I’ve dealt with VAT when trying to export machinery to China. Even in that simplified scenario, it was a total PITA.

  22. From Eastern Europe, I second Leo’s advice.

  23. Let me summarize the media script on this:

    Krugman: “Obama proposes tax increases which will not impact the middle-class – only those evil corporations.”

    Tea Partiers: “We’re not stupid, we know a tax increase is going to come out of our wallets on way or another.”

    Olberman: “Man those Tea Partiers are stupid liars! They keep saying Obamas going to raise taxes on them! Everyone knows that the VAT only raises taxes on evil corporations! Which has no impact on anyone else!”

    David Brooks: “I wish the Tea Partiers would stop lying about the VAT. That said, it might not be a good idea because everyone realizes that it will come out of their pockets on way or another. On the other hand, Obama’s pants are sexy.”

  24. No it wasn’t a joke, but thanks for all the condescension – I now have a better feel for the audience around here. I beg forgiveness for my naivete – I’m clearly not as well informed on tax options as many, if not most of you (thank god). FWIW, I think a system that forces all who buy and/or sell stuff to pay a tax on it is far more equitable than our current system, which sucks up a significant portion of the assets of those who can’t otherwise shelter their assets offshore. Yes, some of us would have to pay more for our sandwiches – but try to keep in mind that a $5 footlong is a luxury.

    All that said – If any of you has anything other than pointless condescension to offer in response, I’m always open to learning something new.

  25. “And that no man might buy or sell, save he that had the mark, or the name of the beast, or the number of his name.”

    Is this the guy in charge of the VAT?

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