The Case Against VAT

I think it would be desirable for the United States to adopt a value-added tax. In a nutshell, I think it’s impossible to cut spending enough to forestall a fiscal crisis, that taxes will eventually be raised a lot, that it would be economically debilitating to raise income tax rates as high as would be necessary to get the necessary revenue, and that a broad-based consumption tax such as a VAT would be much less damaging to the economy than very large budget deficits.

Today I want to look at some of the arguments against my view. Some are serious, but many are not; they’re just straw men created solely to obfuscate the issue. I will try to deal with them in order of seriousness, from least to most.
 
We must repeal the 16th Amendment first in order to avoid having both a VAT and an income tax. Columnist George Will made this the centerpiece of his case against the VAT in a recent column. It’s a silly argument because, contrary to popular belief, Congress was not prohibited from taxing incomes prior to the 16th Amendment. As historian David Levenstam explains in the libertarian magazine Reason, the Supreme Court struck down an income tax enacted in 1894 on narrow grounds and did not find the taxation of incomes to be unconstitutional.
 
While it is reasonable to say that it might be a bad idea to tax both consumption and incomes, repealing the 16th Amendment would provide no guarantee against this happening. We would not only have to get rid of that amendment, but enact another one that clearly, unambiguously prohibits–immune from court challenge–the federal government from taxing incomes. This is impossible, if only because the definition of income is so elastic.
 
The VAT is a hidden tax. This is also a silly argument. The VAT is no more hidden than any other tax. Ask yourself, do you really know what the sales tax rate is in your state or the property tax rate in your community or even what your effective federal income tax rate was last year? (Guess and then check; more than likely you overestimated all of them quite a lot.). According to polls, most people have no idea. The chances are far better that those who pay the VAT in other countries can tell you precisely what the rate is because it covers such a wide array of goods and services and is the same throughout the country.
 
Even if the VAT were an especially hidden tax, is there any reason to believe that hidden taxes are more easily increased than more visible taxes? Indeed, there is none. Economist Casey Mulligan, a VAT opponent, recently looked for evidence and could find none. He concluded that „tax visibility is empirically unrelated to the amount of taxation and government spending.”
 
The VAT is too complicated and will be riddled with exemptions. This is a weak argument because all taxes are complicated. They’re complicated because people don’t like paying them, which then requires governments to continually plug new loopholes and evasion tactics that people are always discovering, and because Congress is continually meddling with the tax code to buy votes and redress legitimate grievances.
 
While a VAT would indeed be tricky to implement, once in place it is not especially complicated, certainly no more than the retail sales taxes that exist in almost every state. One reason I support a VAT is because so many other countries have one that we could learn from their experience and avoid making our VAT unnecessarily complicated.
 
The VAT is inflationary. While it is true that imposition of a VAT will more than likely raise the price level by about the amount of the tax, this is not what economists normally think of as inflation. That would be a continuing rise in the price level year after year resulting primarily from excessive money creation by the central bank. Any rise in prices resulting from imposition of a VAT would be a one-time event that would have no effect on the general trend of inflation.
 
The VAT is a money machine. This is probably the biggest problem most conservatives have with the VAT. In their minds, its primary virtue–the ability to raise large amounts of revenue at low deadweight cost (the output lost to taxation over and above the tax itself)–is also its primary vice. If taxes are insufficiently burdensome, conservatives reckon, then they will be too easy to raise. To keep taxes low, they believe we should raise them in the most painful and burdensome manner possible.
 
In response, I would make three points. First, we will only enact a VAT if we really, really need a lot of new revenue; i.e., a money machine. If by some miracle Congress enacts massive spending cuts that significantly reduce benefits for the largest, most politically powerful and fastest-growing voting bloc in the country–the elderly–thus preventing the need for higher taxes to avoid a financial crisis, then there is no need to consider a VAT. But that’s not going to happen except in a libertarian fantasy world.
 
Second, it’s not true that VATs always rise once implemented. Of the 29 members of the Organization for Economic Cooperation and Development with a VAT–the U.S. is the only country without one–four have never increased their VAT rates and seven others have reduced theirs over time. The average VAT rate in the OECD is actually lower today than it was in 1984: 17.61% today vs. 17.79% then.
 
Third, it is critical to differentiate between those countries enacting VATs before the great inflation of the 1970s and those not initiating one until after. The first group did raise their VAT rates a lot by piggybacking on inflation. But in the era of relative price stability since the 1980s, there is little evidence that the VAT is a money machine. In the 17 countries enacting VATs since 1977 the average rate increase is less than a percentage point.
 
The VAT is regressive, taking more out of the pockets of the poor. This is probably the strongest argument against the VAT. Since the poor consume a higher percentage of their income than the well-to-do, they are necessarily going to pay more VAT as a percentage of their income than the well-to-do. There just isn’t any getting around that fact, and it is something that would have to be addressed if we were to adopt a VAT.
 
That said, one important benefit of a VAT insofar as those with low incomes is concerned is that they would be contributing something to the general cost of government. Everyone benefits from things like national defense, and everyone ought to pay something for it. But as it is, 47% of those filing federal income tax returns have either a zero or negative tax liability; that is, they pay nothing but still get a tax „refund.”
 
When this fact is brought up, liberals always point to all the payroll taxes low-income workers pay. But they never note that the negative income tax liability many of them have comes from something called the Earned Income Tax Credit, which was established precisely for the purpose of indirectly offsetting the payroll tax for such people. Furthermore, the payroll tax does not support the government’s general operations; it funds specific benefit programs, Social Security and Medicare, from which the vast majority of beneficiaries get back far more than they ever pay in.
 
The odd thing is that conservatives are the ones most likely to complain that the poor aren’t pulling their weight, yet they fail to see that a VAT is probably the only way of getting them to help finance the general cost of government. It’s extremely unrealistic to think we are ever going to impose income taxes on very many of those now paying nothing.
 
Of course, there are any number of other reasons why people oppose a federal VAT. One key constituency is state governments, which view consumption as a tax base that belongs exclusively to them. But they could easily piggyback on a federal VAT, which would also be able to tax things like Internet and mail order sales that the states have great difficulty collecting sales taxes on.
 
Lastly, it goes without saying that we would never impose a VAT until well after the economy has returned to reasonable health. And it also goes without saying that a VAT would have a heavy economic cost even if that cost would be far less than that from an equivalent income tax rate increase. But, as noted earlier, a VAT is never going to be seriously considered unless the need is overwhelming. That will be when large deficits are imposing costs on the American people that are even worse in the form of inflation, high interest rates and economic instability.
 
If, as former Vice President Dick Cheney used to say, deficits don’t matter, then we have nothing to worry about. But anyone who believes that deficits have economic costs has to accept that at some point those costs may be greater than the cost of raising taxes to reduce them if, as I believe, spending will never be cut enough to keep deficits from rising to economically disastrous levels.

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