Daniel J. Mitchell at the Cato blog has a new post up, continuing an argument against the imposition of a VAT tax in the United States. His argument in that piece is fundamentally that a VAT tax does not really solve the fiscal problem, but instead merely invites government to grow with the revenue stream, and to leverage the increased revenue stream to increase deficits. He cites new studies suggesting that VAT taxes lead to increased government spending, adds Milton Friedman’s remark that government will grow to match the size of the revenues available to it.
I am often struck, however, by how friendly economists, even those worried about deficits, are to a VAT tax. Greg Mankiw, for example, noted in 2009 that many economists love the VAT on “purely” economic grounds:
From a strictly economic standpoint, a VAT is great. It is essentially a flat consumption tax, like the so-called FairTax, but implemented in a way to reduce compliance problems. Because it is collected in stages along the chain of production, rather than all at the retail level, tax evasion is more difficult.
If you look at the economic effects, a VAT is similar to the Hall-Rabushka Flat Tax, which many economists love. Essentially, the main difference between a VAT and the flat tax as developed by Hall and Rabushka is that firms get to deduct wages as a cost under a flat tax, but then those wages are taxed at the household level. Other than this minor change of shifting the responsibility for the tax on wage income from the firm to the household, the Hall-Rabushka flat tax and VAT have identical economic effects. (There is also an exclusion for the first X thousands of dollars of wage income under Hall-Rabushka, making it progressive in average tax rates, but the same result can be accomplished with a VAT as well by rebating some of the revenue via a demogrant.)
My bottom line: If I could replace our current tax system (including the personal income tax, corporate income tax, payroll tax, and estate tax) with a VAT, I would gladly do it.
The gigantic caveat (as Mankiw emphasizes later) is replacing the rest of the tax system with a VAT. Proposals in the real world are about the VAT as a supplemental source of revenue, not a replacement.
The fundamental problem with the VAT is political – or more precisely, a public choice problem rather than a fiscal economics one. The hidden nature of the VAT makes it a politically feasible way to creep up tax revenues, because of the fact of rational political ignorance on the part of voters, and public choice incentives on the part of politicians to increase government and the concomitant revenues to fund it. This is a slightly different point than Mitchell makes in his piece; Mitchell focuses on more revenue streams available eventually equals government to match, as Friedman argued. But the specific argument against the VAT is the politically hidden nature of the tax, because it is imposed at each stage of value-added, but then is no longer visible to the end user as a tax, but merely as part of the “cost.” If you’re a voter, that should be a bug, not a feature. If you’re a member of the political class, so to speak, it is much more likely to be regarded the other way around.
Since that public choice fact of exploiting rational ignorance is the feature that makes the VAT particularly special among tax mechanisms, however, I am always a little leery of purely technocratic evaluations of the VAT that emphasize that, in a politically purer world than ours, it is the equivalent of a form of flat tax. That equivalence is a great political selling point – but it is not what drives the politicians looking to introduce it in the United States.
Connie says:
Valued added tax tax?
September 2, 2010, 11:10 amalkali says:
You can pay it at the ATM machine.
September 2, 2010, 11:16 amNoonan says:
“The fundamental problem with the VAT is political — or more precisely, a public choice problem rather than a fiscal economics one.”
Isn’t that the problem with just about everything these days?
September 2, 2010, 11:17 amMGA says:
The VAT is a desirable tax if, and only if, it is accompanied by repeal of the 16th amendment.
September 2, 2010, 11:22 amMDT says:
Dagnabbit, here I am with my peeve, and not only has Connie anticipated it, but alkali is right in there with my second-level snark.
I need to get up earlier.
September 2, 2010, 11:25 amJake says:
Don’t forget your PIN number.
September 2, 2010, 11:31 amAbdul Abulbul Amir says:
You no doubt have an LCD display on your cell phone. After a while some acronyms become words in their own right.
September 2, 2010, 11:32 amMarkH says:
I wrote my thesis on replacing all personal taxes with VAT, and the rate would come out at 30-35%, measures to counter regression included.
Have a look at my blog for more VAT discussions.
Mark
September 2, 2010, 11:38 amathEIst says:
A huge VAT was imposed in Canada by Mulroney and the Conservative Party. The Conservatives were annihilated(literally) at the polls in the subsequent election by the Liberal Party which promised to repeal the VAT but did not. Today Canada is in better shape than any other advanced nation.
September 2, 2010, 11:40 amPLR says:
I could support a VAT arrangement only if gift and estate taxation survives, so that consumers and non-consumers are both covered.
I refuse to be a peasant for dynastic wealth. Others may like playing that part.
September 2, 2010, 11:44 amBama 1L says:
I find conservative economists’ responses to VAT quite interesting. It should be the perfect tax, because it taxes consumption, is trivially easy to impose, and is shared across society. It eliminates, at a stroke, so many conservative objections to the current tax system: discouragement of production, compliance burden, and the poor not paying their share. My recollection is that VAT, like flat income tax, has tended to be an idea of the political right in this country. On the other hand, VAT has tended to be unpopular on the left for the same reason that high sales taxes are.
But then the Cato crowd manages to turn these virtues into flaws: because VAT is such an efficient tax and doesn’t create any obvious injustices or disincentives, it must not be adopted. That is just pure size-of-government ideology driving tax policy, isn’t it?
I guess this explains the cognitive dissonance on the right this spring when it was revealed that (1) something like half of American households pay no income tax, thanks in large part to some tax credits; and (2) the Obama administration had not ruled out imposing VAT. Now you would think people upset about (1) would welcome (2), because all those freeloaders would pay their share under VAT–they’d have to. And there’d be no need to “go Galt” if you were one of the productive members of society. Furthermore, you don’t have to worry about redistribution through tax, because VAT works against that. (Indeed, actual VAT proposals have had to include credits to keep the tax from being intolerably regressive.)
But that was not the response at all: instead, we heard it was all part of Obama’s socialist, redistributionist plot. Pretty sneaky of him to work two entirely opposed tax structures into his plot!
September 2, 2010, 11:44 amcirby says:
Ummmm…. No.
By having VAT collected at many different levels, by many times the number of people, on many times the number of transactions, you make tax evasion easier. Read up on some of the enforcement problems they’re running into in places like England – there are some easy schemes to avoid VAT, that usually only get busted when the criminals overdo it.
You also multiply enforcement/auditing costs by a fair amount.
September 2, 2010, 11:46 amJeffDG says:
Yes, PM Mulroney was annihilated (went from a majority in the House of Commons to 2 members)…but the GST at 7% is not what I would describe as a “huge” tax, especially when you look at what it would take to replace all taxes in the US (30% specified above)
September 2, 2010, 11:49 amKevin R says:
While we’re on abbreviation pedantry: “LCD” isn’t an acronym. Only an acronym if you pronounce it as a word. (So PIN or VAT, yes; ATM or LCD, no. Unless you say “atom” or “likkid”, I guess.)
September 2, 2010, 11:53 amFrank G says:
As a law school graduate with student loans, I strongly support the replacement of a portion of the income tax with a VAT.
September 2, 2010, 11:56 amBen says:
Do you have a quote to support that claim?
September 2, 2010, 11:58 amNeo says:
With a $1.4 trillion deficit, it’s pretty obvious that the government has grown beyond the revenues available to it.
September 2, 2010, 12:03 pmThis makes a VAT, if it is ever needed/useful/etc., an obvious STEP II to solving the fiscal problems at hand. STEP I is bringing in spending.
Dr. K says:
A VAT is to economies as cyanide is to living organisms.
Efficient does not necessarily make it better.
September 2, 2010, 12:06 pmHouston Lawyer says:
VAT taxes can be just as distortive as the income tax. There would be constant fights on which items, typically unprepared food, that is exempt from the tax. Can you tax legal services?
September 2, 2010, 12:07 pmjviking says:
See Ras Syndrome, lol:
September 2, 2010, 12:12 pmhttp://en.wikipedia.org/wiki/Ras_syndrome
Mark says:
A VAT does not have to be hidden. The HST in Canada (Ontario) is calculated and listed on every receipt, and it’s the full amount (since it’s calculated on the final price). It replaced the Manufacturer’s Sales Tax, which was a higher rate and was hidden, since it was collected at the manufacturer (not the retailer) and only applied to certain goods.
September 2, 2010, 12:16 pmDon Miller says:
I don’t get this attitude. With a VAT or Sales Tax based system, it doesn’t matter how much wealth anyone has. Everytime they spend their money, they end up paying tax.
If the money sits in the bank without being spent, the wealthy have no advantage over you.
From a personal standpoint, someone else’s wealth doesn’t make me poorer. The Economy isn’t a pie. Just because someone else has a bigger piece doesn’t mean there is less for me.
September 2, 2010, 12:20 pmalkali says:
A couple of actual questions:
1) Has anyone estimated the deadweight loss associated with our current income tax system vs. that associated with a VAT system?
2) Are people in countries with VAT systems really unaware of the level of the VAT? (If anything, I would think that having a single rate to look to would make it easier to keep an eye on the level of tax that is being imposed. I would suspect that I am in the top 5% of the voting public as regards my sophistication regarding tax matters, and I can’t tell you precisely what the current marginal income rate structure is in the US. I have a rough idea, but no more than that.)
Actually, I am told that one of the things that makes the VAT easier to collect is that there is constant pressure on each link in the supply chain to ensure that your suppliers have paid the VAT applicable to them so that you don’t end up paying it. The income tax is not subject to that kind of enforcement.
Yes, in Europe you pay VAT on legal services.
There is no tax system that is free from contention over what is taxable or from enforcement concerns. Any politician who promises to “Abolish the IRS” is an idiot.
September 2, 2010, 12:21 pmMark says:
Some months ago, when my daughter, who was otherwise safely ensconced as a mid level associate in municipal finance practice at a Vault 100 firm, decided to head off for a year and take a tax LLM, I counseled her to the effect that given Obama’s commitment to leverage the economy to public sector commitments and huge entitlement programs, it was a great time to become as much of an expert on the tax code as she might possibly become. My operative theory being that the necessity of funding various government commitments/programs would lead to even greater reticulation of the tax code as government desperately mines for revenue sources; ergo generating demand for lawyers schooled in navigating ways and paths around confiscatory government designs.
What advice I rendered in this connection, however, DID HAVE TO TAKE INTO ACCOUNT THE POSSIBILITY THAT THE GOVERNMENT MIGHT GO TO WHAT MIGHT BE REFERRED TO AS AN “AUXILLARY VAT” (viz. a VAT on top of the existing income tax structure). In this vein, it became necessary to assess what chance there was that the government would recourse a VAT mechanism as adjunct to the existing income tax. At the time, I regarded the prospect for imposition of an auxillary VAT as being remote for the reason that it would be politically unpalatable; even for a Democratic controlled Congress intent upon using the federal tax system as a place where private wealth might be collected and auctioned off in favor of recipient classes comprising the electoral base of the Democratic party. In fact, so confident was I in this respect that I analogized the likelihood of this occurrence as being akin to the prospect of me joining the PLO.
Well, … the more I read of this authentically scary stuff in the months ensuing, the more inclined I am to go out shopping for a kaffiyeh! Does anyone know how to say ‘OY VEY’ (!!!!!!!!!!)?
September 2, 2010, 12:36 pmBama 1L says:
Besides the Original Post and linked article? What are you looking for?
Why don’t you go over to Cato and find me anything on VAT in America that isn’t basically “good idea but watch out because government might grow invisibly and unaccountably”? Read Daniel J. Mitchell (obviously) and Chris Edwards. They have been writing and rewriting this type of piece since at least 2004, when VAT was Denny Hastert’s proposal. (Remember him? Republican if I recall correctly.)
Here’s a 2000 piece saying that Europe’s VAT was a bad model, not because of the merits or flaws of VAT itself, but because of the European Commission’s fundamental lack of accountability to voters.
Cato’s entire discourse about VAT has to do with political process, not tax stricto sensu.
September 2, 2010, 12:43 pmBama 1L says:
I know that Pittsburgh does and I think some other municipalities do, too.
September 2, 2010, 12:45 pmDuracomm says:
PLR said,
The pernicious myth that the death tax is an effective impediment to dynastic wealth appears once again.
The massive wealth of the Kennedy heirs and the Kennedy compound at Cape Cod are daily reminders of just how wrong that myth is.
Kennedy Compound Massachusetts
Interesting that prominent supporters of the death tax like warren buffett and bill gates have specifically structured their assets to avoid paying death tax.
Of course the presence of the death tax is economically advantageous to warren buffett’s business interests (life insurance sales among other things).
There is a good dose of self serving economic rent seeking in buffett’s advocacy for the death tax.
September 2, 2010, 12:52 pmRichard Riley says:
It seems odd that a European-style VAT, or Canadian-style GST, is seen as a left or liberal policy initiative, whereas the “Fair Tax” as promoted by Neil Bortz and Mike Huckabee is apparently seen as full-throatedly conservative.
But both proposals are consumption taxes measured as a percentage of consumption expenditures. I can’t see the difference in principle. Why is one considered liberal and the other conservative?
September 2, 2010, 12:57 pmGreg says:
I’m enormously sympathetic to the CATO institute. But their position seems to be we shouldn’t talk about the VAT because government will institute it in addition to our current tax scheme.
What’s the alternative? That we don’t try to come up with better, more efficient tax systems? I’m certain that government will usually screw up even the best policy suggestions – but the proper response is not stop coming up with ways to enhance our political system at all.
September 2, 2010, 12:59 pmDavid Newton says:
“From a strictly economic standpoint, a VAT is great. It is essentially a flat consumption tax, like the so-called FairTax, but implemented in a way to reduce compliance problems.”
Oh dear, oh dear this person clearly does not know very much about VAT. VAT is not a flat consumption tax if there are multiple rates of it and that occurs quite often. In the UK there are no less than four different rates of VAT. There is the main rate of VAT (17.5% until 4 January 2011 then 20%), the reduced rate of VAT (5%), the zero rate of VAT (0%) and those things either exempt from or outside the scope of VAT. Yes there is a difference between 0% VAT (exempt/outside the scope) and 0% VAT (zero-rated) at least so far as the organisation/person registered for and accounting for the VAT is concerned.
I would also point out that in the UK “essential” things are often zero-rated or lower rated for VAT purposes. There was a famous case where McVities were fighting HMCE over whether Jaffa Cakes were to be classed as cakes or biscuits for VAT purposes as one attracts standard rate VAT and the other attracts zero rate VAT. It all turned on whether Jaffa Cakes go stale like a biscuit or a cake. VAT is not a “flat tax” in many circumstances and to pretend otherwise is just plain silly.
September 2, 2010, 1:07 pmBama 1L says:
It is especially odd because, to my knowledge, liberal politicians haven’t been the ones proposing a VAT. All sorts of economists do, but that’s because, as we are endlessly assured, economics is a Science so economists agree on many things. But the politicians who have been serious about VAT have been conservatives.
September 2, 2010, 1:08 pmBlue Neponset says:
There is only one pile of money. If you take out x from the pile via an income tax or via a value added tax you still take out the same amount. I don’t see how a highly regressive tax that raises the same amount of money helps anyone but the rich. Screw them. I am not paying for any more of their tax cuts.
September 2, 2010, 1:12 pmGovernment will spend whatever the tax system will raise | Radio Vice Online says:
[...] tip to Kenneth Anderson at Volokh Conspiracy for providing all the links, and read his post (lots of referenced links in this post — click and read them all!) as he ponders why many [...]
September 2, 2010, 1:13 pmJoe says:
One of the major shortcomings in our tax policy is that close to 50% have nothing at stake to ensuring a rational and sane tax policy and spending policy. If you dont pay any tax, why should you have any rational reason for a rational spending policy. I agree with the concept of the progressive tax rates, primarily since the rich generally receive a greater indirect benefit, ie more assets to protect and better business enviroment.
A vat/sales tax would be a highly regressive tax with 1) a shift of the tax burden to the poor, greater percent of spending for consumption purposes, and 2) a shift of the tax burden from the older generation (wealthier elderly) who no longer have a need to consume, homes paid for, etc to the younger generation who are still accumulating the necessary assets to live on, clothing, homes, furniture, costs of raising children, etc.
September 2, 2010, 1:13 pmMarc Daniels says:
A small but important technical correction:
The way VAT works means that, economically, it is collected piece by piece at each stage of the payment chain. But actual cost is usually borne by the end-consumer – if he is buying a car for $10,000 and VAT is 10% then he will be charged $10,000 plus $1,000 to cover the VAT.
The European approach is the VAT amounts ends up “hidden” in prices, so the consumer sees the car priced EUR11,000 and only sees the separate VAT amount on his invoice. But there is no reason it has to be that way – you could legislate for the same result as sales tax, where it’s not on the stated price and hits you in the gut when you come to pay.
So the idea that VAT is inevitably a hidden tax is incorrect.
(Actually the above represents something of a simplification, as purchasers of VAT-exempt goods/services will not pay a VAT amount directly, but will likely pay a higher price due to the immediate supplier not being able to recover its own VAT expenses. But VAT exempt goods/services are the exception not the rule, and don’t rescue this particular argument)
September 2, 2010, 1:19 pmSoronel Haetir says:
If you are already pretty sure that doing nothing is preferable to what will come out of the political process (however well intentioned its participants) why shouldn’t you advocate for doing nothing from the outset? That is generally an easier position to win than nudging the political process into doing something better than the status quo once you know _something_ is going to happen. I would say that sort of error is what went wrong with the various financial system rescue measures. It would have been enormously painful at the time but I think we would be starting to look at some sort of actual recovery by now rather than just floundering around.
September 2, 2010, 1:21 pmjack osborne says:
Ah, but concurrent with the VAT should we not be exposed to a VDT wherein a consumer destroying by consumption an asset should have to pay a tax to cover the disposal of the asset?
And, then, would we not have a VCT which would benefit consumers of goods by giving them a tax credit for the consumption not requiring disposal of assets?
So, you could pay a tax buying, a tax consuming, and a tax destroying your goods needed for your life!
I claim the right to espouse these taxes for the benefit of the poor who will need the protection of the government from the results of these taxes.
We willl name it the recirculator tax scheme, where in we tax, spend, and tax the spending caused by the taxes paid.
Democracy in action!
September 2, 2010, 1:29 pmGU says:
Prof. Anderson,
My recommendation to you: stop listening to Daniel Mitchell about taxes; however well-meaning, he is a hack. I say this as a classical liberal who’s generally sympathetic to the Cato Institute.
If you really want to learn about tax policy, a good place to begin is a book by Joel Slemrod and John Bakija, Taxing Ourselves: A Citizen’s Guide to the Debate over Taxes (4th ed.). Reading what serious tax policy scholars believe will be eye-opening, I think.
It should be mentioned that few if any tax policy scholars, in law or economics, believe in Milton Friedman’s “Starve the Beast” theory. Or, I should say, there is no empirical evidence for the idea that cutting taxes decreases the size of government, and vice versa. If anything, the evidence points in the opposite direction. Even Cato veteran William Niskanen has publicly admitted that “Starve the Beast” simply doesn’t work in practice.
For a very brief article on why the Bush tax cuts served to increase the size of government (and reasons for why this could happen generally with tax cuts), see Daniel N. Shaviro, The New Age of Big Government, 27 Regulation 36 (Spring 2004).
September 2, 2010, 1:36 pmChris Travers says:
+1
September 2, 2010, 1:47 pmGU says:
In case I’m perceived as being non-responsive to Prof. Anderson’s tax salience concerns, solving the salience problem for a VAT is simple. On a consumer’s receipt, there can simply be a line that says “VAT @ x% . . . . . $x.” The person can see how much tax was paid, much like he can look at the sales tax line of his receipt. And let’s be serious, you don’t think every newspaper in the country will regularly print articles detailing the VAT rate and revenues collected (if for no other reason than to rile up folks)?
A VAT is economically equivalent to a sales tax, but it is actually enforceable at non-trivial levels (empirical evidence shows that once a retail sales tax goes above 10%, there is mass evasion). That’s all. Conspiracy theories about consumption taxes should not be in the libertarian arsenal.
September 2, 2010, 1:54 pmAlast says:
Evasion of a sales tax requires there to be a mechanism to evade it. That mechanism is the sales-tax-free sales to other resellers. “Of COURSE I am buying it for resale… here is my resale certificate.”
The Fair Tax closes this loophole, by requiring sellers to pay the sales tax on gross sales, including sales to another reseller. The subsequent reseller, can then deduct the sales tax paid upstream, to the sales taxes he remits from his own sales.
VAT still requires much more bureaucracy and lacks transparency. Unfortunately, those two attributes are positives from the perspective of politicians.
September 2, 2010, 2:12 pmHumboldter says:
No matter what any politician says, they will never eliminate the income tax. From a revenue source, it has evolved into a way of shaping social outcome, encouraging some behavior, discouraging others. And, most importantly of all, leading to political contributions and power.
September 2, 2010, 2:18 pmAlast says:
It is a massive fiction that repeal of the 16th amendment would eliminate the federal income tax. The federal government had a federal income taxes in several forms years before the 16th amendment.
The 16th amendment must be AMENDED to allow an income tax only in times of war declared by Congress or national emergency certified by a 2/3 vote of Congress and subject to veto by the president, that the any income tax expires 100 days after the end of the session of Congress that imposed it, and all moneys collected are places under the sole authority of the President for use as commander in chief and must be devoted exclusively for the use of military costs.
September 2, 2010, 2:19 pmPetB says:
VAT is collected during production, but this is just a collection – businesses does not pay VAT, it is (like sales tax) paid by consumer. Businesses have no incentive to avoid it.
It is possible to not pay the tax that was collected, but VAT makes it very easy to uncover any fraud.
September 2, 2010, 2:21 pmAlast says:
The Fair Tax also eliminates this claptrap… everything sold new has the same tax… services, food, clothes, cars. No exemptions. Used things (cars, houses, clothes, etc) have no tax.
September 2, 2010, 2:24 pmgeokstr says:
Yes, yes, of course. The obvious answer, then, to the runaway spending of this out-of-control monstrosity called government must be to increase taxes to 100% from dollar one, for everyone. Then, when everyone except the glitterati and the nomenklatura have starved to death, and even they’re eating the remaining stock of canned goods (and eventually, each other), government spending will finally go down in absolute dollars (maybe).
How about we figure out some way to positively incentivize the political class to reduce spending through a bonus structure of some kind, and if that fails, negatively motivate them with prison sentences or waterboarding or having to watch “An Inconvenient Truth” straight through or some other equally devious torture?
My own prediction, stated here before, is that there is no way the current political and fiscal scenarios, worldwide, can end well. All the incentives for all the power players lead to increases in the power and scope of centralized government. It will take a massive collapse the likes of which has never been seen before, and whatever arises out of the ashes will either have a relationship between the governed and the leaders that is fundamentally transformed towards individual freedom and responsibility or it can only be far worse than what we already have. Likely it will be something in the nature of 1984.
Witness every leftist commenting here. They have gained tremendous power by hook and (mostly) crook in the last century, and every one praises the massive expansion of government, advocates for repealing the laws of supply and demand so that they can strangle a couple more eggs out of the golden goose, and appears to believe that they can transform us all via indoctrination into the “New Man” necessary for the Workers’ Paradise, evolution and DNA be damned.
Hey, the left feels that this is the perfect crisis to not let go to waste. They should be careful what they wish for.
September 2, 2010, 2:41 pmPLR says:
It’s an opportunity cost. Unless you are a giant wealth holder yourself, it is in your rational ecomomic interest to have a portion of the wealth redistributed at the death of the holder.
September 2, 2010, 2:44 pmDavid Schwartz says:
Bad as a VAT tax may be, it’s orders of magnitude better than the comically misnamed “fair tax” that imposes the entire Federal tax compliance burden exclusively on retailers.
September 2, 2010, 2:46 pmPLR says:
September 2, 2010, 2:48 pmGU says:
@geokstr
I don’t know whether to respond, given that your comment had essentially nothing to do with the substance of my post. But here goes:
The government is on an unsustainable fiscal path. The government has to pay its bills eventually (default and the aftermath is possibility as well). The longer it waits to do something, the greater the efficiency costs. “Doing something” is raising taxes, cutting spending, or some combination of the two. I would love for spending to be cut, but since most of the future spending contributing to the fiscal gap will be for Social Security, Medicare, and Medicaid, unless there’s fundamental reform of these programs (unlikely), cutting even every single penny of “discretionary” spending, forever, would not close the fiscal gap. Taxes need to rise. That sucks, but the longer we wait, the higher the efficiency costs (leading to lower aggregate wealth than we’d have otherwise). It also represents a shifting burden from the present to the future. The less we pay in taxes now, the more the future generations will have to pay. There are not any good reasons for future generations to bear substantially higher tax burdens than present generations (some things argue for taxing them more, some argue the opposite, it’s essentially a wash).
On the topic of a fiscal crisis/governmental default, some libertarians seem to imagine this would be a good thing. Maybe we’d surround the Department of Education building and applaud as it’s boarded up or something, and then go on living in libertarian, freely-contracted bliss. Take a peek back into history and look at what happens to failed states—it ain’t pretty.
It sucks that our government sucks, and that they’ve run up a dangerously large fiscal gap. But a priori anarchist rantings about tax policy don’t help us solve the real problem: closing the fiscal gap. The sooner we act, the better off we will be, “we” being the present generations and those in the future.
Reading some non-extremist, non-conspiracy theorists on tax policy could really enlighten a lot of my libertarian brethren.
September 2, 2010, 3:06 pmGreg says:
I’m all in favor of getting rid of the income tax which – as best I can tell – creates an incentive for people not to work. But realistically, there is going to be some level of taxation. It turns out that the VAT can achieve the tax with far fewer transaction costs and much less chance for political favorites to tinker with the code. This will increase the size of the pie for everyone.
Again – I agree with Mankiw’s caveat. And, I suspect, so do many CATO scholars. But it strikes me that we want the Greg Mankiws of the world thinking about ways to improve the tax system. If our politicians are going to abuse Mankiw’s insight – well, that’s something we have to fight against.
September 2, 2010, 3:32 pmTexEd says:
The VAT might be worth considering if it actually replaced income taxes. Liberal politicians don’t only want revenue to squander, they want to punish entrepreneurs (but not actors, athletes, labor fat cats or plaintiffs’ attorneys) for their success.
September 2, 2010, 4:01 pmThus, following a VAT, Congress would tweak it, allowing income based surcharges to make sure that the wealthy pay their fair share and that the very wealthy pay more. The next change would be to allow “special,” maybe time-based differentials, a quarter percent, for example, to accommodate a special problem. We’d need an additional quarter percent added to the VAT in Michigan to rebuild Detroit.
Dan Weber says:
Starve the beast was an interesting theory, but it has completely failed. The cheaper government is, the more people want of it. It’s very easy to say you want lower taxes, but it’s very hard to say you want lower spending. (I want lower spending, but I realize I’m in the minority.)
You won’t replace the income tax. It might be the best from an economic perspective, but from a political perspective, it just will not happen.
Although you could, say, replace employment taxes with an across-the-board VAT. Say it’s “pro-worker” if you wish.
September 2, 2010, 5:05 pmGU says:
For interesting VAT combined with income tax proposals, see:
Michael Graetz, 100 Million Unnecessary Returns
September 2, 2010, 5:22 pmLeonard Burman, A Blueprint for Tax Reform and Health Reform, 28 Virginia Tax Review 287 (2009).
Patty Shundynide says:
That’s an argument against giving VAT exemptions to “essential” products, which would in any case be overinclusive (for the least well-off are a small proportion of all consumers of essentials on whom the VAT falls).
Better to do without the additional layer of complexity and rent-seeking.
September 2, 2010, 5:39 pmDon Miller says:
When my parents die, I expect to inherit hundreds of dollars. Actually, my opposition to the death tax revolves around around three beliefs.
1. We already taxed the income that produced the wealth
September 2, 2010, 5:43 pm2. I believe private individuals choosing to spend their own money or their families money is always preferrable to Government spending.
3. I think our Federal Government is bloated beyond all recognition. I support every reasonable proposal to limit either the size of Government or its ability to collect more revenue.
Patty Shundynide says:
Why must a VAT “get[] rid of” or be a complete “replace[ment]” for income taxes? Lowering the income and corporate tax rate by augmenting the tax regime with a VAT is a good enough reason.
September 2, 2010, 5:50 pmMark Field says:
Item 1 doesn’t really reach the issue. Money gets taxed twice (or more) for many different reasons. Just to pick an obvious example, you use after-tax dollars to pay sales tax.
Items 2 and 3 also don’t get you anywhere. The government must tax something. The only question involves the best way to collect the money. Taxing unearned income seems like a pretty good way to (a) assure a meritocracy; and (b) not interfere with the productive economy.
As for wanting to slow government spending, that’s laudable, within limits, but it’s only half the problem. The evidence of the Bush and Reagan administrations is that decreasing taxes won’t, by itself, slow spending. That means that their tax “cuts” were imaginary: the deficits still have to be paid back in the future. Again, you’re back to deciding the best way to raise that money.
September 2, 2010, 6:20 pmDavid Schwartz says:
Compliance and enforcement have cost and cause pain. All that would happen if the VAT were added in addition is that the government would have a new revenue stream to abuse. If the political will is there to control spending, it should be possible to use the VAT as a replacement tax. To add the VAT and hope to push taxes down later would be a recipe for disaster.
September 2, 2010, 6:35 pmjmaie says:
But both proposals are consumption taxes measured as a percentage of consumption expenditures. I can’t see the difference in principle. Why is one considered liberal and the other conservative?
This just my impression but,
The VAT is considered liberal because it would be a revenue stream collected additionally to income tax. That’s the way it works in the European countries I’m familiar with.
A flat tax is usually considered as a replacement for the income tax, therefore conservative.
September 2, 2010, 9:23 pmjmaie says:
Item 1 doesn’t really reach the issue. Money gets taxed twice (or more) for many different reasons. Just to pick an obvious example, you use after-tax dollars to pay sales tax.
True, but that doesn’t make a good argument for more double taxation.
September 2, 2010, 9:24 pmMark Field says:
I can’t see that it matters much; the overall tax burden is far more important. But even then whether there’s “double” taxation depends on what other taxes are imposed. The best strategy, IMO, is to start with the economically soundest ways to collect taxes and work up from there.
September 2, 2010, 11:10 pmTGGP says:
“The hidden nature of the VAT makes it a politically feasible way to creep up tax revenues, because of the fact of rational political ignorance on the part of voters, and public choice incentives on the part of politicians to increase government and the concomitant revenues to fund it”
September 2, 2010, 11:20 pmCasey Mulligan disagrees.
Chaser says:
The VAT tax would be reasonable, IMHO, only if all prices were quoted pre-VAT (which is a lot easier with the FAIR tax, I think).
In other words, let everyone see, on every economic transaction, how much they are paying for government.
Giving the price with tax included, even if the tax appears on the final receipt, does not achieve this desirable goal.
One of the most evil economic deeds in the US was the invention of income tax withholding. This causes most people to not really feel the impact of the taxes they pay – the taxes disappear before they get the check, and later, at tax time, the often get a bonus back – distorting the whole psychological impact.
Do away with income taxes, death taxes, etc. Institute a VAT or FAIR tax (some sort of consumption tax) with a Constitutional Amendment requiring that all prices be quoted pre-tax.
Then it would probably be a good thing.
It’s about time that everyone feels the cost of the government they are allowed to vote for.
Of course, we could try a different alternative: no vote unless you pay a net tax. But I think a transparent, visible at each transaction tax is both more likely achievable, and more in keeping with the spirit of America (although the founders believed in no economic stake, no vote themselves).
September 3, 2010, 12:58 amDavid M. Nieporent says:
How about something which supports the claim? (Said claim being that Cato argues that the VAT shouldn’t be adopted “because VAT is such an efficient tax and doesn’t create any obvious injustices or disincentives.”) Nothing in the post or linked article says anything of the kind.
Nothing in that article says that the VAT shouldn’t be adopted because it’s efficient. What it actually says is that the VAT is a bad idea if it’s an additional tax, but that it’s “worth considering” if it replaces other taxes.
Nothing in that piece says either that the VAT shouldn’t be adopted because it’s efficient or because of the EC’s lack of accountability to voters. Indeed, it doesn’t discuss adopting the VAT at all. It discusses the idea of the EU coercing American companies to assist them in collecting VAT.
Wait, Cato is analyzing a policy proposal as if it’s an actual policy proposal rather than as if it’s an example in a econ textbook? Imagine that.
September 3, 2010, 2:19 amDavid M. Nieporent says:
That’s sort of an odd way to describe it. At times in his career, Friedman may have endorsed or adopted the theory, but he coined neither the phrase nor the concept, so calling it “Milton Friedman’s ‘Starve the Beast’ theory’” seems misplaced.
September 3, 2010, 2:42 amMartinned says:
Whenever I’m in the US or Canada, that is one of the things that annoy me to no end. All the mental arithmetic you have to do to figure out how much you actually have to pay. (In my defense.) Here in Europe, VAT is required by law (that is: EU law, IIRC) to be stated on the receipt, but at least they don’t make you do the arithmetic yourself.
September 3, 2010, 7:05 amMartinned says:
God forbid US companies should collect VAT just like everybody else selling a good or service in the EU! (And yes, that includes legal services, gym memberships, you name it.) And, BTW, is it really necessary for CATO to make its point by talking about the Revolutionary War?
September 3, 2010, 7:10 amOrenWithAnE says:
You mean everyone buying stuff online (from a retailer with no physical presence in the State of their residence) really files their “use tax” with the State?
Easy enough to then ‘sell’ it to your partner for a penny and have him sell the used one for no tax then.
Yes, the marginal demand for government spending financed by debt is larger than the marginal demand for government spending financed by taxes. This was obvious the 1980s and remains obvious today.
What arithmetic? You see the items totaled on the screen, you swipe your card.
The European obsession with using little metal tokens to signify money really frustrates me when I go visit. I either have to hold up the line while I count out the proper combination of coins or pay with a bill and end up with even more silly tokens. This in an age where computers are capable of transferring money to and fro without jangling my damned pockets!
[Sorry, rant over. ]
September 3, 2010, 9:15 amFriday Highlights | Pseudo-Polymath says:
[...] VAT considered. The bigger problem with VAT is that the Congress critters considering VAT aren’t thinking of it as a replacement but an addition. [...]
September 3, 2010, 9:40 amJam says:
When the government spends more than it takes in, it does not matter what the mechanism is used to
confiscatetax — it will never be enough.If a VAT is being promoted as a means to raise more revenues for the government, to pay for the ever increasing spending, then, it means that more monies will be removed from the private sector and transferred to the government.
How is that a good thing, again?
My solution:
1) The FedGov makes a budget and divies it up to the member States in Union based on this formula:
It is up to the member States to raise the revenue and pay their share to the Fed Gov … in gold or silver, as required by the Constitution. And, if the FedGov limits itself to the Constitution, to follow the requirement that all debts, etc be payed in gold or silver, a balanced budget is the only possibility.
2) Taxes, if based on income ought, to be on a flat basis, excluding the first X dollars of income, to “protect” the poor.
September 3, 2010, 9:55 amSteve Abramson says:
The VAT would be a positive game changer, and could be President Obama’s “Hail Mary.”
As to the “hidden tax” argument, who among us cannot figure out what a percentage tax means? It is the same as figuring out what the tip was in a restaurant that says “20% gratuity included.” In contrast, who among us can guess what the buried tax amount is of the Corporate Income Tax in the price of a product? (It depends on the industry loopholes and the individual corporate tax loopholes.) The CIT is truly a hidden tax. A Revenue-Neutral replacement of the CIT with a VAT would be stimulative to U.S. business and (better) job creation.
See my comments at blog.vat-us.com and the reference website, VAT-US.com.
September 3, 2010, 10:00 amMartinned says:
I guess I’m strange that way. I’d like to know what something costs before I am asked to swipe my card. I don’t care about the price excluding tax, I only care about how much money I will have to pay – by whatever means – to obtain this product.
September 3, 2010, 10:09 amMartinned says:
Unless I’m mistaken, the logic of McCulloch v. Maryland implies that it is unconstitutional to tax the States. That’s a pity, since I agree that it would be a good idea. (It is also how the EU is financed: They get all the import levies, they get a share of VAT, and the rest is split proportionally over the Member States.)
September 3, 2010, 10:13 amOrenWithAnE says:
So you seriously think the 500,000 people in Wyoming and Vermont should pay 1.1% of the Federal budget despite constituting ~0.2% of the population? Meanwhile the 35M in California pay 8% of the taxes despite being 12% of the population?
Or, each VTer pays (in aggregate) 7-8 times more per capita than CAians?
September 3, 2010, 10:17 amOrenWithAnE says:
Wait, I lost an order of magnitude! The WY/VT resident pays on average 70 times more than a Californian (modulo the constant-per-citizen-part), not merely 7 times more!
September 3, 2010, 10:30 amMartinned says:
Maybe that’ll finally motivate them to reconsider the benefits of statehood. If they get two votes in the Senate, why not make them pay in similar disproportion? They can easily avoid this burden by merging with a neighbouring state.
[/exaggeration]
September 3, 2010, 10:48 amcanuckinkl says:
“huge” – it was 7%. I agree with you though, tax reform in Canada in 1991 which brought in the federal GST (VAT) was another wise move by the Tory party and paved the way (along with other factors) for the decade of surpluses which the successive Liberal government managed to achieve.
September 3, 2010, 11:15 amOrenWithAnE says:
And that money is shown to you on the screen where you swipe your card.
If you prefer, you can use the little PIN pad where you have to click “OK $21.53″.
September 3, 2010, 11:25 amJam says:
If it was not noticed I followed the structure of the FedGov’s bicameral representation.
And, I would not call the allocation of the FedGov’s budget to the States a tax. It is a State’s membership fee. If the burden on a State is too high, maybe a State could promote a business environment that would cause people to want to live in that State.
September 3, 2010, 11:25 amOrenWithAnE says:
Unpossible! The party standing to lose two votes in the Senate (and, let’s face it, most States have on party representing them in the Senate) will surely filibuster!
Stupid Article IV for requiring the consent of Congress.
September 3, 2010, 11:28 amOrenWithAnE says:
Seem intrinsically unfair to have the ‘membership fee’ vary wildly per capita based on accidents such as the size, terrain and climate of the various States.
California has a huge population notwithstanding their absurdly restrictive business environment and otherwise dysfunctional government.
September 3, 2010, 11:47 amMartinned says:
Am I allowed to know what something costs before I reach the cash register?
September 3, 2010, 11:53 amOrenWithAnE says:
To within 10%.
September 3, 2010, 1:12 pmChaser says:
If you can’t do the math, why should you be allowed to vote?
September 3, 2010, 1:34 pmhungerburg says:
Speaking from Europe: in my country VAT and income tax make up most of the revenue of the state. The government believes that progressive income tax counters the inherent social imparity in VA-taxing: poor people spend their full income for va-taxed goods, while rich people buy goods that are not va-taxed: treasuries, shares etc.
As a matter of fact: corporate tax evasion has made income tax a failure. VAT is the way to go. Compensation for the poor has to be a state sponsored base-income.
September 3, 2010, 3:44 pmDavid Newton says:
US companies are already obligated to be registered for VAT and to charge it to EU customers if their taxable turnover exceeds the VAT registration threshold. For example if I buy an audiobook download from Audible.com I get charged VAT at the UK rate.
I agree with the poster who decried US pricing practice. The price on the sticker should be the price I pay at the till. I should not get an extra bill slapped on top of that price for sales tax. That is nothing to with it being a sales tax rather than VAT (which from the point of view of the consumer is a sales tax) and it is everything to do with bone-headed US pricing laws. It would be a massive burden on retailers to price everything differently in each jurisdiction that do business in. However it would also make those retailers more amenable to lobby for sales tax rate simplifications.
VAT is a bureaucratic nightmare, but so are other sales taxes. The reality is that any sales tax system will have exemptions and complications galore if the politicians are allowed to get away with it. The same is true of income taxes, capital gains taxes and inheritance taxes.
September 3, 2010, 3:55 pmjmaie says:
As to the “hidden tax” argument, who among us cannot figure out what a percentage tax means?
As I understand it, VAT is collected at each step where a sale takes place.
Hypothetical -
ATI sells chips to Foxconn and collects VAT. Foxconn builds a video card, sells it to Systemax and collects VAT. Systemax adds the card to one of their machines and I pay the final VAT. All three transactions carry different VAT rates.
What percentage of tax is paid?
Yes, I know two of these entities are foreign. Pretend we still make computer components in-county or choose an alternate US made product with multiple supply streams.
September 3, 2010, 4:35 pmManicBeancounter says:
There are a couple of big issues with VAT here in the UK, that the US should be aware of. (NB the rate is 17.5%, soon to rise to 20%)
September 3, 2010, 4:49 pm1. Small businesses do not pay VAT. The current threshold for registraton is around $90,000. Therefore sole traders have a big advantage over larger businesses for decorating, plumbing etc. Due to this cost advantage (on top of avoiding around 35% marginal tax rates for self-employed up to $60,000 per year), the black economy is large. VAT exposes people to the fly-by-night rogues.
2. The UK has a large amount of trade with other EU nations. The Intrastat scheme for dealing intra-state VAT is open to fraud. Criminal gangs have made $m’s through carousel fraud. See http://en.wikipedia.org/wiki/Missing_trader_fraud
3. VAT is charged on other taxes. In the UK the current price of gasoline is GBP 1.13 per litre or $6.60 per US Gallon. With VAT at 17.5%, $1 is VAT, and around 60c is VAT on around $3.20 of excise taxes.
ManicBeancounter says:
jmaie, although I do not like VAT, the accounting treatment is quite simple. For any business, they charge VAT on sales and pay VAT on purchases.
It is the detail that creates a mindfield of complexity. The effective rate is superfluous.
The following is for the tax accountants and the insomniacs:-
If VAT is 10%, for a $1000 net sale the entries are CR Sales $1000, CR VAT payable $100, DR Accounts receivable $1100.
For a $500 purchase, then DR purchases $500, DR VAT reclaim $50, CR Accounts payable $550.
The business then pays $100 – $50 = $50 in VAT.
In theory the system is simple. With basic accounting software filling in a VAT form takes 15 minutes a month. The effective rate that is paid is therefore irrelevant.
The complexity comes with the exceptions. In the UK we have zero rate; VAT exempt; (One businesses can reclaim VAT on the purchases the other they cannot); non-reclaimable (e.g. business entertainment); and special rates (especially 5% for domestic gas and electricity).
September 3, 2010, 5:23 pmIndeed, a supposedly simple tax has help manuals about as long as for income tax. So I would expect the accountancy firms in the USA are privately backing VAT introduction.
David M. Nieporent says:
That’s not what the complaint about it being a “hidden tax” means. What it means is that there’s no real way for a person to know how much total tax he’s paying, unless he happens to religiously track all his purchases.
September 3, 2010, 5:30 pmGU says:
This is a fair point. In tax policy literature Milton Friedman is usually the person associated with STB. This is probably because he is the most distinguished person to argue that cutting taxes would decrease the size of the government—when Milton spoke, people listened. STB, whether he called it that or not, was, IIRC, one of Friedman’s main tax policy talking points. He also pumped for the so-called negative income tax (which he does not get enough credit for). So perhaps I worded my post in a slightly misleading way, but Friedman did in fact subscribe to the substantive policy of STB.
NB: I am a huge Milton Friedman fan and have been heavily influenced by his work. I would view STB more favorably if it actually decreased the size of the government, but it does not. The question “How big should the government be?” is separate from “How can we tax people in the most efficient, fair manner?”
September 3, 2010, 8:00 pmjmaie says:
Thanks ManicBeancounter. Having had no direct experience with this system, I wouldn’t bet large sums that I am correct in my assumptions. What I mean is, a computer purchaser won’t really know how much of the total price is VAT, certainly not as simple as calculating a tip.
You mention software, is that something only businesses use or do individuals need this as well? The effective rate would certainly matter – I would hate to eliminate an income tax at 25% and replace it with a VAT that took 35%, regardless of how little time or effort the forms took :<)
September 4, 2010, 12:15 amManicBeancounter says:
jmaie – the total amount in VAT should be shown on any receipt when purchasing.
Purchases for businesses can be reclaimed. But the consumer is the end of the line. The tax just adds to the purchase cost.
All business accounting software in Europe can account for VAT, from those for sole trader, to the biggest multinational.
The rate proposed is certainly important, but a separate issue. I doubt that it would replace income tax. It would be an additional source of revenue, to help close the massive structural deficit you have in the US.
September 4, 2010, 8:04 amMartinned says:
Nice… It’s good to see someone actually reads my comments. FYI, I am perfectly able to do the math, I just find it tiresome to have to.
September 4, 2010, 9:36 amMarkH says:
VAT is included in the purchase price, not added to it. In fact, it is illegal to advertise products and services to individuals without including VAT in the advertised price. Also, retail stores that sell predominantly to individuals are not required to mention VAT on the receipt as a separate line item. In that sense, VAT is a hidden tax. But you bet that individuals in the high-rate VAT jurisdictions are well aware of VAT.
Also see here: http://www.us-vat.com/blog/?p=81
September 4, 2010, 10:52 amMartinned says:
I’m not sure what jurisdiction you’re talking about, and I don’t really feel like digging through the (EU) law in this area, but at least I can say that I’ve never seen a receipt that didn’t specify VAT.
September 6, 2010, 8:53 amPetB says:
Each receipt must specify VAT – otherwise the payer would not be able to deduct the paid VAT.
There are exceptions for simple receipts for small amounts – like parking tickets – but they are rare – at least where I live. In fact, I do not know about any other exception then parking tickets and tram tickets.
September 6, 2010, 4:20 pm