Is there a case for a VAT?

by on February 17, 2010 at 7:50 am in Economics, Political Science | Permalink

I outlined it yesterday, to a small group at GMU.  My tale went as follows:

1. The United States is on an unsustainable fiscal path.

2. For whatever reason, long-term interest rates don't reflect this problem.  There will either be a sudden collapse of demand for government securities, or the current market already is figuring we will get a VAT.  Either way it is more revenue for the government or a Greece-like scenario writ large.

3. I would prefer spending cuts, but voters seem too irrational to be willing to cut spending; here the libertarian argument comes back to bite us on the bum.  They might be willing to cut spending once a financial crisis arrives (though maybe not), but then there will be days or only hours for decisive action.

4. We could, for now, wait and postpone fiscal reform.  That means encountering a sudden collapse some number of years from now.  We will then clean up the budget in some way, but under a TARP sort of mood rather than what we might do today.

5. We'll get a better deal, and make wiser decisions, if we do it today rather than in a panic.  Plus another financial crisis would prove deadly to both the budget and to the quality of economic thinking.

6. There exists a credible bipartisan deal which involves at least half the VAT revenue for deficit reduction, combined with cuts, or slower increases, in marginal tax rates on income and perhaps an elimination of the corporate income tax.  Spend some of the rest on health care for the poor, if that is the deal on the Democratic side.

I am by no means convinced this argument is correct but I would like to hear the strongest arguments against it.  No one I talked to succeeded in defeating it, other than mentioning they don't like the idea of more revenue for the government.  You will notice I structured the argument to be as neutral on the "left vs. right" question as possible.

You'll notice the use of a pivot here: the common "right-wing" views that a fiscal crisis would be awful, voters are irrational, and governments make bad decisions in panic times, are used to favor a VAT.

I wonder: how many people agree with this argument, but they are unwilling to say so because they don't want to weaken their bargaining position if and when a "deal" is put on the table.

Addendum: You'll notice that on Sunday Greg Mankiw mentioned that a VAT might be the best of available alternatives.

Adam Ozimek February 17, 2010 at 8:12 am

Is there nothing to be said for raising taxes during a recession? And what makes a VAT more desirable, or importantly, more likely to get enough votes to pass, than a carbon tax? With a carbon tax you’d maybe get enough democratic support that you don’t need to spend some of it on health care. A carbon tax has the advantage that if you declare today that it will start going into effect 3 years down the road, you immediately start changing behavior with regard to polluting behaviors, and you shore up the long-term deficit, but without having any impact on overall consumption today. As a tax on all consumption, a VAT would lead to higher savings and lower consumption, right?

Ted Craig February 17, 2010 at 8:24 am

2. As long as propping up our debt is a cost of entry into our market and our market remains the most desirable in the world, the issue is distorted.

Bill February 17, 2010 at 8:30 am

@Adam, actually, the threat of a VAT tax in the near future would cause people to increase their consumption of goods (cars, and other durable assets) to avoid the VAT tax in the future.

Doc Merlin February 17, 2010 at 8:35 am

My arguments against is that even if we use a VAT to increase government income, all that money will go into increased spending.

The same happens with personal finances, a person who is bad with their money thinks increased income will help them out, but when they increase their income they just spend it all. If the united states is as fiscally irresponsible as you say, increasing tax revenues will most definitely not solve the problem.

eccdogg February 17, 2010 at 8:41 am

Personally I am willing to risk a crisis instead of increasing taxes. A crisis might be painful but I think we will emerge from it with a smaller government. I don’t see anyway that raising taxes leads to reduced government size and I don’t find any promisses credible. There are plenty of areas that we could cut easily the biggest being our oversized military, I would like to see us do that first.

David February 17, 2010 at 8:43 am

We have borrowed trillions to ineffectively stimulate consumer demand. So now, naturally, we propose a tax on consumption.

Alex February 17, 2010 at 8:50 am

As others have mentioned previously, I don’t see how more tax revenues could possibly make the government smaller. In fact, couldn’t a larger cash flow cause legislators to believe they can afford more debt?

Doc Merlin February 17, 2010 at 8:52 am

Lastly, evidence suggests that when governments misuse money more money for them to misuse doesn’t prevent the debt from destroying them. They can raise taxes all they want, but the real problem is they are willing to spend more than they make… not that they don’t have enough revenues.

If the state continues to spend the same percent more of every dollar, than it earns (as I believe they will), your solution of increasing revenues will only turn a bad fiscal problem into a far worse one. The absolute debt level will be much higher.

Doc Merlin February 17, 2010 at 8:54 am

@BKarn
Oh please… the democrats are easily worse than the republicans in this regard.

Jon February 17, 2010 at 8:59 am

Two objections

First, as others have noted, there’s no guarantee that the government simply won’t spend this revenue stream.

Second, a VAT is a highly regressive tax.

BKarn February 17, 2010 at 9:02 am

“Oh please… the democrats are easily worse than the republicans in this regard.”

My point was that if Democrats (as we see even here) cannot accept that they, too, may – just may – be a large problem here, I don’t see how anything gets ‘fixed,’ regardless of the quality of that fix on paper.

Colin February 17, 2010 at 9:06 am

If your house is on fire and you complain about not having enough livable space the answer is not building on another room. The answer is putting out the fire.

More taxes do not fix fiscal irresponsibility. I don’t see how VAT follows from (1).

floccina February 17, 2010 at 9:10 am

Perhaps I am not studied enough but I do not see how the USA Government can get in such a crisis. It can make dollars out of nothing, dollars that must be taken for all debts public and private. Inflation is a worry but inflation although net bad, solves some problems by pushing people up into higher income tax rates and buy reducing the price of exports.

On the other hand a crisis might allow the corruption in the system to reduced. For example IMO most military spending today in waste (the USSR is no more and radical Islam is very weak and more of police problem) and only stays so high to keep installations and projects congressional districts. I think that in the current world, defense could be safely cut by two thirds. In another example, most SS money goes to the rich and middle class by just keeping the social insurance aspect of the program and giving everyone the same payout you would reduce that cost greatly. As far as medicare goes I think that as more and more people get on it, the more you can squeeze the providers accomplishing that same thing that easing states licensing requirements would do in a more perfect world and approaching something closer to monopsony. IMO monopsony is how Japan keeps medical spending so low.

Minderbinder February 17, 2010 at 9:15 am

So what are we thinking? An extra 10% on top of the 10.5% I already pay in Chicago?

floccina February 17, 2010 at 9:17 am

Also I would not eliminate the corporate tax because it encourages people to form partnerships which unlike corporations are fully liable for their actions.

Andrew February 17, 2010 at 9:19 am

So, what we are saying is, let’s raise taxes now so we don’t have to raise taxes later?

Peter February 17, 2010 at 9:29 am

An additional virtue of a VAT is that it extends the burden of taxation across a greater portion of the population, who then (maybe) will become more sensitive to tax policies in the future because they will have a stake in the process. Right now, only a small percentage of citizens actually pay federal income tax but many more people benefit from government services. When some of the taxpayers complain about taxes, they come across as selfish cranks who put narrow self-interest above public good. When public-minded legislators fund government services, they can afford to be generous because they are spending the money of only a few of their constituents. Since a VAT would balance the ratio of taxpayers to consumers of government service, it seems plausible that such a balance could be reflected in the positions of representative legislators.

Bill February 17, 2010 at 9:35 am

@quints,
You couldn’t do an import VAT without violating WTO.

libert February 17, 2010 at 9:55 am

dlr said, “Spending cuts are the answer, not higher taxes. And don’t be so sure that the voters are completely powerless to rein in Washington DC. One of the major themes of the Tea Party movement is smaller government, and less spending.”

This is only true if you plan to eliminate Medicare, Medicaid, and Social Security, while still collecting taxes for them. Paul Ryan’s plan does just that, in addition to a non-defense discretionary spending freeze, and still doesn’t balance the budget for 70 years, according to the CBO report.

Anonymous Backstabber February 17, 2010 at 10:05 am

Don’t VATs have notoriously high compliance costs? Instead of collection and reporting costs at the point of sale, those costs hit multiple times throughout the manufacturing process. Seems like they would strongly favor large, vertically integrated businesses. Sounds great!

In my opinion, taxes should be low, unobtrusive, easy to identify, difficult to raise, and easy to evade (so as to avoid instilling a spirit and habit of compliance and servitude)… VATs are none of these. But then, I don’t work for the man.

David Shor February 17, 2010 at 10:15 am

Tyler’s point is this:

1) The public simply does not want spending cuts to entitlement spending or defense, which together make up over 90% of the budget. Polling has been unequivocal on this, opposition to cuts in either has been stable and massive over the last 60 years. Furthermore, there is *No* international precedent of a developed country engaging in massive defense and entitlement cuts to the level needed to balance the budget. There are strong theoretical reasons grounded in public choice theory that suggest neither will ever happen. This point is pretty much unassailable.

2) Given that we are not going to have the necessary spending cuts, we can either raise taxes, or we can have a financial crisis.

3) It is impossible to raise the needed money to close the deficit with income taxes. Laffer curve issues, while not relevant at current taxation levels, come into play. Carbon Taxes and/or Cap and Trade credit auctioning could raise enough revenue (I’ve seen estimates of 400 billion per year), but since even vastly more liberal countries with more majoritarian institutions neither fully auction permits nor raise high carbon taxes, this seems unlikely as well. A VAT or similar consumption tax is the most efficient politically plausible way to raise tax dollars.

4) While many people here like to entertain the idea that imminent bankruptcy of the State and the ensuing Great Depression that would follow would lead to smaller government, that is quite a gamble. Historically, countries faced with collapse have turned to Fascism, Communism, or at best massive expansions in the role of the state. No country came out of the Great Depression a libertarian paradise. More generally, no country has emerged from a crisis heading in a more libertarian direction, with the possible exception of Pinochet’s Chile and post-91 Somalia. Those are not enviable examples…

Realistically, given the realities of public choice and game theory, we are faced with two options: A country with a European style safety net, or a cataclysmic economic collapse that could lead to something much worse. Given the two, the choice seems clear…

John Thacker February 17, 2010 at 10:26 am

“I would prefer spending cuts, but voters seem too irrational to be willing to cut spending; here the libertarian argument comes back to bite us on the bum.”

The argument against a VAT or any other tax increase happening is basically that voters oppose tax increases just as much as they oppose spending. I’m never fully convinced by the “the voters hate cutting spending, so we must increase taxes” argument, because the converse seems to be true as well.

That’s why we have an incipient crisis, instead of ever-escalating taxes, which would be the result if voters had a stronger antipathy to cutting spending than to raising taxes.

B.B. February 17, 2010 at 10:48 am

Members of the EU have large governments and VAT with high rates (over 15%, sometimes over 20%). What is cause and effect?

If some deity could guarantee that all of the revenues for a VAT would be used to reduce current & prospective deficits, I would support it.

But I suspect, and I fear, that the marginal propensity to consume of the federal government is close to 100%. A higher VAT will produce a larger government, not a lower deficit. Given the choice between using revenues to fund oh-so-important projects now (bullet trains from Tampa to Orlando and from Anaheim to Las Vegas) and using them to cut the deficit, voters will chose to spend. Maybe you should read The Myth of the Rational Voter.

I am an empiricist. Do the high VAT countries of the EU have better fiscal responsibility than the US? You say that the alternative to a big, fat VAT is a Greek scenario. Hello!!! Greece has a VAT with a high tax rate.

Consider that the US will get a big, fat VAT AND will get a Greek-style fiscal-financial scenario.

David Shor February 17, 2010 at 11:00 am

Jim Vernon,

We balanced the budget in the 90’s with a combination of tax increases passed by democrats and defense cuts, with help from a massive stock market bubble. It took the collapse of the world’s second largest superpower to make even tiny defense cuts possible. That was a one-off deal.

The other issue, is that demographics were a lot different then. The reason our long-term deficit is so bad isn’t that we’ve been creating more and more government programs, it’s that the programs we’ve had for 30 years have become a lot more expensive to run. Rapidly rising healthcare costs are one factor, but another one is that there are about to be a lot more old people to pay for once the baby-boomers retire, which will start to happen in a year or two.

So even keeping programs constant, taxes need to go up, by a lot. Without either a VAT or a large Carbon tax/Cap’n’Trade, deficits will stay very large. The Republican party will not support those things, so anyone who cares about fiscal responsibility should vote for Democrats.

David Shor February 17, 2010 at 11:25 am

B.B,

If you want data, http://krugman.blogs.nytimes.com/2010/02/05/the-spanish-tragedy/ is a good place to start. Every country on that list except the US has a VAT, and most of those countries have seen large reductions in their Debt to GDP ratio.

More specifically, look at Canada. Canada had large structural deficits until it instituted a VAT in the 90’s. Once they instituted a VAT, and spending didn’t go up to compensate. Their deficit turned into a surplus, and it proved stable. Now most people agree that Canada is on good fiscal footing.

And well…this makes sense. The people’s thirst for spending is not insatiable. Eventually, the people just don’t want government to get any bigger. All the bullet trains get built, everyone has universal healthcare, and pensions are ok. At that point, you get centrist caretakers that maintain the Welfare state and have minor arguments about trivial stuff(Like France arguing about banning Burkas). Looking at the politics of Western Europe will confirm this.

Set taxes a little bit above this satiation point, and you get balanced budgets. Maybe you don’t like the “high tax, high spending” equilibrium, but it really does seem to be the inevitable endpoint of a developed country given public choice theory.

Jim February 17, 2010 at 11:34 am

@ B.B.

Right. The choice is really:

1) No VAT and face a fiscal crisis in the near future, with potentialy dangerous political reaction

2) Pass a VAT now and face an even worse fiscal crisis further down the road with the same or greater political risk and higher taxes in the mean time (not to mention the other negative aspects of a VAT noted by B.B and hibikir)

Andrew February 17, 2010 at 11:37 am

I have another question. So, are we saying that the correlation between spending and taxing goes one way only?

eccdogg February 17, 2010 at 11:43 am

Why must I be obliged to support higher taxes because my fellow countrymen support higher spending.

I do not support higher spending or higher taxes and will vote for lower levels of both with a larger move down in spending than taxes. And I have said where I would cut first, our giant military followed by no expansion of entitlments freezes on discretionary spending and a gradual slowing of their growth rate of entitlements through increase age requirments, means testing, inflation adjustment etc. This is in no way a fiscally irresponsible position.

If my fellow countrymen want high spending and low taxes then they are being fiscally irresponsible. If they can be convinced to favor high spending and high taxes then so be it, but I am in no way compeled to support that outcome because they do or support bargains that have that as the result.

John February 17, 2010 at 11:47 am

I guess I”m missing something… why is a VAT better than income tax while we’re nowhere near the top of the Laffert curve?

Jim February 17, 2010 at 11:51 am

“voters seem too irrational to be willing to cut spending”

This is weapons-grade stupidity here.

Voters are taking to the streets and demanding spending cuts, but Congress refuses.

Here is MA — of all places — we just elected Scott Brown because he is promising spending cuts.

It ain’t the voters.

John February 17, 2010 at 11:58 am

“The argument against a VAT or any other tax increase happening is basically that voters oppose tax increases just as much as they oppose spending. I’m never fully convinced by the “the voters hate cutting spending, so we must increase taxes” argument, because the converse seems to be true as well.”

…this is cultural. In 2007, when I lived in Quebec, Jean Charest tried to lower income taxes for the middle class. Up to that point I had never seen such pushback on a tax cut. Polls showed it was horribly unpopular (“irresponsible, bound to lead to service cuts”), and the right wing party refused to support it. I think that since the Reagan Revolution there’s been a ‘have your cake and eat it too’ in popular culture here on fiscal matters, but I’m not sure it exists anywhere else.

Dan H. February 17, 2010 at 12:27 pm

Canada did not balance its budget because it instituted a VAT. Canada balanced its budget because it held the growth of government below the growth of GDP, shrinking the size of government in absolute terms over the past 15 years by a significant amount.

Alberta is the only province without a provincial VAT, and it also maintains one of the smallest governments. Other provinces have run big deficits, instituted VATs to control the deficit, then spent the VAT money anyway. Now they have big deficits AND high taxes.

The big question is whether spending in the United States is constrained only when deficits are high. If spending is only brought under control when the deficit becomes big enough to act as a political brake, then adding more revenue will make the problem worse.

California is the perfect example of a state continuing to explode in size until it consumes all taxes, borrows as much money as it can, and uses all the tricks it can to keep itself afloat. If California is a microcosm of the U.S., then a major tax increase will likely result in more entitlement benefits and even higher wages and benefits for public sector employees.

It seems to me that the American political system is simply broken. Canada could reduce the size of government and keep health care spending in check because in a parliamentary system with strong party loyalty, individual politicans are given ‘cover’ by their parties and are not held personally responsible for the taxes and benefits of their constituents. If the party in power makes a decision to cut benefits which will harm an individual politician’s district, that politician isn’t necessarily on the hook for it. The voters know that he has to vote the party line even if he disagrees with the legislation. He gets re-elected so long as the public feels his party in general is better than the opposition.

In the U.S. system, where every vote is a free vote, each member of Congress has to answer for his/her votes, and this drives NIMBY-ism and ever-increasing benefits without the tax hikes to pay for them, and it also causes wheeling and dealing which ultimately makes large regulatory packages like health care reform incoherent and bloated with pork.

I think American government works well when it’s strictly limited. When Americans try to implement Euro-style social democracy, they fail due to the nature of American government. It is uniquely unsuited to centralized technocratic governance.

Andrew February 17, 2010 at 12:29 pm

So, the deal is that they get a new tax to spend half on their past overspending as long as we get to spend the other half on medical treatments for the poor?

Ryan Vann February 17, 2010 at 12:38 pm

So we aught to impose more individual burdens, in the form of taxation, so that we might sustain the spending habits of our electorate? Seems pretty backward to me.

John Thacker February 17, 2010 at 1:03 pm

David Shor, couldn’t your argument be rephrased as follows:

“1) The public simply does not want tax hikes to those making under $250k/year, which together makes up over 90% of potential revenue. Polling has been unequivocal on this. Furthermore, the percentage of government revenue from taxes has been remarkably stable over the last 60 years; every time it begins to exceed that amount, there is a public clamor to cut taxes.

2) Given that we are not going to have the necessary tax increases, we can either cut spending, or we can have a financial crisis.”

It seems like it follows equally well. Surely the public has been equally against both the necessary spending cuts and the necessary tax increases to solve the deficit.

Michael F. Martin February 17, 2010 at 1:41 pm

a VAT is dangerous because there is too much discretion in how it is implemented and executed. It’s an invitation to dishonest people to cheat. I just think it would invite even more sin and folly than we’ve already seen in the last few years.

Tax rules need to be made simpler, not more complex. The cost of complexity in implementation isn’t factored into your analysis.

David Shor February 17, 2010 at 2:27 pm

John Thacker,

That’s a good point. On the other hand, while most polling asks about taxes on those who make more then 250k, I recall a couple of polls that showed people approve taxes on those who make more then 100k as well. Median personal income is $26,000, even 50k gets us into the 75th percentile of the income distribution. So I wouldn’t be surprised if one could gin up support for a tax that mostly hit people above 50k. Put the right offsets to overcome the effects of a VAT on the middle class, and I can imagine a proposal that could get majority support, especially if one of the parties doesn’t start lying about it for political advantage.

Historically, plenty of developed countries have instituted VATs. None have engaged in massive entitlement cuts. This tells me that one is much more politically feasible then the other.

Of course, that’s not a sure thing. It is fully possible that both cutting spending and raising taxes are politically impossible. Then we’ll have a crisis.

But ignoring the rest of the world, we have examples of politicians successfully raising taxes. We have not seen, despite attempts in the 90’s and in the last decade, successful attempts to lower entitlements, so one approach seems more promising then the other.

Dan H. February 17, 2010 at 2:45 pm

A VAT that doesn’t include the majority of consumers is a waste of time. The whole reason a VAT can raise so much money is that it’s broadly applied across the economy. It’s a flat or regressive tax.

It seems to me that if you need a broad-based tax that’s applied across the economy, it would be better to simply eliminate all those tax credits and rebates people in the lower income quintiles get. Simplify the tax code, spread the tax base out more, and make more people in the midlle and lower middle classes pay tax. This would also be good from the standpoint of public choice theory – the U.S. is rapidly heading towards an unstable situation where the majority of voters do not pay for the things they are voting for.

Again, this is a problem with the U.S. form of government. Try to implement a VAT, and by the time it goes through the Congress and gets hacked apart and put back together in ways that appease the more powerful members, it will be so riddled with exemptions and loopholes that it will be ineffective and a bureaucratic nightmare.

The only way you could avoid charging a VAT on people below a certain income level would be to refund the money as a tax credit. You certainly can’t make retailers do income checks before charging a sales tax. But a tax credit is a blunt instrument unless you’re going to make people itemize all their purchases and provide receipts to the government for a rebate.

The other option is to only apply the VAT to items that aren’t purchased by lower income people, but then you wind up with a luxury tax, and we all know how the last one worked out.

eccdogg February 17, 2010 at 3:15 pm

But taxes don’t “Make” more money that would be increasing GDP.

Taxes just take a higher percentage of the money that we all allready make.

Barkley Rosser February 17, 2010 at 3:40 pm

It is a historical fact that the only times in the last several decades we have seen
federal tax increases, they were accompanied by spending cuts, indeed, the only serious
spending cuts we have seen, unless you count the Reagan social security deal. Those
two times were under President George H.W. Bush, who suffered politically for it because
he had said “read my lips, no new taxes” when running against Bob Dole in the New Hampshire
primary (which Bush won, setting him on the path to the White House) and in 1993 under
President Bill Clinton. It seems that for any of this to be done, whatever form the
tax increase takes (and the VAT is less prone to fraud and cheating than many other taxes),
it goes with some sort of spending cut deal, and indeed it is the case that our most
rapidly rising expenditures are in the health care area. Of course, just as Bush, Sr.
paid for his temerity (and his was a bipartisian deal), the Dems lost control of the
Congress to the GOP in 1994, after not a single one voted for Clinton’s deal, with many
of them forecasting imminent recession from his policy, which did not happen. But, who cares
about facts as long as we win the elections?

Dan H. February 17, 2010 at 3:46 pm

If you simply give people a rebate based on income, you are disconnecting the tax from consumption. In addition, you have a situation where you have the overhead of collecting the tax, then the overhead of giving the tax money back to the people. Taxing someone and then giving them the money back as benefits or tax credits is pure deadweight. You have to maintain an entire infrastructure that imposes paperwork burdens on businesses, individuals, and the government, for no benefit whatsoever.

And again – the VAT has a big revenue impact because it is broadly applied. If you’re going to exclude 50-80% of population from the VAT, then you’d be better off raising the money another way.

M1EK Said:
“The analogies being made to an irresponsible individual spending more than they make are just breathtakingly stupid. To take your analogy further – you would actually advocate that somebody in debt and getting further in debt *not* go out and try to make more money? Really?”

I know people who were in debt up to their eyeballs when they were making minimum wage, and who are still in debt up to their eyeballs now that they make good money. Their problem isn’t income, it’s their inability to live within their means. If such a person came to me and showed me his 50K in credit card debt, his BMW on a 7 year loan, his financed speedboat, and his house with a 40 year mortgage, I would not suggest that his problem is that he just doesn’t make enough money. I would suggest that he learn to live within his means. I would fully expect that if such a person had his salary doubled, he would eventually just wind up with a bigger house with a bigger mortgage and a 7 year loan on a Ferrari instead of a BMW.

Some people manage to live within their means on 30K a year. Mike Tyson wound up bankrupt after making tens of millions of dollars.

To bring the analogy back to government – California experienced a massive revenue boost in the 90’s, and all it did was encourage them to go on a spending binge. Do you think California’s problem is that it just doesn’t have enough revenue?

Andrew February 17, 2010 at 3:53 pm

What is this libertarian argument that bites us on the bum, by the way?

sean February 17, 2010 at 4:31 pm

While I dont have any studies to point to, the VAT system seems to make future tax increases more politically viable as they tend be more concealed and insulated from electoral pressures.

Doc Merlin February 17, 2010 at 5:27 pm

“But we all know, the real problem is the unsustainability of the current Medicare system. Over the coming decades, under the current system, the Medicare outlays just completely swamp the Federal budget. (SS has issues as well, but they are minor in comparison and can be reasonably fixed).

Until there is some solution to the Medicare crisis, all of the other discussion become immaterial.”

I disagree about it being immaterial. We have to fix medicare, I agree. But at the same time we have to worry about other gross fiscal irresponsibilities. The stimulus and tarp money that went to payoffs for example was a MASSIVE amount of money, that kind of thing happening routinely would lead us to fiscal ruin far before medicare has a chance to.

In the long run, I agree the “entitlement” programs and other non-discretionary spending is the real problem.

rewt66 February 17, 2010 at 6:56 pm

I agree with all the comments that giving more money to those who are irresponsible does not lead to responsibility, but…

The US is a democracy. Ultimately, the buck stops with the voters. When voters start throwing out members of congress for wasting money in the voters’ own district, then we’ll see congress stop acting so irresponsibly – and not until then.

The virtue of adding a VAT, then, is that it increases the pain the voters feel from too much government. That may well be the ONLY virtue. (If it truly were used for deficit reduction, without causing an increase in the size of government, that would be another virtue, but don’t hold your breath for that to happen.)

R. Richard Schweitzer February 17, 2010 at 7:23 pm

The purpose of taxation, however structured, is to provide revenues for the functions of governments.

There is no point in examining a structural change in taxation without examining the structure of the functions of governments at all levels, FEDERAL, STATE AND LOCAL – all have issues.

We can make the extractions of tax from Business Associations (Corporations, etc) more efficient, less disruptive, less discriminatory, and less destructive by phasing in VAT as a net income tax is phased out.

A general VAT (all transactions) will NOT fit our complex and more services-oriented transactions form of commerce. By fit, we include need for voluntary compliance – it just won’t happen.

To bring home to the public, or to at least enough of it, the need for a return to a constitutional authority, rather than beneficial goals, as the determinant for the functions of at least the Federal government, simply suspend the withholding taxes, and require remittances quarterly (once again, by using a periodic phasing-in technique).

Two of the principal expenditures, Social Security and Medicare/Medicaid, however beneficial, do not fall within any specific Constitutional authority, nor do expenditures for Healthcare, Education, Art, Science and aid to States. So, it really does all rest on the determination of the functions of the various levels of governments.

Disclosure: At 85+, I confess to having been an advocate of VAT as far back as when I started Legal Tax Practice (from which I gratefully escaped) back when the IRC of 1954 just became effective. I strongly recommend review of the work of Stanley S. Surrey from 1948-1968.

Little is new in this area. The complexities of application are enormous. But, it can be done – to the benefit of all, especially those to come.

Ned February 17, 2010 at 7:37 pm

A VAT won’t fix anything, because the problem is excessive government spending. Giving the government more money to spend is like giving an alcoholic a glass of whiskey to help him get over his hangover. Sooner or later, a crisis is going to cause this fiscal house of cards to collapse. That means cuts in entitlements, ends to favorite congressional porky projects, and no more military spending to allow the US to play “policeman to the world.” It will be painful, but better to face the problem sooner rather than later.

Nathan February 18, 2010 at 2:21 am

Under the VAT, when people in the middle of the supply chain buy raw materials, they are essentially making a no interest loans to the government until they can sell their inventory. Companies will vertically integrate in order to avoid paying the opportunity cost of making a no interest loan to the government. (HT: Anonymous Backstabber, see also http://taxationlawblog.blogspot.com/2010/02/value-added-tax-vat-and-vertical.html ).

On balance I suspect that the VAT is the lesser evil when compared to an income tax increase, but we should account for the fact that the VAT encourages otherwise inefficient parings of companies.

grabski February 18, 2010 at 8:00 am

Since the progressives refuse to face reality and cut spending, the ‘responsible’ thing to do is to unilaterally surrender and give the progressives a hidden, money machine like the VAT? Why, so we get a “better deal”?

President Reagan learned a hard lesson; Congress will gladly accept the tax hike but not make the promised spending cuts. Why should we expect them to cut spending once they get a money stream that will finance their spending if they won’t cut when they don’t have a revenue stream?

Eric Younghans February 18, 2010 at 9:05 am

Pass a VAT who’s only purpose is for debt reduction …….. period …….. and then get on with the business of fixing the reasons we got ourselves into the financial mess we are in.

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