Is the VAT a money machine?

by on April 9, 2010 at 8:04 am in Data Source, Economics | Permalink

This is a very useful paper, full of facts and figures on VATs around the world.  Here is one bit:

As shown in the first column, all OECD members other than the U.S. have adopted the VAT over the last 30 years or so, beginning with France continuing through adoption by Australia in 2000. The (unweighted) average standard rate of VAT is about 17 percent, but with considerable variation. Within the EU, it varies between 15 percent (the minimum permissible under the union’s rules) in Luxembourg, and 25 percent (the maximum) in Denmark and Hungary. And several non–EU countries apply far lower standard rates than this, the most striking being the fi ve–percent rate in Japan. Most also apply a reduced rate to some commodities, with domestic zero–rating being quite widespread. The fourth column shows that revenue from the VAT is also typically substantial– averaging a little over seven percent of GDP–but again with considerable variation, from a high of over 12 percent of GDP in Iceland to a low of around 2.5 percent in Japan.

The authors — Michael Keen and Ben Lockwood — conclude that a VAT is a "weak" money machine in the sense that increases in a VAT are partially offset by declines in other tax rates.  They also note:

In a purely statistical sense, there is, thus, no strong evidence that the VAT has in itself caused the growth of government.

I saw this on Twitter somewhere, though now I forget whom to thank; sorry! [Update: It is probably "the wisdom of Garett Jones"]

Jeff Holmes April 9, 2010 at 8:24 am
Ted Craig April 9, 2010 at 9:01 am

I’m less concerned about the growth of government and more concerned about economic growth. What’s the effect there?

E. Barandiaran April 9, 2010 at 9:11 am

Tyler, given what Paul Volker said a few days ago about VAT as a source of new revenue for the federal government, and to support the conclusion of the paper you’re linking, let me repeat it: In USA the only way to introduce a VAT is at state level, as a replacement of sales taxes. Most state governments can increase their revenues with this reform but in many states the increase will not be enough to eliminate the deficits. For the federal government to benefit from this reform, it will have to reduce its transfer payments to state governments. VAT will never be a solution to the federal government’s ONGOING fiscal crisis. In addition, for VAT to be a solution to state governments’ fiscal crises, it will have to be implemented properly but if you take California as an example you can easily argue that the state’s political system and administration are not capable of doing that.

Paul April 9, 2010 at 10:18 am

Maybe the causation is the reverse. The growth of government causes governments to turn to the VAT to sustain the never ending growth of the welfare state.

Yancey Ward April 9, 2010 at 10:40 am

Here is how it will work.

The US passes a VAT that allows the reduction of the top income tax rate to fall to 20%. Then, after about 3 years, politicians start clamoring about how the rich aren’t paying their fair share and need to have the income tax raised to 25, then to 30%, then to the old rate pre-VAT. Once that is done, they look down the scale at those in the second tier of income tax rates and so on.

In Connecticut, we saw the same damned thing in reverse when the state instituted its first income tax in the early 90s. The promises to reduce, and keep reduced, the previous taxes vanished like a fart in the wind.

jimbino April 9, 2010 at 12:10 pm

The beauty of a new VAT in the USSA is that it would give me even more incentive to leave the country to spend my dollars in nicer places like Brazil!

Gabe April 9, 2010 at 12:16 pm

The PR rep for the mosquitos says “lets just try to make the blood extraction a little more efficient, that would be a marginal improvement.”

Barkley Rosser April 9, 2010 at 4:15 pm

E. Barandian,

There are arguments against a VAT, but an incompatibility with state sales taxes is not among
them any more than the fact that there is a federal income tax obviates the possibiity of state
income taxes, which are widespread. Indeed, while their ultimate effect is similar, VAT and a
state sales tax are collected in very different mannners, VAT through the chain of production
with the tax not listed at the end, while the state sales taxes are only added on at the point
of sale of the final good as an add-on. Indeed, I have heard people arguing for the latter so
that people will always see the evil tax that they are paying to the state, unlike that sneaky
VAT.

Some years ago I had a student who was from Germany. I went through the differences between
these, partly to illustrate details of the construction of the national income and product
accounts. This student became quite upset about the US state sales taxes, declaring that the
fact that they were not included in the price that the customer would see when contemplating
buying the good was “irrational.” He would not let go of this and went on and on. I finally
had to cut him off with, “OK, it is irrational, but it is just the way it is done here and
everybody knows how it is done and how it works and so does not feel the way that you do.”

Darren April 10, 2010 at 3:23 pm

The VAT and state/provincial sales taxes are not incompatible, in fact, Canada had a VAT (federal GST) and provincial RSTs collected side by side at point of sale for years…. only now are the provincial RSTs

anon: “When the state has a monopoly on legal violence and coercion, the state will become corrupt.”

There are public goods and externalities. A State is the only way to deal with them. They are better dealt with than not (that is, the cure is better than the disease). A state needs taxes to function. In my mind, this is a settled matter. Therefore, I wish I had some kind of filter on my browser that automatically recognized the rantings of a libertarian (who is likely 18 and has just discovered Ayn Rand) and simply blocked it out, so I didn’t have to weary my eyes with the same argument for the thousandth time.

E. Barandiaran April 10, 2010 at 8:00 pm

Darren, thanks for your comment. I’ve checked a couple of Wikipedia articles on Canada’s sales taxes and the GST and I’d like to highlight two points:

1. The introduction of GST was to replaced another tax:
“The Canadian Goods and Services Tax (GST) (French: Taxe sur les produits et services, TPS) is a multi-level value-added tax introduced in Canada on January 1, 1991, by Prime Minister Brian Mulroney and finance minister Michael Wilson. The GST replaced a hidden 13.5% Manufacturers’ Sales Tax (MST); Mulroney claimed the GST was implemented because the MST hurt the manufacturing sector’s ability to export. The introduction of the GST was very controversial. As of January 1, 2008, the GST rate is 5%.” Source: http://en.wikipedia.org/wiki/Goods_and_Services_Tax_(Canada)

2. An increasing number of provinces are shifting to what is called a harmonized sales tax:
“In Canada, the Harmonized Sales Tax (HST) combines the Goods and Services Tax (GST) and Provincial Sales Tax (PST) into a single sales tax.[1] This changes the PST from a cascading tax system, which has been abandoned by most economies throughout the world,[2][3] to a value added tax like the GST.”
Source: http://en.wikipedia.org/wiki/Harmonized_Sales_Tax
The Harmonized Sales Tax (HST) is used in certain provinces to combine the federal Goods and Services Tax (GST) and the Provincial Sales Tax (PST) into a single, blended sales tax. Currently, there is a 13% HST in the provinces of New Brunswick, Newfoundland, and Nova Scotia. The HST is collected by the Canada Revenue Agency, which then remits the appropriate amounts to the participating provinces. Like the GST, the HST is value-added. Effective July 1, 2010, British Columbia and Ontario will adopt HST at 12% and 13% respectively, replacing their current split tax mechanism (PST and GST). Also on July 1, 2010, Nova Scotia will increase HST to 15%.
Source: http://en.wikipedia.org/wiki/Sales_taxes_in_Canada

My impression is that the initial conditions (1991) were quite different from those of USA today and it is taking some time to “harmonize” the system.

Barkley Rosser April 12, 2010 at 1:51 pm

arnoll,

Ah yes, the old “people should see the evil tax they are paying” argument for the superiority of sales taxes.

E.B.,

Why on earth should anybody study the Indian fiscal system. This is a model? It would appear that while it has since changed it, Canada did implement a VAT when it already had a separate sales tax system. There simply is no reason whatsoever why the two cannot coexist.

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