I don't agree with everything in this paper, but it's the best case against a VAT that I have seen to date.
…the tax is not a good fit for the United States. It taxes a base that has traditionally belonged to state governments, its introduction would bring with it intergenerational inequities, it has a cumbersome administrative structure that would impose large compliance and administrative costs, and it would slow economic growth. Because of slower economic growth, tax revenues from existing tax bases will fall if a VAT is introduced.
If you're wondering, as an alternative he favors a mix of spending cuts and, if needed, increases in the income tax.
the best argument against the VAT is that it hides from the voters the real cost of government, and hence makes them believe they get a better deal than they really do. Everybody in Denmark at least has a fairly good idea about how much they pay in income tax each year, but nobody really seems to have a clue about how much they pay in VAT.
Denmark has high VAT.
I’m not convinced that VAT has a more cumbersome administrative structure than other taxes.
I’m not convinced it would slow economic growth more than other taxes. In fact from what I’ve seen from the OECD it is the tax that reduces growth the least other than land value taxes.
The reason the nordic countries have high taxes and high growth is because of the blend of taxes they use. They tax consumption highly and capital lightly.
I see the logic in the keeping consumption taxes as a state only thing.
It’s a scheme to change the rules after the game has commenced WRT Roth IRAs.
Taxing “value-added” just seems like a bad idea, though obviously something government would find natural. I Second dearieme.
Tyler, I’m glad that at least one U.S. economist has taken note of the near impossibility of introducing a VAT at the national level. As I have said many times in comments to your posts, the VAT will replace state and local sale taxes. Anyway, a discussion about tax reform in your country is a waste of time: the Dems want it to increase spending significantly, and the Republicans want it at best to complement a significant reduction in spending. As long as there is no large majoritiy in favor of reducing and restructuring government spending, there will be no tax reform. Good luck.
In the meantime, you should worry about employment and the manipulation of data. In less than an hour, we will know the report for last month and it looks quite bad, at least for Obama and the Dems, so be ready for all kind of nonsense proposals during the Congressional election campaign. The manipulation has already started:
http://www.bloomberg.com/news/2010-07-02/payrolls-in-u-s-probably-dropped-in-june-as-government-cut-census-workers.html
“Anyway, a discussion about tax reform in your country is a waste of time: the Dems want it to increase spending significantly, and the Republicans want it at best to complement a significant reduction in spending.”
You’re showing your age with that assumption about Republicans (as am I in responding).
Meter, I’m talking about tax reform. As long as there is no prospect of a tax reform, most likely a new Republican Administration would increase spending, as it happened during GWB Administration. In the Congressional election campaign or in a negotiation with Congressional Dems after the upcoming election, they may promise, however, to balance the budget by complementing a tax reform that will increase tax revenue with a reduction and restructuring of spending.
Like every other strategy having a VAT or not boils down to how
well you do it. In Canada it was done in conjunction with broader tax reform and
has worked relatively well. It has also been moving to a HST approach where
it is harmonized with the provincial sales taxes. This change is
good for business and the economy. In addition the Federal
Governments have been willing to re-evaluate levels and give
reductions as warranted. In full it has worked well in Canada because
it has been done relatively well. I am not sure it can be done as
cleanly in the US since the problems of co-ordination are much larger
with 50 states and way more politicians. Also culturally I think in the US
there is much more suspicion of federal authorty. In Canada we have an
uneasy tolerance for the federal government since it is on the whole
a “do nothing” institution. The best period in Canadian history was
under the Cretien Liberals for the simple reason they did essentially
nothing for 10 plus years. VAT can work if it is part of a broader reform
package carried out over a number of years. This is also difficult
in the US because of the extreme polarization in politics. It is
easier for a Canadian PM to drive an agenda within a parlimentary
system than it is in the US where the president does not rule the
houses. I don’t know if this is an instittional strength or weakness
the US has on the whole done very well dispite the rhetoric from
both sides of the political spectrum.
From Rob: ‘”It taxes a base that has traditionally belonged to state governments”
That is a meaningless argument because I’m left asking, “so?”‘
The welfare loss caused by a sales tax increases in the square of the tax rate. So the welfare effects of a 0% —> 10% change are different (in particular less bad) than say a 10% —> 20% change. It’s all in the paper…
You might investigate Kotlikoff’s case for replacing the entire federal tax system with a single comprehensive VAT. Once the transition is completed, compliance costs would be no higher than under the current regime (probably less), the deadweight loss would be lower. Slowing economic growth is about higher taxes, not a tax reform. The argument that other tax bases would be irrelevant if the other taxes are gone.
if needed, increases in the income tax.
Is economic growth and job creation a “need”?
No period of growth in production and jobs has occurred without tax increases since 1930.
Tim, Beyond a shadow of a doubt? Really? Nothing else has happened recently that could affect investment? Capital gains taxes are zero??
Mulp, sounds like you’ve got the prescription for success. Just keep increasing tax rates into infinity! By the way, to take a recent example, how about the 2003-2007 period? How about the period over the last 6 months?
Mulp-
See Federal Tax rates, for example, for married filing jointly:
1980 – 49% at $45,800; 1983 – 40%; 1985 – 38% at $47,670 and brackets indexed for inflation; 1987 – 35% – $45,000; 1989 top rate is 28%. Source Tax Foundation – use the Google for historical tax rates.
Reagan knew how to deal with the Carter malaise and get an economy moving. Obama, aka “The Mistake in ’08″, has no clue (assuming that he isn’t deliberately trying to destroy the economy).
There is no economic difference between a VAT and an income tax. For any VAT structure you can craft an income tax which replicates its economic impact. For example, everyone is talking about how a VAT would reduce consumption. Income taxes already reduce consumption. The VAT rewards saving only in as much as there is not a tax on interest and dividents. An income tax can reward savings just like a VAT if it provides deductions for savings.
The worst nightmare of a VAT is that we get a VAT AND and income tax. The VAT might crowd out some of the state tax base and make their revenues more volatile thereby. But income taxes already do that to some degree.
I used to agree with those who say a tax should whack you in the face. In my experience though, people often make purchase decisions based on advertised, pre-tax prices and don’t change their minds after seeing the tax bill. Economic theory says they should incorporate the full price in decisions but I don’t think that happens. Businesses price everything with 99 for a good reason – it works. For the same reason, government fools people by allowing nominal menu prices with add on taxes.
In Germany, the VAT and the gratuity is included in the menu price. People make decisions based on the full price. An intelligent, informed consumer can subtract the marginal tax rate just as easily as they can add, so the tax transparency advocates have inconsistent assumptions in their argument.
It is the final price which should be transparent. All advertised prices should include all taxes, gratuities, fees, shipping and handling, surcharges and any other charges which cannot voluntarily be removed from the sale. For national advertising, the final price should be based on the highest possible applicable tax rate with a statement that the price could be lower.
What you see is what you pay.
Tyler, what do you think of the menu prices in Germany?
German phrase of the day: Stimmt so = keep the change.
Because gratuity is already included, customers usually round off the bill to the next higher currency unit as an added tip.
“Reagan knew how to deal with the Carter malaise and get an economy moving.”
Right, borrow money and then spend it. It worked for twenty-five years, what could possibly go wrong?
@Steve Reilly. Mankiews quotation: “Yet, such an argument ignores an essential truth about imports and exports: over the long term, exports and imports must be equal.” And, that over the long run, is offset by the exchange rate. Might be true if we did not have a trade imbalance, but the argument would also be that the VAT tax would bring us in equilibrium. Not so bad.
Mankiw’s quote also did not consider that the VAT tax would probably be made in conjunction with a reduction in corporate income taxes, things which domestic manufacturers pay, but which MNCs have done a good job avoiding through transfer pricing schemes. To the extent we can place domestic manufacturers on equal footing with MNCs, there will be an opportunity for them to grow faster than the MNCs who have taken advantage of the transfer pricing regime and other mechanisms to avoid taxes on domestic sourced income.
@Andrey, Re your comment: “it doesn’t mean that foreign nations will sit on their hands and let US levy an “invisible” tariff on their exports” They already do through the VAT exercise.
I hadn’t seen Mankiw’s argument–that the VAT would increase exports, but that the dollar would rise and everything would settle at an equilibrium in the long run, so why bother–but then thought: we run a trading deficit; what if, in the short term, export rise in the short term, helping American businesses achieve some economies of scale and hire more persons. Maybe getting to the equilibrium is half the fun. and, incidentally, the threat of a VAT might cause everyone to purchase now, rather than wait for the tax increase!
Andrey, My knowledge of VAT is only based on a discussion with a Deloitte international tax accountant and export consultant a number of years ago. But, what you describe as counterstrategies would likely raise WTO objections. What a VAT tax would do, of course, is raise the price of imported goods, along with goods produced in the US and consumed in the US and reduce the price of goods that are exported.
You or someone else may be more knowledgeable on this than I am, but if you, as a trading partner do not have a VAT deduct for export system, like the US, and your rivals do, does the assymetry put you at a competitive disadvantage. I would think it would. This is why, by the way, our trading partners opposed the ECTC tax credit a number of years ago (export trading companies) before the WTO.
And, then, of course, there is the issue of incidence of tax. Usually, when there is a sale tax proposal on such things as lawyer or doctor services, someone says: it will be passed on to the consumer; usually, though, it is said by the worried doctor, lawyer, service person who is concerned that a portion of the tax will be passed back to them, in other words, that they will not be able to Pass On the full tax increase, and part of it would have to be absorbed, if they are to sell the same quantity of services.
Now, I’m not against a foreign manufacturer paying part of my taxes if part of the incidence falls back on them. Are you?
Holcombe makes some good points, but he misses a couple of sources he should have looked at from the Tax Policy Center. One, by Toder and Rosenberg (http://www.taxpolicycenter.org/UploadedPDF/412062_VAT.pdf) agrees with H. that there would be canibalization of other revenues, but argues that this is not fatal to the idea of a VAT. Another by Altschuler et al. (http://www.taxpolicycenter.org/publications/url.cfm?ID=412018) argues that it is essentially impossible to raise enough revenue to close the budget gap by raising tax rates within the current income tax system. I agree with H, the collection mechanism is clumsy, and in Europe, there are perennial problems with VAT fraud, but I do not think the VAT can be taken off the table when long-term budget sustainability is under discussion. (Neither should energy taxes, of course, as I have argued again and again.) A VAT as part of a general structural reform of the tax system could mitigate the even worse distortions of other taxes.
VAT compliance is a piece of cake. I handle ours for Cananda, and it takes us about as much time as it does for sales tax in one US state, and I guarantee that we’re much more accurate. It seems like the only real risk is in determining who is a business and who isn’t.
Most complexities aren’t even due to the fact that it’s a VAT, but due to the fact that politicians can’t help but try their hand at social engineering.
My company probably spends 100x more hours on income tax compliance than VAT compliance, and we still get way more wrong. Plus, there’s very little dead weight loss in VAT planning (unlike income tax planning) at least that I know of.
I guess it’s possible that my company just has straightforward VAT facts but complicated income tax facts, but I don’t think so.
@Bill
“But, what you describe as counterstrategies would likely raise WTO objections”
Problem with those objections is that a) point is not to block, but to delay and b) objections are just that – they can be countered, denied, argued about and the whole bureaucratic process will play in favor of a).
“if you, as a trading partner do not have a VAT deduct for export system, like the US, and your rivals do, does the assymetry put you at a competitive disadvantage”
That’s a good question, and I’m not knowledgeable enough to answer it with absolute certainty. My guess is no, since a) Mankiw’s argument works both ways, b) situation at home matters more. Also I might be wrong, but I think that components and raw materials and I doubt that US industry only uses those produced at home.
“they will not be able to Pass On the full tax increase, and part of it would have to be absorbed, if they are to sell the same quantity of services.”
So the tax will be passed on to consumer, other producers and investment at the same time. Even if we forget for a moment that world economy is a closed system, consider that domestic producer will have to pay taxes both at home and abroad. Are there really no businesses in US that already work on domestic market and for various reasons cannot export their goods or services?
“Now, I’m not against a foreign manufacturer paying part of my taxes if part of the incidence falls back on them.”
Leave WTO then.
Casey Mulligan says Don’t fear the invisible tax.
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