White House adviser and former Federal Reserve Chairman Paul Volcker floated the idea of introducing a Value Added Tax (VAT) as part of an overhaul of the U.S. tax system in early April. Since then there has been significantly more buzz about the idea.
Supporters say the VAT is remarkably efficient to collect and, unlike income taxes, applies to nearly everyone. Detractors have been focusing on the burden of yet another tax, as well as the effect more sales taxes might have on the poor.
But both sides so far have been missing the largest issue: that a VAT is not just any old tax, it is a plague of potentially epic proportions that promises to further expand the size and scope of the federal government and prop open the spending floodgates for good.
To fiscal conservatives, small-government advocates, and fans of a flat tax alike, the VAT has many admirable qualities. Originally introduced in France in 1954, and now in widespread use across Western Europe and elsewhere, the VAT is a remarkably simple tax.
Basically, a VAT is a tax on the creation of value. At each stage of producing a product, from raw materials to assembly, to packing and shipping, each company is responsible for paying a tax on the value it adds.
And because each company along the line gets an effective tax break so long as the one before it pays its share of the VAT, paying tax only on the incremental value they add from the last time taxes were paid in the value chain, companies are incentivized to take on the role of tax collector, rather than the IRS.
This community policing makes the VAT incredibly difficult to escape, and also remarkably cheap to implement, especially when compared to the nearly $15 billion per year the IRS spends collecting our current taxes.
The tax would also apply to nearly every American, just as sales tax does at the state level
As a tax on consumption of anything from cars to computers, to candy bars, everyone in society would end up paying a portion.
The sheer number of payers and transactions allows the government to generate the same income at a much lower rate than when it is dipping deep into the pockets of just a few of the nation’s wealthier residents.
A 10% VAT rate – not a shockingly large increase over the 8.75% paid in California or the 7% in Indiana and Mississippi – would generate about $1 trillion dollars in tax revenue, given our nearly $15 trillion gross domestic product. That would constitute a nearly 50% addition to the $2.15 trillion the Congressional Budget Office predicts for 2010 federal tax revenues.
In all likelihood, a VAT would replace state sales taxes, so starting at a 10% would mean most or all of the money raised would just end up sent back to the states’ coffers as part of the deal to get states on board. But any rise in rates from there would bring in another $100 billion per 1% hike.
The added taxes alone, which would have dramatic economic consequences, are not the problem with the VAT, however. Rather, it’s the insidious new powers it would grant to Washington.
Introducing a VAT in the U.S. would consolidate more taxing power with the federal government, reduce the transparency of taxes to everyday citizens, and give the feds free reign to increase taxes virtually whenever they see fit.
Not only is the VAT yet another tax, it is far too easy and tempting for the government to raise the VAT once it is implemented as well. When Denmark introduced the VAT in 1967, it was at a rate of 10%. That rate has steadily risen to 25% today.
Germany has gone from 10% to 19%. Italy from 12% to 20%.The list goes on, yet each of the individual tax increases creates little or no media fanfare.
The price of a new iPod going from $110 to $112 is marginal and not a major issue for the average consumer, yet it represents a 2% increase in taxes, and in the U.S. would be approximately $200 billion dollars in new tax revenue. As a senator, that kind of incremental increase is incredibly easy to justify.
Yet, for a news outlet, that minor 2% increase is difficult to make into a front-page story. Consumers simply don’t feel the pinch enough each time to pay attention, as the Europeans have proven, as well as our own states with recent sales tax increases up to 1.25% in California, Massachusetts, Maine, Washington, Minnesota, and elsewhere.
Many argue that consumers would feel that pinch even less, thanks to the decreased transparency of the VAT compared to the sales taxes it would replace. Whereas with state sales tax, you immediately see the $10 added onto your bill when you try to purchase that $100 iPod, with the VAT retailers must advertise the final price of the product as it is enacted most places.
One of the few challenges a VAT would face is the legal implications of taking this autonomy away from states. Normally that we’d expect serious challenges to such a federal land grab. However, given the dismal condition of many states’ balance sheets, and the promise of increased revenues, including finally capturing those billions in untaxed ecommerce transactions as only the feds can do, it is quite likely many states would hop on board such a proposal.
The federal government is looking to the VAT for the same reasons. Its only choices right now are to decrease costs or increase revenue – and the former is obviously not on the current (or previous) administration’s agenda, given the plethora of new spending that has ballooned the budget gap from the “usual” $100-$400 billion all the way to $1.8 trillion dollars last year.
With a VAT in place, filling that gap would just be a matter of 1% here and 2% there. And, in an ironic twist for a Democratic administration that relied heavily on lower-income voters for election and promised a “redistribution of wealth,” the bulk of that new burden would be carried by lower-income groups.
The lack of transparency that comes with a VAT, coupled with the power of small percentage increases to increase tax receipts by tens or hundreds of billions of dollars, would give the government carte blanche to raise taxes a little bit at a time.
Any remaining incentives to reduce spending back to sustainable levels would all but vanish, and Americans would be faced with a larger, more emboldened federal government than the one that got us into this.
The VAT would just be a license to spend, and that is the last thing the federal government needs.
Olivier Garret is CEO of Casey Research.
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