By Edward Zelinsky
A federal value-added tax (VAT) is today’s magic bullet for slaying the federal budget deficit. A federal VAT would be a veritable cash cow, obviating the need for painful measures like serious spending reductions and middle class income tax hikes. A VAT would be more regressive and complex than its proponents acknowledge. Like most putative panaceas, a VAT should be rejected.
VATs are national sales taxes, widely used in Europe. Unlike a conventional retail sales tax, a VAT requires that, at each stage of production, manufacturers add to the cost of goods (and services) a tax reflecting the value added at that stage. The cumulative VAT payments paid as a product is made become part of the final price paid by the purchaser when he buys the finished product.
Among the influential proponents of a VAT is former Federal Reserve Chairman Paul Volcker. Some observers assert that President Obama’s National Commission on Fiscal Responsibility and Reform is designed to provide Mr. Obama with the political cover to propose a VAT after this year’s mid-term elections. This perception was reinforced by Mr. Obama when he said he is open to all budgetary “options,” including a VAT. Among the other prominent passengers on the VAT bandwagon is former President Bill Clinton.
Many who advocate a VAT are sincerely concerned about federal deficits and believe that tax increases in the form of a federal VAT must be the solution. However, the case for a federal VAT is unconvincing.
We don’t need another layer of taxation in our federal tax system. However, a VAT, placed on top of existing federal taxes, would be just that, adding to the complexity and regressivity of the federal tax system.
Some VAT proponents tout it as a means of simplifying the federal tax system. A portion of VAT revenues, they argue, can be used to remove more, perhaps most, Americans from the burden of paying the federal income tax.
These claims should be met with skepticism. Even if a portion of VAT revenues are initially used to relieve some taxpayers’ federal income liabilities, for the long term, a VAT would likely be added on top of federal income taxes for individuals and corporations.
Taxes should be transparent, making clear to voters the price of government so that they can assess the benefits of public activities against such activities’ costs. A VAT, in contrast, is largely hidden since it is embedded in the prices of the goods and services consumers buy.
VAT proponents retort that, when a customer purchases a product or service, the amount of tax built into the price will be disclosed. It is, however, unlikely that such disclosure will in practice prove meaningful.
While VATs made sense in the European context after World War II, the European model of public finance looks less attractive today with Greece, Portugal and Spain teetering on the edge of national bankruptcy.
Moreover, a VAT would fit uncomfortably into the existing structure of U.S. public finance. A national VAT would compete with and eventually crowd out the retail sales taxes which are central to the fiscal autonomy of the states. We value the financial independence of the states in a way that Europeans do not prize the autonomy of their provinces.
VAT proponents contend that a VAT, as a tax on consumption, will incent Americans to save more by increasing the cost of consumption. However, most federal taxpayers are already encouraged to save on a tax-advantaged basis through IRAs, 401(k) plans and similar individual account devices.
As a tax on consumption, a VAT is inherently regressive, imposing heavier burdens on lower income individuals and families who cannot afford to save and thereby avoid the VAT. VAT supporters respond that a VAT can exempt certain items (e.g., food) or that refundable income tax credits or similar devices can be used to return some or all of the VAT to low-income persons.
Again, we should be skeptical. At best, such exemptions and credits will compound the complexity of an already complicated federal tax system.
VAT proponents correctly stress the urgency of addressing federal deficits. However, the deficit should be confronted in a balanced fashion which addresses spending as well as taxation and addresses both openly. In the final analysis, a VAT is a cash cow, designed to avoid spending cuts and more transparent income tax increases on middle income households.
The steps necessary to reduce the federal deficit will be politically painful, e.g., increasing retirement ages for social security payments and Medicare coverage. The Obama Administration’s health reform law, advertised as a deficit reducer, is more likely to exacerbate the federal deficit.
Genuine budget discipline will require tough decisions which, to date, the President and Congress have preferred to avoid. President Obama’s pledge to eschew income tax increases for those making less than $250,000 annually impedes deficit reduction as does his apparent determination to preserve, indeed extend, federal entitlement spending.
A federal VAT is neither desirable nor a substitute for courageous leadership on budgetary issues, leadership we today get from neither party. To reduce the federal deficit, tough, transparent and balanced choices must be made to reduce spending and increase taxes. A VAT is not one of these compelling choices.
Edward A. Zelinsky is the Morris and Annie Trachman Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University. He is the author of The Origins of the Ownership Society: How The Defined Contribution Paradigm Changed America.