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.
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I do wish that people who knew little about the practice of VATs would refrain from discussing them. First, VATs are now hardly “European,” unless somehow Canada, Australia, Mexico, New Zealand, South Africa, Egypt, and practically every other nation you have heard of has somehow migrated to that continent. They are better referred to as “a standard element of virtually all civilized national tax systems.” Second, they are hardly invisible. In Canada, the GST (what they call their VAT) is added at the cash register — just like our state retail sales taxes. And in many European (and other countries), while the tax is included on the sticker price, the cash register neatly reports both the rate of the VAT and the amount of VAT paid on the total transaction on the receipt, just like a receipt from an American WalMart or whatever. You can hardly call it invisible. There is much else that is wrong about the discussion of VATs here but I don’t have time for further corrections.
while i am (as a german who has grown up with VAT) all against VAT (as much as a sales tax), i must second @mike that your article is verily very u.s.-myopic.
especially your remark that “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” leaves my brains in the dust.
it should be very hard for any ‘economist’ (and haven’t many people of late come to see this profession as not much more than ‘astrology’, plain lies, or at best educated guessing?) to convincingly draw a historic line of causes and effects that leads from a shattered post-WWII europe over installation of VATs in various places (all over the world) to the financial ruin of greece et.al. that we are witnessing right now, and make it plausible that VATs, of all things, are directly relevant to the debacle?
i am confident that ‘even’ most americans (sorry guys) will be smart enough to cut through the abomination that this proposition is, so in order to be more helpful in staving off yet another added complexity of the tax system maybe one should look for better arguments.
the central arguments against VAT, to me, are:
(1) taxes should be ‘just’ (‘appropriate for each tax payer’). taxes that overly burden some people are not ‘just’, and VATs overly burden people with small incomes. people with better (net) income, you know, they have one gadget less they can afford per month, per year. people with less money have to work hard in the super market to find the mix of essential products that is enough to sustain them at a price they can afford. if all you can spend for apartment and food is $1,000 per month, then $200 is probably a LOT for you. if you have around $10,000 dollars a month, then after paying around $2,000 for VAT you have still $8,000 left to consume, which looks a lot less scary than the slide from $1,000 down all the way to $800 a month.
(2) taxes should be ‘accountable’. VAT per se looks accountable in the sense that, if you spend $1000 a month for food and commodities, that should mean you deducted a little less than $200 for VAT (with a VAT around 20%). however, the devil is in the details: many countries have more than one VAT rate depending on the type of goods sold. here in germany, books and foodstuffs are taxed with 7%, while pretty much everything else is taxed with 19%. recently hotel accommodations went from 19% to 7%; now they are fighting over the taxation of meals provided by the hotel—which will depend on whether it was included in a package offer, and whether it is consumed on or off the premises. this is a can of worms.
you are, in my view, absolutely right in wanting to prevent yet another form of taxation. according to a research done in the netherlands, around 10% of all tax-related literature, worldwide, deals with the byzantine details of the german tax system.
fundamentally, tax systems and laws in general lose ‘accountability’ when they become too complicated for the layman to understand. a single convoluted law is too hard to understand and to predict, and so can be a thousand short and simple laws. so even if VAT in itself looks not so complicated and rather predictable to you now, it will initiate countless interactions with existing legal dealings as well as commercial and taxation cash flows, sometimes in surprising ways (ex.: lowering VAT rates for accommodation in germany did not effect lower hotel prices; in contrary, the number of nights spent in hotels by business people reduced, since they are the ones who can deduce less now).
since, traditionally, main street seems to be taken fairly seriously by federal and local legislators, let me close with this observation: in germany, only people with absolutely nothing, regular employees and rich people are more or less left alone by the tax bureaucracy: the poor have nothing to tax, the tax statements of employees are accounted for by their employers, and rich people pay a tax guy to do that for them. everybody else, whether running a small shop, trying to survive as a free-lancer or artist, has to deal with a level of paper work that is breathtaking. you basically work so-and-so many days a year to pay the taxes, and then some more days filling out these arcane forms. over the years, the german government has managed to outsource more and more paper work to the general public, and the main burden lies naturally with small shops who do not have the volume to open up an accounting dep.
now VAT is an inherently complicated system, and you know that legislators just love to prove their efficacy by making some existing law more ‘just’ by adapting it to more edge and corner cases. every few years it will be a tad more involved to get those VAT statements (in germany: four statements each year, plus one finalizing statement; that is around one official document per 40 work days or so) off the table. so this means that—in case american VAT should turn out to resemble german UST in any way—everybody who runs a shop on mainstreet u.s.a. can prepare to spend one or more work days each year for this single form of taxation alone. i doubt joe the plumber looks forward to that.