Desperate for fresh revenues to feed the giant spending appetite of President Obama, Democratic policymakers are talking up ‘tax reform’ as a way to reduce the deficit. Some are considering a European‐style value‐added tax (VAT), which would have a similar effect as a national sales tax, and be a large new burden on American families.
A VAT would raise hundreds of billions of dollars a year for the government, even at a 10‐percent rate. The math is simple: total U.S. consumption in 2008 was $10 trillion. VATs usually tax about half of a nation’s consumption or less, say $5 trillion. That means that a 10% VAT would raise about $500 billion a year in the United States, or about $4,300 from every household. Obviously such a huge tax hit would fundamentally change the American economy and society, and for the worse.
Some fiscal experts think that a VAT would solve the government’s budget problems and reduce the deficit, as the Washington Post noted yesterday. That certainly has not happened in Europe where the average VAT rate is a huge 20 percent, and most nations face large budget deficits just as we do. The hard truth for policymakers to swallow is that the only real cure for our federal fiscal crisis is to cut spending.
Liberals like VATs because of the revenue‐raising potential, but some conservatives are drawn to the idea of using VAT revenues to reduce the corporate tax rate. The Post story reflected this in noting “A 21 percent VAT has permitted Ireland to attract investment by lowering the corporate tax rate.” That implies that the Irish government lost money when it cut its corporate rate, but actually the reverse happened in the most dramatic way.
Ireland installed a 10% corporate rate for certain industries in the 1980s, but also steadily cut its regular corporate rate during the 1990s. It switched over to a 12.5% rate for all corporations in 2004. OECD data show that as the Irish corporate tax rate fell, corporate tax revenues went through the roof — from 1.6% of GDP in 1990, to 3.7% in 2000, to 3.8% in 2006.
In sum, a VAT would not solve our deficit problems because Congress would simply boost its spending even higher, as happened in Europe as VAT rates increased over time. Also, a VAT is not needed to cut the corporate income tax rate because a corporate rate cut would be self‐financing over the long‐term as tax avoidance fell and economic growth increased.
The Washington Post reports that there is growing interest among politicians for a form of national sales tax known as the value‐added tax (VAT). But rather than use the VAT to replace the income tax, the politicians want a new source of revenue to expand the burden of government. The story explains:
With… President Obama pushing a trillion‐dollar‐plus expansion of health coverage, some Washington policymakers are taking a fresh look at a money‐making idea long considered politically taboo: a national sales tax. Common around the world, including in Europe, such a tax — called a value‐added tax, or VAT — has not been seriously considered in the United States. But advocates say few other options can generate the kind of money the nation will need… At a White House conference earlier this year on the government’s budget problems, a roomful of tax experts pleaded with Treasury Secretary Timothy F. Geithner to consider a VAT. A recent flurry of books and papers on the subject is attracting genuine, if furtive, interest in Congress. And last month, after wrestling with the White House over the massive deficits projected under Obama’s policies, the chairman of the Senate Budget Committee declared that a VAT should be part of the debate. “There is a growing awareness of the need for fundamental tax reform,” Sen. Kent Conrad (D‑N.D.) said in an interview. “I think a VAT and a high‐end income tax have got to be on the table.” …“While we do not want to rule any credible idea in or out as we discuss the way forward with Congress, the VAT tax, in particular, is popular with academics but highly controversial with policymakers,” said Kenneth Baer, a spokesman for White House Budget Director Peter Orszag. Still, Orszag has hired a prominent VAT advocate to advise him on health care: Ezekiel Emanuel, brother of White House chief of staff Rahm Emanuel and author of the 2008 book “Health Care, Guaranteed.” Meanwhile, former Federal Reserve chairman Paul A. Volcker, chairman of a task force Obama assigned to study the tax system, has expressed at least tentative support for a VAT. “Everybody who understands our long‐term budget problems understands we’re going to need a new source of revenue, and a VAT is an obvious candidate,” said Leonard Burman, co‐director of the Tax Policy Center, a joint project of the Urban Institute and the Brookings Institution, who testified on Capitol Hill this month about his own VAT plan.
Not surprisingly, the Washington Post did not bother to quote any free‐market people who oppose giving politicians a new source of money. For what it is worth, I wrote a piece for National Review in 2005 that explains why a VAT is a terrible idea. The core arguments are just as relevant today as they were then:
A VAT might have some theoretically attractive features, but it is a perniciously effective way of raising revenues and inevitably leads to bigger government. The best evidence comes from Europe. Back in the mid‐1960s, the burden of government in Europe wasn’t that much higher than it was in the United States. Tax revenues consumed about 30 percent of gross domestic product in Europe. The U.S. had a small advantage: The tax burden, including state and local governments, was about 27 percent of GDP. But then European governments started adopting the VAT. Denmark was the first to do so in 1967. France and Germany followed, with many other European nations imposing the tax within 5 years. For politicians, the VAT was great news. Besides being a new source of revenue, the VAT has been a disturbingly easy tax to increase since it’s built into the price of products and hidden from consumers. Moreover, even small increases generate a big pile of revenue because the tax base is so broad. The tax has become so easy to raise that VAT rates in Europe average more than 20 percent. For taxpayers, however, the news has been disastrous. Thanks to this levy, the burden of government in Europe today is much higher than it is in the U.S. On average, taxes consume about 41 percent of Europe’s economic output. While other taxes have also climbed, the VAT certainly has helped finance the explosion of social welfare spending that creates such a drag on European economies. In the U.S., by contrast, the total tax burden as a share of GDP is about where it was 40 years ago — 27 percent… Many European governments…claimed that more destructive taxes would be reduced or repealed once the VAT was implemented. In the short term, this was true: As late as 1975, taxes on income and profits were lower in the EU than they were in the U.S. But this was a transitory phenomenon. Income‐tax rates quickly began climbing and almost immediately jumped above U.S. levels. Ironically, the VAT facilitated higher tax rates on income since politicians often argued that a higher VAT had to be accompanied by higher income‐tax burdens to ensure the tax burden wasn’t being shifted to lower‐income taxpayers. There is only one scenario that would make a VAT acceptable. If U.S. lawmakers were willing to repeal the 16th Amendment and abolish all taxes on income, a VAT would be an acceptable risk. But until that happens, taxpayers should vigorously resist the Europeanization of America.
The Daily Mail reports that a Romanian student who sold her virginity to the highest bidder as part of an online auction may wind up keeping less than half of her earnings thanks to Germany’s oppressive tax system:
Tax authorities in Germany are poised to claim 50 per cent of the money that a teenage student earned for ‘auctioning’ her virginity… Romanian‐born Alina Percea, who is a student in Germany, was paid £8,800 in cash for a weekend of sex with the Italian businessman after she auctioned her virginity online. But tax officials in Berlin regard the 18‐year‐old’s act as ‘nothing more than prostitution’. Prostitution is legal in Germany — but it is heavily taxed. …It also emerged that, because Alina earned so much in such a short time, she may even be liable for a hefty VAT bill too. VAT in Germany works out to 19 per cent, meaning the sale of her virginity could land her with just over £3,000 in the end.
I was a panelist for a Tax Notes forum on April 3 regarding Obama’s tax policies. The other panelists were Len Burman of the Urban Institute and Gene Steuerle of the Peterson Foundation. It was an expert and ideologically diverse panel, but nobody was fond of Obama’s fiscal policy direction. (In the photo, that’s former CBO director Rudy Penner to my left. Photo credit to Derek Squires)
Tax Notes summarized the discussion: “A diverse panel of economists and tax specialists largely agreed … that President Obama’s tax and budget plans at best would fail to forestall long‐term fiscal ruin and could even hasten its arrival.” One point of agreement was that the tax code is too complex and it doesn’t need the complicated new tax credits that Obama has proposed.
Where we differed was on the need for added federal revenue, and herein lies the big tax policy battle ahead. Len thought that some form of new value‐added tax (VAT) was inevitable in order that the government could raise more money. I am increasingly hearing that argument from top fiscal scholars, and I fear that the drumbeat for a VAT will get louder.
Dan Mitchell and I are dead‐set against a VAT because it will be a tool to fund even larger government, as we discuss in Global Tax Revolution. But supporters of limited government need to start watching this issue and making preparations to ward off a Euro‐style money machine.