August 19, 2009 5:34PM

VAT Hikes

From this week’s Tax Notes International (subscription required):

In a stark warning to all countries facing mounting debt, Croatia, Estonia, Latvia, and Lithuania are all imposing further VAT increases to help shore up their faltering finances. They join countries such as Ireland and Hungary that have been forced into recent crisis VAT increases, and a number of Western countries seem certain to follow. This includes the U.K., which may be looking at a 20 percent VAT within the next two years.

I’m not a fan of raising taxes to balance budgets, but what’s interesting here is that all of these governments are reaching for the VAT tool to shake more money out of their citizens. The take‐​home points I think are that:

1) VATs are handy money machines for governments. Governments fear raising income taxes during recessions because of concerns over damaging their economies. But they have less such concerns with respect to VATs.

2) International tax competition continues to generate pressure for countries to keep income tax rates down. Policymakers don’t want businesses and investment capital fleeing abroad for lower taxes, particularly during economic downturns.

VATs are generally less damaging to economic growth than income taxes. But the flip side to that widely‐​understood result is that politicians have less fear about using them to grow the size of governments during good times and bad.