Happy tax day, readers! If you haven’t read today’s fantastic Wall Street Journal editorial on Europe’s experience with the VAT tax, do so now. Here’s the gist: The value-added tax “is essentially a national sales tax that is assessed at each stage of production, with the bill passed along to consumers at the cash register.” It’s considered a politically safe tax to impose, as taxpayers can opt out of the tax by simply not buying things. So, you want a new TV but you don’t want to pay a 20% VAT on top of, say, a 6.5%-10% sales tax? Then keep your old TV forever!
Is it really that simple? Yes.
The biggest problem with the VAT as highlighted by the WSJ is that the tax’s political feasibility allows politicians to tinker the rate up. In a memo to Rep. John Boehner, Carnegie Mellon University’s Professor Allan H. Meltzer offered this example:
[W]hen coal and iron ore are sold to a steel mill, the mill pays tax on the value of the steel it sells but deducts the amounts paid for coal and iron ore. The auto company that buys the steel charges tax on the car it sells to a consumer but deducts the cost of the steel and other inputs. The consumer pays the tax on the auto it buys and thus on all the inputs that went into its production.
The collection costs are borne by the sellers, and the full tax is paid by the consumer. The tax is costly to collect and to monitor. To avoid the tax, people pay for services in cash. The service provider does not report the sale and aslo avoids paying income or other taxes. The so-called underground economy grows. Because the VAT raises the price faced by the consumer, spending declines.
Yet despite the inevitable decline in spending, argues Meltzer, the VAT is still appealing because of the incredible revenue:
Estimates are that each 1 percent VAT tax in the United States yields $ 50 billion in revenue. A 5 percent VAT would add $250 billion to Federal tax receipts. To close the projected budget deficits, the tax rate would have to be substantially higher than 5 percent.
So what’s the catch? This:
The VAT is a regressive tax; it takes a larger share of low incomes because it taxes spending and average spending declines as income rises. To compensate, many countries rebate income tax to low income earners. In the United States, low income earners pay little or no income tax.
And this:
VAT, like a sales tax, falls on consumer spending. State governments are a likely source of opposition to a Federal VAT. States and local governments have large unfunded liabiliies for pensions and health care, so they will need their sources of revenue.
The implication of the above, I think, is that stacking the VAT on local and state taxes would decrease consumption, thereby decreasing local and state revenue. I’d be interested to see a model of the effect of increasing consumption taxes without providing low-income rebates–which is how our model would be different from Europe’s. Why? because you can’t use rebates to offset the negative effects of the VAT if people making less than $30k per annum are already paying no taxes.
As the WSJ points out, only in Canada has the VAT rate decreased since its inception (from 7% to 5%). In Denmark and the UK, the VAT has increased by 16 percentage point and 9.5 percentage points respectively. The average increase in the VAT, according to the WSJ’s data, is 7%. In other words, a lot.