“Should five percent appear too small, be thankful I don’t take it all.” George Harrison wrote the Beatles song “Taxman” after watching an astounding 95 percent of the band’s earnings go to pay British taxes. A tax rate that high might sound absurd, but a recent study by the Tax Policy Center found that the two top rates would have to climb to 86 and 91 percent in order to close the budget gap by only raising taxes on the wealthy.
Since under these rates the wealthy would work less or find other ways to avoid taxes, such a rate would fail to actually close the gap. However, there is another way to some in Washington want to raise taxes—the Value Added Tax. Speaker Nancy Pelosi and Presidential Economic Advisor Paul Volcker have already publicly speculated that it may be time for such a tax.
The so-called VAT is essentially a hidden sales tax. The tax is levied at each stage of production so that industries pass the increased costs up along each stage until ultimately the consumer pays a higher price at the cash register. Unlike state sales taxes, there is no easy way for the consumer to find out how much the VAT has affected the price of products.
In Europe, where most countries have already levied a VAT, the average rate is just under 20 percent. In almost every country where the VAT has been introduced, it has risen over time. In the case of Britain, the VAT has more than doubled since its introduction.
In some cases the VAT was sold to voters with a tacit promise to lower income tax rates. When Margaret Thatcher’s government established a VAT, she privately doubted whether the Parliament would also go along with the proposed reduction in rates. She was right to worry since today the United Kingdom has both a 17.5 percent VAT tax and a 50 percent top income tax rate.
Even with all this taxation, European nations are struggling with budget deficits just as much as the United States. The ability of the VAT to generate revenue, and to do so without a major tax revolt, encourages politicians to spend more and increase the size of government.
What do these governments get out all this government spending? They certainly don’t get lower unemployment or faster job growth. What they get are expansive welfare states that discourage economic growth.
Carnegie Mellon Professor Alan Meltzer notes that, “The European welfare state is a main reason that since about 1980 Europe’s growth rate has fallen below the U.S. growth rate, and reported European unemployment rates have been well above U.S. rates on average. The United States should avoid locking the country into a low growth future.”
The United States is facing an uncharacteristically high unemployment rate of 9.7 percent right now. The reality is that many European nations were facing this level of unemployment before the financial crisis. In March 2005, France, Germany, Spain, and Greece all had unemployment rates of 9.7 percent or greater.
A new VAT tax could also reduce state sales tax revenue. Since a VAT raises the price of goods, it would discourage consumption and lower sales.
Most state budgets, including Pennsylvania’s, are already in crisis. States would be forced to come up with revenue by other means or come begging to the federal government for relief. Most European nations do not have federalist systems like the U.S., and so we don’t really know all the repercussions this new tax would have on the individual states.
I don’t think that making our tax system more complex will create jobs or balance our federal and state budgets. In fact, simplifying our tax system could yield more revenue by making it easier for the government to determine when individuals and businesses are not paying their taxes.
We also need to get our spending under control. We cannot continue to expand the government without discouraging economic growth. I think the balance between government and the private sector has been upset by the current leadership in the White House and Congress which has promoted a government solution to every problem.
George Harrison concludes: “And you’re working for no one but me. Taxman.” Unleashing American entrepreneurs and encouraging private sector growth means letting Americans work for themselves, not the government.