Tax Analysts Blog

Reading Between the Lines

Posted on Mar 12, 2015

Senator Orrin Hatch has twice confessed his fondness for a federal consumption tax. Inquiring minds want to know where it comes from.

The first time was in December 2014, when the Senate Finance Committee, which Hatch chairs, released a 330 page magnum opus, "Comprehensive Tax Reform for 2015 and Beyond." The report argues that a consumption tax would be pro-investment, pro-growth, and good for the nation's economy because it eliminates the bias against savings inherent in an income tax system.

The second time was during a recent interview with The New York Times. Hatch was asked what he thought about the comprehensive tax reform plan proposed by former Ways and Means Committee Chair Dave Camp. Hatch's response was revealing. By the second sentence he was praising consumption taxation, which has nothing whatsoever to do with the Camp plan. By the fourth sentence he was discussing a VAT, which also has nothing to do with Camp's plan.

What Hatch thinks about the future direction of tax reform can be inferred by his emphasis on what was not included in Camp's plan: an alternate revenue source. That is, a funding mechanism from outside our current income tax system to finance the desired rate reductions inside the income tax.

Reading between the lines, we can surmise that conservatives in Congress are now trying to decide which is worse: Camp's revenue raisers or a federal consumption tax. They don't like either, but tax reform inevitably boils down to a game of pick your poison. Hatch has made up his mind -- thus the recent messaging campaign to educate stakeholders on the relative merits of taxing consumption.

Is it possible to have a consumption tax without having a traditional VAT? The answer is yes. Years ago the late professor David Bradford developed a type of "consumed income tax” that roughly approximates the tax base of a VAT, but is not applied on a transactional basis. Bradford called his creation the X tax. You can view economist and American Enterprise Institute resident scholar Alan Viard discussing the X tax here. There are several variations on Bradford’s approach, known as cash flow taxes. These typically emphasize the immediate expensing of capital acquisitions.

I refer to this entire group of tax proposals as VAT-lite because of their resemblance to a subtraction method VAT, as distinguished from the more common credit invoice VAT.

Whatever you label them, there's little doubt that people in Washington are now giving these tax plans some serious thought. For evidence, look no further than the discussion draft released in January by Rep. Devin Nunes or the white paper released earlier this month by Sens. Marco Rubio and Mike Lee.

Note that Nunes, Rubio, and Lee are Republicans. So it’s not just Democrats (e.g., Senator Ben Cardin) who are willing to talk about a federal consumption tax.

For tax reform to be both revenue neutral (as most Democrats want) and palatable to powerful multinational businesses (as most Republicans want), an alternative revenue source is necessary. Tax wonks have been harping on this for years, often to deaf ears. Now, in the aftermath of the Camp legislation, the idea is on the verge of going mainstream.

Read Comments (4)

emsig beobachterMar 13, 2015

I believe it was Lawrence Summers who said the U.S. will get a VAT; or, VAT
like tax when liberals (Cardin) view it as a "money machine" for government and
conservatives (Rubio, Lee Hatch) view it as regressive. Now, liberals don't
want VAT like taxes because they believe they are regressive; and,
conservatives don't want them because they view them as "money machines" for
government. Plus ca change, plus ca meme chose.

bubba shawnMar 13, 2015

Consumption taxes are already being assessed as sales taxes in many states.
Former Texas Rep Dick Armey promoted a consumption tax to replace the 16th
Amendment with a $35,000 exemption for a family of four.

A federal consumption tax on top of the current income tax is a bad idea that
will slow the already dismal economic growth.

VAT taxes are not only regressive but also stifle national productivity but
also produces inflation without increases in wages.

The European Union Nations are fighting their way out massive national debts
because they adopted VAT tax schemes.

The 16th Amendment must be repealed before any consumption tax schemes will be
accepted by American taxpayers.

emsig beobachterMar 16, 2015

Dick Armey was not the first to propose a VAT or other consumption tax. Irving
Fisher's 1942 book on Spending Taxes preceded Armey by a significant number of
years.

Robert GoulderMar 17, 2015

Bubba; Emsig: Thanks much for your comments. My additional thoughts are as
follows:

Yes, the concept is rather old. Most chatter of VAT is rehash some degree.
Fisher (1942), and before him Thomas S. Adams (1921) and Wilhelm Von Siemens
(1918). Even Nixon flirted with VAT to help pay for Vietnam War spending.

The idea never seems to go away completely. And I don't expect it to given
that: (i) we have a massive deficit and little realistic hope of fixing it with
our current revenue tools [see Camp]; (ii) most of our major trading partners
have successfully used VAT to finance corporate rate cuts - which is what the
lobbyists are all screaming for; and (iii) VAT is up and running in about 160
countries and thus not experimental.

As Bubba points out, we are already taxing consumption at the state/local
level. However, IMHO, we are going about it rather poorly. RSTs are flawed.
RSTs tax a lot of things they should exempt (business inputs) while exempting a
lot of things they should tax (services). RST also can't deal with remote
vendors, and might represent the ultimate case of government picking winners
and losers.

re: Europe. Those nations are in troubled positions due to a decades-long
electoral process in which politicians promised lavish public spending, and the
citizenry voted for it. They wanted bigger government, and they got it. Not so
much fun when the bill finally arrives. But I'm hard pressed to blame their
fiscal bloat on VAT. If Europe didn't tax consumption as they do, their public
sectors would be just as big as they are now. They'd simply tax other things
more to make up the difference (labor income, capital income, property,
inheritance, net wealth, carbon emissions, etc.) I don't see the causality.

Thanks again for reading and commenting.

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