Tax Analysts Blog

Time for an American VAT

Posted on Mar 30, 2011

For decades the conventional political wisdom has been that a VAT will never be enacted in the United States because liberals view it as a tax targeted on the poor and conservatives view it as a money machine. And in response to this observation pundits would quip: a VAT will be enacted when liberals view a VAT as a money machine and conservatives view it as a tax on the poor.

It is time to jettison this type of talk. What passed for healthy skepticism in the 1990s is no longer useful or particularly relevant. Unlike previous episodes where the federal deficit was front page news—as in the years 1982-84 (debt-to-GDP at about 25 percent) or 1990-93 (debt-to-GDP at about 45 percent) —now we truly are playing with the possibility of the collapse of federal finances (debt-to-GDP surpassing 80 percent in 2015 and growing). Until somebody can guarantee our fiscal problems are under control—either because spending cuts are politically feasible or because concerns about the economic fallout from rising debt are overblown—it is prudent to give value added taxation a prominent role in the debate about deficit reduction.

Moreover, as globalization increases demand for a more competitive tax system, the United States must consider shifting from a system that primarily relies on income taxation to one that relies primarily on consumption taxation. Most other major economies around the world depend more heavily on consumption taxation than does the United States. And all indications are reliance on consumption taxes is increasing.

Finally, the traditional liberal and conservative arguments against consumption taxation are hardly insurmountable. True, value-added taxes are generally more regressive than income taxes, but the differences are usually overstated (because government analyses usually equate well-being as equal to annual income as opposed to lifetime income—a superior measure). But more importantly, however one evaluates fairness, any regressive effects of a value-added tax can be offset by changes elsewhere in the tax system or in the provision of government support and services. For example, Len Burman of Syracuse University has proposed using a value-added tax to pay for expansion of health care to the poor. (“A Blueprint for Tax Reform and Health Reform,” Urban Institute, April 7, 2009)

As for conservatives who make the money-machine argument, they are nothing more than fiscal Luddites. Their wish to drastically reduce government spending must be separated from the issue of how the revenue is raised. The VAT is a modern and efficient method of raising revenue, as any conservative economist will privately tell you. Consumption taxation is the revenue raiser most conducive to international competitiveness. Insisting on this indirect method of limiting government spending comes at a huge cost to the economy.

If there is a movement to reduce traffic deaths, we do not tell automakers to make smaller and less powerful engines. We seek better roads, safer cars, and improved driving skills. Similarly, if there is a movement to reduce government spending, we should not make the revenue engine less efficient. We should put caps on government spending and make arguments against programs on a case-by-case basis.

Conservatives repeatedly express their fear that an efficient revenue generator will only make it easier for politicians to finance big government. That is a possibility but hardly an iron law. If a VAT were in place, it is hard to believe the politics of raising revenue will be any easier than now. Canada’s version of a VAT, called the General Services Tax (GST) originally had a 7 percent rate. It was subsequently reduced to 5 percent.

In summary, if conservatives can sufficiently cut government spending and if they are willing to remain dependent on income taxation, they are correct to shun value added taxation. But they have not proposed the necessary cuts. And, if anything, their efforts to promote competitiveness through the tax system suggest less, not more, income taxation.

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