Marketplace Scratch Pad

What’s that? A VAT?

Scott Jagow May 27, 2009

One of the more controversial political grenades has always been a national sales tax. But in these extreme economic times, nothing is off the table. So, there’s some talk about touching the untouchable.

From this morning’s Washington Post:

Common around the world, including in Europe, such a tax — called a value-added tax, or VAT — has not been seriously considered in the United States. But advocates say few other options can generate the kind of money the nation will need to avert fiscal calamity…

“There is a growing awareness of the need for fundamental tax reform,” Sen. Kent Conrad (D-N.D.) said in an interview. “I think a VAT and a high-end income tax have got to be on the table.”

But those two things have very different political implications. It’s fairly easy to get support for taxes on the wealthy because they are a significant minority, and the Dems control Congress. A national sales tax hits everyone, and it hits the poor the hardest. Supporters of a VAT say the tax’s regressive nature could be offset if the revenue paid for something of value to the poor — universal health care, for example.

In the academic community, support for a national sales tax has been growing:

In his 2008 book, “100 Million Unnecessary Returns,” Yale law professor Michael J. Graetz estimates that a VAT of 10 to 14 percent would raise enough money to exempt families earning less than $100,000 — about 90 percent of households — from the income tax and would lower rates for everyone else.

And in a paper published last month in the Virginia Tax Review, (Leonard Burman, co-director of the Tax Policy Center) suggests that a 25 percent VAT could do it all: Pay for health-care reform, balance the federal budget and exempt millions of families from the income tax while slashing the top rate to 25 percent. A gallon of milk would jump from $3.69 to $4.61, and a $5,000 bathroom renovation would suddenly cost $6,250, but the nation’s debt would stabilize and everybody could see a doctor.

The VAT’s appeal is its simplicity, its potential for lowering income and corporate taxes and for funding a program like health care.

A VAT certainly wouldn’t be a boost to the economy, since it encourages saving instead of spending. You could argue that shift has already taken place, perhaps for the long-term and for the better. But there’s also this argument against a national sales tax from the group Americans for Tax Reform:

VATs are a gateway drug to more government spending. When VATs first came on the scene in Western Europe in the 1960s, they were modest taxes averaging around 5 percent in rate. In the years since, the rates have climbed to an average of 20 percent (with a 15 percent minimum to get into the European Union).

There are two reasons for this. First, politicians are always tempted to hike the rate and exclude preferred items like food, medicine, and housing. Second, because a VAT is embedded in the price of a good (unlike state sales taxes in the United States), most people are unaware of the tax or how high it is. Raising the VAT rate becomes a relatively-painless political maneuver, especially if it’s linked to higher welfare spending or VAT-based carve-outs.

Both sides make a pretty good argument. It’s easy to envision the VAT being a “gateway” to more government inefficiency. But the money has to come from somewhere. There is no magical, painless source of revenue waiting in the wings.

Where do you come down on this?

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