Retirement and Social Security Reform
The Dangers of a Value-Added Tax
This European version of the sales tax could
stealthily and dramatically grow the federal government.
Wall Street Journal
October 15, 2009
By Ernest S. Christian and Gary A. Robbins
On its way out of the recession, the economy
may encounter a VAT blocking its way.
Last week on PBS's "Charlie Rose Show," House Speaker
Nancy Pelosi said she thinks "it's fair to look at a
value-added tax." And the Congressional Research Service
just published a lengthy new paper on the value-added tax
that tends to obscure the fact that the middle class will
bear the majority of its burden.
Even Alan Greenspan is on board, albeit reluctantly, he says.
Paul Volcker, chairman of Mr. Obama's tax reform panel, may
not be far behind.
With the deficits at a historic high, these former heads of
the Federal Reserve may prefer to pay for President Obama's
spending spree with taxes instead of borrowed money. But tax
and spend is no better than borrow and spend. Why not just
stop spending so much?
For Mr. Obama, a VAT, which appears on the surface to simply
tax goods and services at the cash register, is the ideal
tax. At a 17% tax rate, for example, he can quickly increase
taxes by $1.5 trillion a year in a partially hidden way. A
VAT is by its nature hidden, because no one files a tax return.
The VAT is so slippery that academics here and abroad do not
agree on who pays this seemingly magical tax. Some economists
still deceive themselves with the old notion that a VAT is
simply a tax on consumers. This misperception comes from the
European VAT, which uses a system of credits to create the
illusion of pushing the tax forward from one business to another
and finally to consumers.
Modern economists in the U.S. take the view that consumers
bear only about 50% of the VAT, basically through higher prices
and fewer product choices. Because of market forces, the rest
of the tax ends up back on the owners and the employees of
the companies that produce and sell the goods and services
subject to the VAT.
Our own simple general equilibrium model suggests that about
33% of the VAT tax is borne by people in proportion to their
relative wage levels, about 17% in proportion to their capital,
and about 50% in proportion to their consumption. Federal,
state and municipal employees escape the implicit wage tax,
but otherwise, the VAT is predominantly a tax on middle-class
and upper-income earners and consumers.
The VAT also taxes imports, but excludes exports from taxation.
But here again there is confusion. For instance, who really
pays the import tax?
The old idea was that U.S. consumers would in all cases pony
up the import tax in addition to the price of the imported
product. In the case of most manufactured goods, however,
the modern view is that market competition pushes all or part
of the import tax back onto foreign sellers. There is no definitive
answer as yet.
Amidst all this uncertainty, just imagine what a master political
spin doctor like Mr. Obama could do with vast amounts of additional
tax revenues drawn heavily from the wages and savings of the
middle class, though widely misperceived to be paid disproportionately
by lower-income consumers.
Proceeding from that misperception, he could create a vast
new subsidy program that would offset by many multiples the
VAT tax actually borne by these newly created welfare recipients.
He could also increase the income tax on "the rich,"
saying that they and the middle class get a nearly free ride
under the VAT compared to less affluent people who must spend
everything on purchasing "taxable" essentials. Not
so, but the VAT lends itself to spin.
Mr. Obama and Mrs. Pelosi might also use the VAT to fund "free"
government-run medical care and hospitals for everyone, as
well as "free" college education and "free"
How about a temporary VAT, solely to pay down the federal
debt? When was the last time a tax ever went away? Or how
about a smaller VAT of only 5%? Obviously, it could quickly
grow. Any tax increase big enough to repay much of the huge
federal debt would devastate the economy for years to come.
The one certainty about a VAT is its enormous revenue-producing
potential. At a rate of 17% to 18%-about average for Europe-it
could increase total federal taxes to 30% of GDP or more from
15% now, according to the Congressional Budget Office. In
combination with higher federal spending, this could forever
alter the balance between the public and private sectors.
America and its economy would be radically changed-and not
for the better. The first priority in Washington should be
to cut spending, not to add a powerful new weapon to the tax
Mr. Christian, a lawyer, is co-author of "The Value Added
Tax: Orthodoxy and New Thinking" (Kluwer, 1989). Mr.
Robbins is the chief economist at the Center for Strategic
Tax Reform in Washington, D.C.