Yesterday, the National Retail Federation made news for its economic analysis of a Value Added Tax (VAT). The study considered the addition of a VAT to the existing tax structure, something that just won’t happen. But assuming that the existing tax structure was somehow tweaked, there is likely some limited support for a VAT (click here for my prior post on efforts to implement a VAT in the US).
So today’s Fix the Tax Code Friday question is:
I would support less spending.
I agree that adding a VAT on top of the current system is a non-starter, but replacing the current system with a VAT is equally ridiculous. I think a progressive form of consumption tax, along with a continued income tax for the very wealthy would be a better choice. Of course, taxes are only onside of the equation, and spending will also need to be address.
Going to a VAT only system would narrow the tax base and rates would have to be increased to produce the same amount of revenue. The current mean effective tax rate for all Americans is about 22%. That means that a VAT would have to be at least 25-30%, and since 60% of Americans have effective federal tax rates below 15.5% a majority of Americans would see an increase in their tax burden, while the top 20% would be reduced significantly (the other 20% would remain about the same). That just isn’t going to happen.
Independent of the huge rate required a VAT is a bad idea (at least alone it is). Since a VAT is a form of consumption tax, it can be viewed similarly to a national sales tax. Both types of taxes would impact those at the lower end of the socio-economic spectrum, because those with higher-incomes have the choice to spend or consume. And that impact is made more significant because both a VAT and national sales tax would have to be flat rate taxes.
There is, however, a way to make consumption taxes progressive, and in reality our current income tax system functions as a hybrid consumption/income tax. All income is either saved or consumed, so every preference we give to savings programs (IRAs and 401Ks) moves us closer to a consumption tax base. For the millions of Americans whose primary (or only) savings is in the form of preferred retirement accounts, the tax they pay is a consumption tax, and a progressive on at that. All that would need to be done to turn our current system into a consumption based tax would be to allow everyone to deduct from their income the increase in all of their savings for that year. Imagine, you get the same w-2, but instead of all the crazy credits and deductions they ask you account balances in the beginning of the year, and at the end, you deduct the difference from your income and POOF a progressive consumption tax. I would still impose some income tax on the very wealth, to encourage them to consume (which stimulates the economy) and protect against the continued consolidation of wealth.
Not so fun fact…. The top 20% of Americans own 85% of the wealth, while the bottom 40% own a mere .3%. The middle and upper-middle class (40th to 80th percentiles) owns about 14.7%.
Another option would be that proposed by Michael Graetz, in his article 100 Million Unnecessary returns, in which he proposes to eliminate the federal income tax for all those making less than $100,000. He argues the administrative costs on the government, and the compliance costs on the taxpayers make imposing the normal reporting requirements on most Americans inefficient. Graetz suggests that a small VAT be added to the system collect taxes from all based on their consumption, could replace the income lost by eliminating those making less than 100K from the income tax roles.
And now a response to Chris’ comment. I agree, and I think most would, that lower taxes for everyone would be great and I think most would also agree that eliminating the deficit is important as well. The only way to do both is to significantly reduce spending, but I have not heard one candidate say what they would cut. Increased efficiency won’t do it, we need major cuts to many popular programs. Are we willing to means test Social Security, should we cut defense spending, do we cut spending on science or education? I am waiting for someone to step up and show that they are willing to make tough choices, and to make compelling arguments as to why their choices are the right ones.
I, too, am for far less spending. Why send local dollars to the federal government, only to be (partially) “returned” to the states in the form of entitlement spending? I would support serious cuts to federal entitlement programs while maintaining a strong defense budget.
Starting from scratch sounds impossible. but singapore manahed to do it and folks there, for the most part, were cooperative. The following is a Wikopedia explanation for Singapores’ GST. I believe current GST is 7%.
Singapore’s GST is a broad-based consumption tax levied on import of goods, as well as nearly all supplies of goods and services. The only exemptions are for the sales and leases of residential properties and most financial services. Export of goods and international services are zero-rated.
Before 1986, Singapore’s corporate income tax rate and top marginal personal income tax rate both stood at 40%. Such high rates were deemed to be uncompetitive. On the recommendation of the 1986 Economic Committee, Singapore’s government decided that it needed to shift from direct to indirect taxes, in order to maintain its international competitiveness in attracting investments, and to sustain its economic growth in order to create well-paying jobs for Singaporeans.
Go to Wikipedia for more explanation, and remember there is no income tax, at all.
The great attribute of the VAT system is that it becomes INVISIBLE. If Joe American does not see it, Joe (and Josephine) don’t feel any pain or outrage at paying it. After all, it’s something that businesses pay, right? It does not hurt individuals — does it?
Maybe it starts small, like 1%. That wasn’t too much, was it? Didn’t the income tax start out that way? Then 1.5%. And, before you know it, 25.0%. A politician’s dream! Unlimited taxation, and the public does not even realize what is happening!
So, yes, I am very much opposed to the VAT.
Tim said it very well. VAT’s “work” in Europe because income distribution in most European countries is far less skewed than it is here. My opinion of “flat” tax and VAT is that, in the US, it’s just a scam to get middle class Americans to pay more of wealthy people’s taxes. Malcolm Forbes may give all sorts of smoke and miorrors arguments why the flat tax is such a wonderful thing, but the bottom line is that it would save him a bundle — at my expense.
I also wonder at the wisdom of taxing consumption. Why is that such a smart thing to do? Ours is a consumption-driven economy. The same economists who endorse consumption taxes are now wailing that US consumers are playing it too close to the vest and need to consume more if the economy is to get out of this hole.
I also am very much interested in whqat is supposed to follow in nthe conversation when politicians say ‘cur spending!” They never get to the part about what should be cut, although I would assume the actual answer is cut the programs that result in largesse for you and keep the ones that benefit me intact.
And lest I be mistaken for a know-nothing — I have a PhD in Economics, from a real Unibersity: Duke.