Robert Samuelson critiques a value-added tax as a remedy for our fiscal woes:
A VAT is no panacea; deficit reduction can’t be painless. We’ll need both spending cuts and tax increases. A VAT might be the least bad tax, though my preference is for energy taxes. But what’s wrong with the simplistic VAT advocacy is that it deemphasizes spending cuts. The consequences would be unnecessarily high taxes that would weaken the economy and discriminate against the young. It would become harder for families to raise children. VAT enthusiasts need to answer two questions: What government spending would you cut? And how high would your VAT rates go?
I’ll add another problem with a VAT in the United States that I haven’t seen mentioned elsewhere: federalism. A VAT will result in a reduction in retail sales activity and that could well be ruinous to the states, largely dependent on real estate and sales taxes.
I’d like to propose a modest alternative to a value-added tax for increasing revenue: tax services. If we are, indeed, making a transition from an economy based on buying and selling objects to one based on services, doesn’t taxing the sales of objects while exempting the sales of services put additional downwards pressure on the sale of objects and, at least in relative terms, promote the sales of services?
The bank robber Willie Sutton allegedly said that he robbed banks because that’s where the money is and taxation functions along much the same lines. Clearly, the money is now going to services and I can’t see that providing services can escape being taxed forever.
In the final analysis we’re going to need to reduce spending and the only real candidates are Medicare, Social Security, and Defense for just the same reason: it’s where the money is. The big ticket items in the budget are Social Security, Medicare, Defense, and interest on the debt and of those Medicare is growing the fastest and, importantly, growing without bounds.
There are limits to how far we can cut the defense budget and even if we were to cut it entirely it wouldn’t produce as much savings as we need to going forward.
I don’t know if it’s still the case but Tennessee was doing precisely that when I lived there in 1995-1996. I’ve never seen it anywhere else, although I can’t think of any good reason for taxing goods but nt services.
As best as I can determine it only a handful of states levy use taxes on a broad range of services and all states limit the services on which taxes are levied.
There are very good reasons for not levying taxes on services: lawyers and doctors perform services.
Dave,
I think your complaint about a VAT is only true if it is a tax in addition to the income tax. However, if it replaced the income tax then your conclusion is not clear to me at all. If you think it is true for the VAT you have to think it is true for something like Hall and Rabushka’s flat income tax.
The benefits of a VAT or Hall and Rabushka’s flat tax is that they are considerably more efficient at raising the same amount of revenue in the sense of deadweight loss and lost hours, not necessarily that they will raise more money. Given this, I’m not sure what Samuelson is on about.
Nobody seems to mention a huge problem with the VAT: those of us with money and sense will leave the country to spend our dollars, sans the US VAT. If Costa Rica and Brazil were bargains before, they will become some 10% to 20% cheaper! They have long been much more fun.
Meh, we’ll just get you with import duties.
Samuelson is wrong. Those who want to cut spending need to say what they want to cut. If you read Cowen this w/e, it is possible. The problem is that it will probably have to be done by the left, as in Canada, and I am not sure they are ready to do it yet. They really got beat up trying to make some changes in Medicare.
Steve
Steve Verdon, a value-added tax will increase prices at the cash register and, consequently, reduce retail sales. Less retail sales means less sales tax revenue. If you’re arguing that eliminating the income tax (when the VAT was imposed) would increase economic activity, I doubt it unless the VAT is imposed on services and the purchase of financial instruments and so on as well. Does somebody who makes 100 times the median income spend 100 times as much on retail sales as somebody who makes the median income?
Additionally, there’s no prospect whatever of eliminating the income tax so, yes, I assume the VAT is in addition to the income tax and current sales taxes.
Dave,
Offsetting your effect will be an income effect, more income means more spending across the board as well. Basically a VAT is a flat consumption tax. Why wouldn’t services be taxed?
As I noted the economic effects are largely identical to those of the Hall & Rabushka flat income tax. If you think the VAT is bad you should think the Hall & Rabushka flat inocme tax is bad, and not many economists think that. The two are extraordinarily similar with the exception that wages are not taxed at the corporate level, but at the household level.
So let me rephrase the question: why is the Hall and Rabushka flat tax (tax rate 19% with a deduction to make the tax progressive in terms of average tax rates) a bad idea?
You can read all abou the tax here. Note the bood is also listed there in pdf format for those of you who don’t want to buy it.
It will tax all business income. The basic idea is to tax consumption. Here is a key graph from the chapter “The Postcard Tax Return”,
All business would determine their taxes as follows:
Total revenue – purchases from other firms – wages, salaries, other labor costs – purchases of plant and equipment.
Take that money and multiply it by 0.19 and there is your buisness tax.
Households/individuals would calculate their taxes this way:
(Wages+salary+retirement income) – an allowance multiplied by 0.19.
As can be seen it is vastly simpler than our current system and achieves the same goals as a VAT and has the added benefit of being progressive in marginal rates.
BTW, in regards to doing away with the current income tax and replacing it with a flat income tax or a VAT, it highlights once again the failure of government. We have a considerably superior method of raising the same amount of income yet we don’t switch. Why not? Rent seeking. There are billions and billions of dollars at stake and those who get those billions will fight tooth and nail to see that the current system is preserved. It is why, in the end, technocrats are actually stupid people.