Vapidness of the VAT

Robert Samuelson discusses the rhetoric surrounding a Value Added Tax being put forth by the VAT advocates:

The VAT is being merchandised as an almost-painless way to avoid deep spending cuts. The implicit, though often unstated, message is that a VAT could raise so much money it could eliminate future deficits by itself. This reasoning, if embraced, would create staggering tax burdens and exempt us from a debate we desperately need.

The debate that Samuelson notes we need is about the size of government. Of course, the VAT is being championed as a cure-all for the massive, soul-crushing, economy-killing deficits we are seeing in the next few years. But the most important thing to remember about the VAT is that is being suggested IN ADDITION TO not IN PLACE OF the current income tax system. Everytime you hear about the "success" of the VAT in Europe, be sure to remember that Europeans don't just pay the VAT as they only significant tax, they pay a VAT AND an Income tax, usually the combined marginal rates of the VAT and income tax approach and exceed 50 percent.

Of course advocates are saying "we just need a small VAT" since it will apply to just about everything. The problem is that like any other tax that applies to "just about everything" it implies that the VAT won't apply to everything and then the jockeying will begin to have an exemption:

A VAT could not painlessly fill this void. Applied to all consumption spending -- about 70 percent of GDP -- the required VAT rate would equal about 8 percent. But the actual increase might be closer to 16 percent because there would be huge pressures to exempt groceries, rent and housing, health care, education and charitable groups. Together, they account for nearly half of $10 trillion of consumer spending. There would also be other upward (and more technical) pressures on the VAT rate.

Does anyone believe that Americans wouldn't notice 16 percent price increases for cars, televisions, airfares, gasoline -- and much more -- even if phased in? As for a VAT's claimed benefits (simplicity, promotion of investment), these depend mainly on a VAT replacing the present complex income tax that discriminates against investment. That's unlikely because it would require implausibly steep VAT rates. Chances are we'd pay both the income tax and the VAT, making the overall tax system more complicated.

Europe's widespread VATs aren't models of simplicity. Among the European Union's 27 members, the basic rate varies from 15 percent (Cyprus, Luxembourg) to 25 percent (Denmark, Hungary and Sweden). But there are many preferential rates and exemptions. In Ireland, food is taxed at three rates (zero, 4.8 percent and 13.5 percent). In the Netherlands, hotels are taxed at 6 percent. An American VAT would stimulate ferocious lobbying for favorable treatment.

If the VAT is going to be in place of an income tax, fine--I can live with a reasonable VAT, but that is not what is going to happen.

In order to close those massive, soul-crushing, economy-killing deficits, the VAT and the income tax would have to be in place. Proponents may even admit that truth, but would say "it is only temporary, until we close the deficit." But it will never happen, once in place, the government will become addicted to the income and will never take the next step--either eliminate the income tax or eliminate the VAT. As Samuelson notes in conclusion:

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.

That's right--if you really want to cut the deficit in government you have to cut the government spending. It really is that simple and it won't need a VAT to do it.