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Anyone smell a big, regressive Value Added Tax coming our way?

COMMENTARY | September 23, 2011

Most Western European countries have VATs, but, as Henry Banta points out, their experience is of doubtful use for us. For one thing, most of them have genuine universal health care, and they differ in other ways in the distribution of benefits to the middle and working classes.

By Henry Banta

In the world of tax policy (a veritable cauldron of cynicism) there is an old saying that the U.S. will get a value added tax (VAT) when the Democrats discover that it would be a money machine for the government and the Republicans figure out it would be regressive.

A little more than a week ago we took another step in the direction of that bipartisan tax nirvana. In a New York Times op-ed piece Robert Barro (of Harvard and a favorite economist of Republicans) supported the replacement of the corporate income tax with a VAT. His piece drew immediate fire from liberal quarters, not because of his support of the VAT, but because of his argument that, “Today’s priority has to be austerity, not stimulus. . . .” But his proposal that we replace the corporate income tax with a VAT drew little comment.  Perhaps in the interest of giving the idea a little more appeal to Republicans, he actually overstated the degree of liberal opposition to the VAT. Jared Bernstein noted that in his experience, “liberal tax reformers typically like a progressive VAT.”

In any case, some conservatives see the VAT as appealing to the worst instincts of “tax-and-spend” liberals. Once in place, it has a low visibility and it is easy to raise large sums in tiny increments that can go unnoticed. It functions as a hidden sales tax. At each level of production or distribution the added value is taxed. The total tax is hidden in the final prices of goods and services paid for by consumers. Upward creep is almost inevitable. In the conservative mind, this gives it an irresistible appeal to politicians.

Reporters and editors should get to understand the VAT and write about it, since eventually the Republicans will morph their “no taxes” pledge into something they no doubt will call a great compromise, the most they can possibly bend. Grover Norquist could be working on it right now. Would Democrats, aside from the knowledgeable ones, say no to that? 

There are a number of features of the VAT that Professor Barro did not mention and that many liberals might find objectionable if they give it sufficient thought. First, and by far the most important is that it is really regressive. As a tax on the value of all goods and services, it is a monster sales tax. Since the less affluent spend a much greater portion of their income just keeping alive, warm, and moderately amused, the burden would fall disproportionally on them. Proponents of the VAT argue that this can’t be all that bad because a lot of other countries use the VAT without serious damage to middle and lower classes. That may be true, at least in part, but it is of very questionable relevance to where most Americans find themselves at the moment.

Most Western European countries use a VAT in one form or another. However, the European experience is of doubtful use to us. First, the major European economies simply do not have the frightful disparity in both wealth and income between the very rich and everybody else that we do. Second, the European economies are quite different from ours in their overall tax structure and in the distribution of benefits to the middle and lower classes. (Most really do have universal health care.) All of which mitigates the inherent regressive effect of the VAT tax. 

A recent study by Peter Diamond and Emmanuel Saez noted that in the U.S., “The share of total income going to the top 1 percent of income earners (those with annual income above roughly about $400,000 in 2007) has increased dramatically from 9 percent in 1970 to 23.5 percent in 2007, the highest level on record since 1928 and much higher than in European countries, or Japan today . . . .“

In fact the massive redistribution of wealth and income in the United States has most certainly been abetted by our tax code. Hacker and Pierson in their book, Winner-Take-All Politics, attribute much of the gain by the very rich to their increasingly favorable treatment in the tax code: “They are not simply richer because their paychecks have grown; they’re richer because the government taxes them much less heavily than it once did.”

One of the more regressive features of the tax code has to do with its treatment of capital gains as opposed to salary income. A recent Washington Post article (September 11, 2011) reported that, “Over the past 20 years, more than 80 percent of the capital gains income realized in the United States has gone to 5 percent of the people; about half of all the capital gains have gone to the wealthiest 0.1 percent.” The article goes on to say that, “The 400 richest taxpayers in 2008 counted 60 percent of their income in the form of capital gains and 8 percent from salary and wages. The rest of the country reported 5 percent in capital gains and 72 percent in salary.”

Yet in the face of all this, we tax investment income at a much lower rate than income from labor. In sum, our growing inequality does need any more help from the tax code. Particularly since the political class shows little sign of abandoning its obscene pandering to the limitless greed of the top 0.1 percent.

The substitution of a VAT for the corporate income tax as Professor Barro suggests has the potential of putting the regressive effect on steroids. Most tax experts consider the corporate income tax to have a progressive effect because it generally falls on stock owners who are clustered at the top of the economic ladder. Hence replacing it with the regressive VAT seems a really bad idea. Granted there are a few who consider the corporate income tax regressive because of a theory that says the burden falls on labor.  Some have suggested that somewhere around 40 to 80 percent falls on labor.  Lee Sheppard, writing in Tax Notes (August 22, 2011) dismisses this idea “because if labor bore such a significant share of the corporate income tax, corporate managers would not devote so much time and effort to fighting it.” She also notes that in Europe managers don’t fight high value added taxes because they know that they clearly fall on consumers.

Advocates of the VAT frequently point to its ease of administration and to the difficulty of evasion. There is an obvious appeal in anything that might justify reducing the resources of the  IRS. But the simplicity of a VAT is an illusion and opportunities for evasion are many. A review of the European tax literature will dispel any notion that the VAT can be simply administered. Even the basic notion of a tax on “value” is fraught with endless complexity. Anyone who doubts this should look at the century-long legal war waged by the U.S. Interior Department, various oil producing states, Indian tribes and a score of oil companies over the federal oil royalties which are based on the “value” of the oil produced on federal lands. Oil, one might note, is a fairly simple commodity, traded across the world in myriads of markets. If  “value” is a problem for oil what happens with something really complicated? 

Also relevant here is our nightmare experience with “transfer pricing” of goods between the foreign and domestic branches of the same corporation. For decades the IRS has attempted to deal with the problem where a foreign subsidiary of a domestic corporation “sells” a product to the domestic firm at an artificially inflated price, i.e. a price above its actual value. This has the effect of reducing firms’ domestic tax liability. It is, of course, illegal but it is also almost impossible to police because the accurate determination of value is so difficult. One commentator suggested the problem couldn’t be resolved even if we converted the entire Marine Corps into cost accountants.

The trading of intangible assets, in particular, presents endless complications that bring joy to tax lawyers and accountants. One can only sympathize with the frustration of the Tax Court of Canada in its efforts to deal with the “philosophical conundrums” presented by the trading of intangibles under the Canadian VAT.” (State Farm v. The Queen, 2003 G.T.C. 632, Doc 2005-4356.)  Intangibles are a growing part of trade both domestic and international and the issues they present can be insanely complex when one attempts to tax their value. For example, what is the value of an architect’s work or a lawyer’s advice when it is done “in house” and then becomes part of something else which is sold?

With a Congressional super-committee deadlocked on taxes as it begins looking to cut the national debt, a VAT could seem logical. But for those who might be tempted to see the VAT as a way of getting past ideological differences on tax policy, simplifying the tax code, reducing the debt and saving social security and Medicare: Think again.


They get what they want from this "democracy"
Posted by P Brandt
09/23/2011, 06:32 PM

We will get whatever they want. It is clear that since Corporate PACs overtook unions in raising campaign cash for politicians races, sometime before 1980, the money people get exactly what they want from this system. There may be a little dancing like with DADT just for show that the Dems can do something, but don't tell anybody, DADT costs the Top 1% not one penny! It does provide a nice platform for some divide-and-rule and scare mongering for the next election. We will get whatever they want. That is it. My friend says it is going to be a 40% drop in standard of living that they're shooting for. Fix the institutions and the foundational elements. These little issues are nothing.

Not a burden on the poor
Posted by Peter Devlin
09/27/2011, 03:17 PM

Actually, in almost every VAT / GST country with the exception of Singapore and New Zealand, the potential regressive nature of the VAT is addressed through carve-outs, which ensure that essential goods and services are not subject to the tax, so that those folks who do spend proportionately more of their dollars on basic necessities are not being taxed. For example, basic food items / basic groceries, health care, public transportation, education, residential real estate are all usually included in the basket of goods / services to which VAT is not added.

As Barry says, it's not warfare, it is simple math.

VAT tax
Posted by ACitizen
10/01/2011, 10:48 AM

Actually a VAT tax would not effect me because I have no money for anything but necessities anyway.

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