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It has been said that a value added
tax (VAT) will not pass because liberals fear it is regressive and
conservatives fear it will increase the size of the federal government. “However, the joke continues, a VAT will be
passed when liberals recognize that it could be a money machine and
conservatives recognize that it is regressive.”
But are the terms of the joke accurate?
Would enacting a vat be trading a regressive tax for more government?
I. What Is a VAT
There is more than one way to
implement a VAT and the intricacies of such implementation are beyond the scope
of this article. Suffice it to say, a
VAT imposes taxes at every level of production so that all taxes have been paid
by the time the good reaches the consumer.
This method of taxation gives each producer a tax credit equal to the
tax levied on his portion of the production.
Because the taxes are built into the price of the final good purchased
by a consumer, the consumer pays no additional tax at the cash register and
receives no corresponding credit. Though
it sounds complicated, a VAT is actually quite simple and better explained with
an example.
Alan owns a wheat farm and buys
seeds for ten dollars. When Alan
harvests his wheat and sells it to Bob for 110 dollars the government imposes
taxes on the 100 value Alan added (110 – 10) but gives him a corresponding
deduction for that tax; that is, at the end of the process Alan will not pay
taxes. Bob takes the wheat and makes
beer which he sells to Carl for 1000 dollars.
Bob is taxed on the 900 dollar value he added, but like Alan, Bob is
given a credit to offset this tax burden.
When Carl buys the beer form Bob he pays 1000 dollars and is not charged
any additional tax at the register – because the tax is built into the price of
the beer – and Carl gets no tax credit.
Essentially, a VAT imposes taxes on
the value the business adds to the good or service he sells. Notably, when the consumer purchases the good
he will pay the price on the good, not the price of the good plus an additional
tax.
II. Effects of a VAT
It is difficult, if not impossible,
to divide the effects of a VAT into categories of advantages and disadvantages
because, as illustrated by the joke above, one person’s advantage is another’s
disadvantage. Increasing government
revenue or equality may be seen as an advantage to some while they may be viewed
as a disadvantage to others. However, it
might be possible to conclude whether a VAT would be a tradeoff between a more
regressive tax system and more government intervention.
A. Would a VAT be Regressive?
At first glance, a VAT appears
regressive. Wealthier people consume
proportionately less of their income while less wealthy people may consume all
or almost all of their income. However, people
tend to consume about how much they earn so over a lifetime a VAT tends to be a
lot less regressive than one might think.
More importantly, one should start an analysis of whether a VAT would be
regressive by asking: to what are we comparing a VAT? In the United Sates corporate and personal
income taxes are progressive while payroll and excise taxes are regressive.
A second integral part of analyzing
how regressive a VAT would be is defining what would be subject to the VAT. It is likely that if Congress passed a VAT,
it would create a zero tax designation for a number of goods frequently
purchased by low-income people. It is
also possible that Congress would create a flat exemption for the VAT which
might be aimed at alleviating a certain level of spending from the VAT thus
insulating low-income Americans from the effects of a VAT.
Additionally, Congress might target
small business for exemption from a VAT (partially due to high administrative costs). While the point of taxation is to raise
revenue for the government, exempting small businesses, which are the “engine
of job growth in America,” would be politically popular while the specter of
raising taxes on small business might be considered a political nonstarter, so
this is a likely possibility.
Importantly, exempting small business might relieve them from compliance
cost which would make a VAT less regressive.
Finally, changing from our current
system to a VAT would change incentives for saving. The current system in the United States taxes
a person’s savings twice: once when he earns money and a second time when his
savings earns interest. Clearly this double taxation dissuades Americans from
saving. However, a VAT would create an
incentive to save. Recently, the
personal savings rates of Americans has been cause for concern as the personal
saving rate dipped into the negative for the first time ever in 2006. However, while it might have been wise to
remove disincentives to personal savings in the past, it might be unwise to
create incentives to save during a recession when the government needs people
to spend their money. In terms of how
regressive a VAT would be, it would create an incentive to save but that
incentive could only be acted upon by individuals wealthy enough to have
disposable income. At the same time, and
mentioned above, in the long run individuals tend to spend the money they earn
so the effect on savings might be overstated.
Simply put, whether a VAT would be
regressive is a bit more complicated than one might think.
B. Would a VAT Increase the Size of Government?
Whether a VAT would increase the
size of government, at least partially, depends on if the VAT increases
revenue, which in turn depends on the rate of the VAT, the spending habits of
consumers, and the exemptions provided for by Congress. These variables are difficult to assess but two
consequences for government of a implementing a VAT are noteworthy.
A VAT will decrease a consumer’s association
between taxes and increased costs because taxes are built in to the price of
the good. When a consumer takes a good
to a cash register he will only see the price he pays for, essentially
eliminating the ability to take into account the cost of the good added by
taxes. This disassociation will make it
easier for government to raise taxes in the future because consumers will be
less likely to notice the increase or if they notice the increase consumers
will be less likely to blame government.
Shrouding government taxes through a VAT makes it less likely that
people will notice or oppose tax increases which might make it easier for
government to grow.
This change in how consumer will
assess the role of taxes in the price of a good has a corresponding upside: it
makes collecting taxes less politically contentious (a problem noted by above)
which might in turn help the government avoid a situations like California’s
current budget crises in which revenue cannot be raised without a
referendum. Clearly, for proponents of
smaller government the way to avoid government growth would be to cut expenditures
but a VAT might still help avoid a political stalemate.
Second, and related, consumers are
better able to assess the cost of goods and therefore better able to make good
decisions. That is to say, not having
taxes add at the register and removing the possibility of owing the government
taxes at the end of the year better equip a consumer to make smart choices.
III. Conclusion
Like most tax issues the VAT is
complex. VATs are difficult to assess in
the abstract because the “devil is in the details.” However, two conclusions are worth
making. First, VATs might not be as
regressive as one might think because of life-time spending habits and thus the
difference between our current tax system and a VAT might be “less than
commonly imagined.” Additionally, there are ways to implement a
VAT that would minimize how regressive it might be in the short-term. Second, while a VAT hides taxes within the
cost of a good and thus might make it easier to raise taxes, it also makes a
consumer’s choice better informed and therefore more efficient.
If liberals choose to oppose a VAT
it should not be because it is necessarily regressive and if conservatives
choose to oppose a VAT it should not be because it necessarily will grow
government.
Endnotes:
[1] Gilbert E. Metcalf, Value-Added Taxation: A Tax Whose Time has
Come? 9 Journal of Economic
Perspectives 121, 123 (1995).
[2] Two common types of VATs are the subtraction method and the credit
method. “Under a subtraction method VAT,
a business deducts business purchases, including capital outlays, from sales
and pays tax on the difference. A subtraction method VAT, sometimes called a
business activities tax (BAT), differs from a single-rate credit method VAT
only in computation procedure, and the two taxes produce the same revenue if
imposed at the same rate.” J. Clifton
Fleming, Jr., Sorting out the Uncertain
Simplification (Complication?) Effects of VATs, BATs and Consumed Income Taxes
2 Fla. Tax Rev. 390 (1995).
[3] Id.
[4] John K. McNulty, Flat Tax, Consumption Tax, Consumption-Type
Income Tax Proposals in the United States: A Tax Policy Discussion of
Fundamental Tax Reform 88 Calif. L.
Rev. 2095, 2147 (2000).
[5] Id at 2148; see also,
Gilbert E. Metcalf, supra note 1; see
also, Joseph Bankman and Barbara H. Fried, Winners
and Loser in the Shift to a Consumption Tax 86
Geo. L.J. 539, 546-47 (1998).
[6] John K. McNulty, supra note 4.
[7] Sean Raft, Imagining a Progressive and Comprehensive
Consumption Tax 86 Or. L. Rev. 161, 177
(2007).
[8] Gary Chartier, A Progressive Case for a Universal Transaction
Tax 58 Me. L. Rev 1, 7 (2006).
[9] Gilbert E. Metcalf, supra note 1.
[10] Jesse Lee, “The Engine of
Job Growth in America” White House Blog, available
at http://www.whitehouse.gov/blog/2010/02/02/jumpstarting-small-businesses-engine-job-growth-america.
[11] Barry M. Freiman, The Japanese Consumption Tax: Value-Added
Model or Administrative Nightmare? 40
Am. U.L. Rev. 1265, 1299 (1991).
[12] Michael J. Graetz, Taxes that Work: A Simple American Plan 58 Fla. L. Rev. 1043, 1054 (2006).
[13] Gilbert E. Metcalf, supra note 1 at 131.
[14] Bureau of Economic Analysis,
Comparison of Personal Saving in the NIPAs with Personal Saving in the FFAs, http://www.bea.gov/national/nipaweb/Nipa-Frb.asp.
[15] Sean Raft, supra note 7 at 198.
[16]
Joseph Bankman and Barbara H. Fried, supra
note 5 at 546.