“As the night follows the day, VAT follows health care reform.” That’s how Charles Krauthammer started his Washington Post op-ed yesterday. He blissfully implies Uncle Sam can flip a switch and collect a trillion dollars over 10 years for every percentage point of VAT, “the ultimate cash cow.” I beg to differ.
Some of the lessons I learned from my experience formulating Al Ullman’s VAT proposal of 1979 include:
1. Like, the U.K. when it adopted its VAT in 1973, the U.S. will struggle for at least two years and probably longer to implement a VAT. Hundreds of thousands of small businesses would have to register with the IRS and have their sales and remittances monitored. The IRS would have to hire tens of thousands more agents. Exemptions will alleviate some of that problem, but a VAT exemption still hits those businesses with the tax. The income tax looks bad now, but wait until you see this.
2. Compared to our income tax, the VAT is regressive. The poor and the elderly will be particularly hard hit because they consume more than their income out of transfer payments and wealth. To alleviate that, there will be tremendous political pressure to “zero rate” food, housing, and medical services, roughly half of the VAT personal consumption tax base. My work with the Treasury Tax Model showed these zero rates yielded surprisingly little improvement in progressivity. Far better to let the poor and the elderly pay the tax and provide them with a refundable tax credit roughly equal to what they paid. Not only would this be quite complicated, it would increase fraud and IRS enforcement actions to stem fraud.
3. Tax reformers lambast the complexity of our income tax with good reason, but somehow assume that the same people who legislated that complexity will bring legislate a clean VAT. Again, the U.K. experience is very instructive. Their VAT is notoriously complicated, and so would be ours.
4. I can’t think of a faster way to kill Rust Belt jobs than to impose a VAT. That’s because a VAT is a tax on wages plus old capital. Old capital would be doubly taxed because it was already taxed under the income tax and would be taxed again under the VAT. New capital would benefit under a VAT, but it would tend to create higher value added jobs that Rust Belt workers might not qualify for. Labor intensive industries would be particularly hard hit by a VAT.
5. Housing would be hurt be a VAT even if it is zero rated. Studies have shown that approximately half of the economic gains from a VAT result from shifting capital from housing to business.
6. Exporters would benefit from a VAT, but that benefit would be partially offset to the extend that the dollar appreciated against the currencies of our trading partners. Conversely, importers would be hurt with some relief from the dollar appreciation.
7. State government sales tax revenues would be directly impacted by a federal VAT. That’s why some have called for a portion of the federal VAT to be allocated back to the states. This would be an additional complication and would be subject to lots of political tinkering.