Erroneous and Dubious Anti-VAT Arguments

The other day the Wall Street Journal editorial page ran an article by Ernest S. Christian and Gary A. Robbins attacking the idea of a value-added tax for the United States. This is the second anti-VAT op-ed the Journal has run this year on top of two highly negative editorials. Only one piece has appeared favorable to the VAT and that was written by former Clinton administration Treasury official Roger Altman. Apparently, it’s okay for Democrats to get space in the Journal to promote the VAT because it allows the editorial page to maintain the fiction that only liberals favor such a tax as part of their nefarious plan to eventually tax 100% of everything. When I’ve queried the Journal about an article on why conservatives ought to support a VAT I did not get a reply.

Griping about rejected article ideas is not my point. I would rather look more deeply at the arguments used by those the Journal does publish on the subject of a VAT. Two things about the Christian-Robbins piece jumped out at me.

First, they make this extraordinary argument:

“Modern economists in the US take the view that consumers bear only about 50% of the VAT, basically through higher prices and fewer product choices. Because of market forces, the rest of the tax ends up back on the owners and the employees of the companies that produce and sell the goods and services subject to the VAT.”

The reason it is extraordinary is because the universal view of economists has always been that 100% of a VAT is shifted onto consumers. That’s what makes it a consumption tax and not a tax on capital, which is the main problem with income taxes. Reflecting the conventional wisdom among economists, a recent Congressional Research Service report put it this way,

“In estimating a VAT’s revenue yield, economists and public officials use the operating assumption that a VAT would be fully shifted to final consumers in the form of higher prices of goods.”

I searched through the various VAT books and public finance textbooks in my library, as well as searching the Internet for academic research showing that 50% of a VAT is borne by producers, and couldn’t find anything supporting this argument. Just to be on the safe side, I e-mailed some experts to see if they were aware of any reputable research making such an argument. Harvard economics professor Greg Mankiw, Stanford University economics professor Charles McLure Jr., Syracuse University economics professor Len Burman, and Tax Policy Center director Roseanne Altshuler all told me that they were unfamiliar with any such research.

If it is true that only half of a VAT is passed through to consumers then we would observe in cases where a VAT is introduced or increased that the prices for affected goods and services would rise by only half the amount of the VAT rate. In fact, we do not see this at all. Experience shows that prices do in fact rise by the amount of the VAT, exactly as one would expect under the generally-held assumption that consumers bear all the tax and that monetary authorities accommodate a one-time increase in the price level. (Of course, there are cases where prices didn’t rise by the amount of the VAT because it replaced other taxes already incorporated into prices, but when this is accounted for the effect of the VAT on the price level is the same as everywhere else.)

At a minimum, the Christian-Robbins view of the incidence of the VAT is eccentric and not one that can simply be asserted as if it is the conventional wisdom among economists. This wouldn’t matter so much if the point were made in a professional economists’ forum, but appearing in a publication primarily read by non-economists the assertion that “modern economists” hold a view that none except Robbins appear to hold is liable to make some people assume that something which is generally considered by economists to be untrue is true. (Mr. Christian is a tax lawyer.)

In the past, corporate executives have been among the VAT’s biggest supporters. They especially like its border adjustability. If a VAT replaced some tax that cannot be rebated at the border, such as the corporate income tax, a VAT would greatly improve their competitiveness. But corporations will certainly think twice about supporting a VAT if they believe that they will bear much of its burden. Indeed, if a VAT is in fact not fully shifted onto consumers then the whole rationale for border adjustability falls apart. It is only because world trade law assumes that the burden falls entirely on consumers that permits the VAT to be rebated at the border while corporate income taxes may not. (Although some portion of the corporate tax is incorporated into prices, there is no agreement among economists on what that is. Estimates vary widely.)

I assume that undermining support for a VAT among corporate executives is the principal reason why Christian and Robbins made their assertion in a forum heavily read by such people. If they had attempted to make it in a peer-reviewed academic journal it undoubtedly would have been rejected absent a vast amount of supporting data, analysis and econometrics proving the point. Indeed, if true, such an argument would be so novel that it would be considered an extremely important theoretical breakthrough that would call into question the justification for border-adjustability and force massive changes in world trade law and practice.

But this is not the only problem I had with the Christian-Robbins article. Later on they argue against a VAT on the grounds that it raises too much revenue. According to them, a rate of 17% to 18% — about average for Europe — would increase federal revenues from 15% of GDP to 30% of GDP. In other words, they are saying that a VAT would tax between 83% and 88% of GDP; that’s what would be required to get revenue equal to 15% of GDP from a tax rate of 17% or 18%.

Again, this is an absolutely extraordinary assertion that is passed off as if it is common knowledge. The Congressional Budget is given as the source of this estimate.

I searched in vain on the CBO web site for anything that came close to showing a potential VAT tax base of 80% to 90% of GDP. In fact, every CBO estimate I could find showed nothing of the kind. Various CBO publications consistently estimated the maximum tax base for a VAT as 70% of GDP. But a more reasonable tax base that didn’t attempt to tax things like the implicit rent homeowners pay to themselves, medical care, religious and welfare activities and other items that are both hard to tax administratively and impossible to tax politically reduce the potential tax base to about a third of GDP.

This is consistent with the experience in countries with VATs. I calculated the VAT tax base for countries comparable to the US and found that these were the percentages of GDP covered by the VAT: Germany, 29.5%; Italy, 30.2%; Canada, 32.8%; France, 37.1%; and the UK, 37.2%. The average for these countries is 33.4% and the median country is Canada. It’s also the country most like the US.

Therefore, it is reasonable to assume that a third of GDP is the most that could be taxed by a US VAT. To raise 15% of GDP in revenues on such a base would require a VAT tax rate of 45%, not 17% to 18%, as Christian and Robbins erroneously assert. The highest VAT rate I am aware of anywhere is 25% in Denmark, Norway and Sweden, three countries long known for exceptionally high taxes. For reference, the rates in countries more comparable to ours are these: Canada, 5%; Australia, 10%; the UK, 18%; Germany, 19%; France, 19.6%; and Italy, 20%. I should note that these are the standard rates; almost all countries have lower rates on some things and higher rates on others.

There are certainly legitimate arguments that can be made against a VAT for the US. But in its zeal to discredit the idea for purely partisan and ideological reasons, the Wall Street Journal has published an article making erroneous and highly dubious arguments.

• Become A Funded Futures Trader