Is BBCT the New VAT?

Anyone who reads the Wall Street Journal’s editorial page knows that it hates the value-added tax. I don’t mean hate the way it hates liberals, government regulators and the capital gains tax. No, the Journal hates the VAT more deeply and strenuously than anything else.

The reason is that the Journal sees the VAT as the essential fuel of the welfare state. Without it a European-style welfare state cannot exist. Therefore, if you hate the welfare state–as the Journal does–you must oppose the VAT with every fiber of your being. No fooling around; the VAT means Armageddon, the end of America as we know it and victory for welfare state liberalism. If we impose a VAT we will all soon be cheese-eating surrender monkeys just like the French.

The problem with the Journal’s hatred of the VAT is that it also embraces consumption-based taxation. Under a pure consumption tax there would essentially be no taxes on the returns to capital–no taxes on interest, dividends or capital gains. Such would be the Journal’s Nirvana, the perfect tax system (insofar as we have to have taxes at least to pay for a really big Defense Department to protect all the wealth that would quickly be accumulated under this perfect tax system).

Hence, the Journal has long championed the flat tax originally developed by Hoover Institution scholars Robert Hall and Alvin Rabushka, who first put forward their plan in a Journal op-ed. The Hall-Rabushka plan is a pure consumption tax with a single rate that is levied equally on businesses and individuals.

Economists have long recognized that while the single or flat rate is the most obvious fact about the plan, it’s not the most important. Imagine a flat rate on our current tax base. It would probably increase growth a bit, but not very much because the greatest economic distortions in our tax system relate to the tax base. Substituting any sort of coherent base, whether a consumption base or a comprehensive income (i.e., Haig-Simons) base would unquestionably improve economic performance much more. Even allowing for progressive rates on a consumption base would be far preferable to what we have now.

The problem is that there are really only two ways of taxing consumption broadly: the VAT or a retail sales tax. Every country with a national consumption tax has a VAT, none use a retail sales tax such as we have at the state level. The reason is that the tax collection system is too fragile to allow retail sales tax rates much above 10%. The VAT works well at rates at least twice as high because it is self-enforcing to a large extent–tax payments have to be reported by businesses to collect credits on taxes paid on inputs.

For this reason, the so-called FairTax that many unsophisticated tax reformers favor will not work. I know of no serious tax analyst who thinks it is possible to collect all federal taxes including the payroll tax using this system. Of course, it’s politically impossible anyway and therefore not worth wasting one’s time with. (The proponents are also crackpots who grossly misstate how their plan really works. See here for analysis.)

Consequently, the only consumption based tax system worth serious consideration is a VAT. Indeed, the Hall-Rabushka plan is a VAT. It is what is known as a subtraction-method VAT similar to the one in Japan. The other type of VAT is the credit-invoice method, which is widely used in Europe. They are mathematically identical.

So we come to the crux of the Journal’s dilemma. It wants a consumption-based tax system, but it hates the only type of consumption tax that would actually work.

As long as the Journal could confine the debate to tax reform, replacing the current system in a revenue-neutral manner, it could fudge the contradiction in its philosophy. The problem now is that the Journal also hates budget deficits and they are now much too large to realistically suggest that they be eliminated solely by spending cuts, even if the nitwit tea party crowd thinks so.

The Journal knows that revenues have to rise if we are to make a serious dent in projected budget deficits. It hasn’t yet said so in so many words, but it is finally allowing one of its most trusted op-ed writers to suggest the idea in a roundabout way. Thus this morning it allowed Glenn Hubbard, former chairman of the Council of Economic Advisers under George W. Bush, to say this:

If the administration wants to maintain the spending path on which its budget blueprint places us, it must confront and propose significant, broad-based tax increases. Let’s be clear what this means.

Our present income tax already relies very heavily on revenue from high earners; the top 1% pay well over one-third of federal income taxes. Mr. Obama’s budget increases the reliance. But we cannot count “taxes on the rich” for deficit reduction, health-care expansion and funding entitlements while ignoring the effect of those tax increases on investment, innovation and growth.

To raise the revenue for the president’s welfare-state ambitions, the tax increases must necessarily be broad-based, as, for example, with a broad-based consumption tax. A useful start would be to calculate—and present to the public each year—the broad-based consumption tax required to pay for higher spending.

To appreciate the importance of this statement one must read between the lines. Of course, the blame for any large tax increase must be placed squarely on Barack Obama’s policies even though half of projected deficits result from Bush’s policies. Nevertheless, it is the very first sign of realism with regard to higher revenues that I can recall reading on the Journal’s editorial page, ever. Up until now its position has been that the only permissible tax increase is that resulting from a further cut in the capital gains tax, which would lead to a flood of new revenues according to Journal dogma.

Moreover, the Journal seems to finally be dipping its toe into the VAT pool. Of course, it can’t reverse decades of opposition overnight, so it will have to be called a broad-based consumption tax or BBCT. But as I have noted, the only viable BBCT is a VAT.

It will be interesting to see whether the Journal allows other dissenting views to its heretofore unrelenting opposition to tax increases of any kind and a VAT in particular. It may end up having to take it all back and disown its own blasphemy. Nevertheless, it is a start, the beginning of fiscal sanity in a place where little has been seen since the death of Bob Bartley.

Addendum

Fortune also suggests the need for a VAT today. Chait comments on the same Hubbard article here.

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