A VAT Won’t Produce Instant Revenue, Easily Collected Revenue, or Fairness

“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.

See this 1993 Congressional Budget Office study and my October 12, 2009 blog for more.

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About Pete Davis 99 Articles

Affiliation: Davis Capital Investment Ideas

Pete Davis advises Wall Street money managers on Washington policy developments that affect the financial markets. President of his own consulting firm since 1992, Davis Capital Investment Ideas, he draws on 11 years of experience as a Capitol Hill economist with the Joint Committee on Taxation (1974-1981), the Senate Budget Committee (1981-1983), and Senator Robert C. Byrd (1992). He worked in the House and Senate, and for Republicans and Democrats.

Davis brought the first computer policy model, the Treasury Individual Income Tax Model, to Capitol Hill in early 1974, when he became a revenue estimator on the Joint Committee on Taxation. He formulated the 1975 rebate, the earned income tax credit, the 1976 estate tax rates, the 1978 marginal tax rates, and the Roth-Kemp tax cut. He left Capitol Hill in 1983 for the Washington Research Office of Prudential-Bache Securities, where he advised investors for seven years.

Davis has long written a newsletter on the Washington-Wall Street connection for his clients; Capital Gains and Games is his first foray into the blogosphere.

Visit: Capital Gains and Games

3 Comments on A VAT Won’t Produce Instant Revenue, Easily Collected Revenue, or Fairness

  1. Not quite certain of the nexus between a VAT and wages. In the UK, Ireland, rest of the EU, and pretty much every other country operating a VAT or GST (there is over 140 of them btw) salary and wages are not subject to any VAT / GST. How is “old capital” taxed by a new VAT? Again, I fail to see any nexus. New capital you are correct, VAT would be incurred and would not be a cost to the acquirer of the capital, it would be a VAT credit.

    Would also appreciate if the author might elucidate on the following comment:

    “Labor intensive industries would be particularly hard hit by a VAT.”

  2. As for the 7th point in the article, many countries operating GST / VAT systems are addressing this by way of harmonizing the national VAT with provincial / state taxes.

    Look to the north and Canada is a good example of a GST system where the 2 levels of taxation are being meshed into one. Why complicated, it has the benefit of easing compliance for businesses.

    An even more complicated excercise is underway in India where VAT / GST harmonization is underway with the plan for a unified GST to be applied from April 2011.

    In both cases a difficult approach to taxation at the federal and sub-national levels, but it can be done.

  3. Any new tax, VAT or otherwise, is nothing but destructive. It is pitiful that the supposed brilliance in D.C. can think of nothing other than confiscating more money from us. Gov’t produces NOTHING…yet consumes EVERYTHING. DUMP the entire code, all of it and pass a National Sales Tax of 15%, period!! NO exemptions!! EVERYBODY PAYS, everybody has skin in the game, the drug dealers, illegal aliens, babysitters, working class, the rich…ALL will pay into the system and thus have a valid interest into what is going on with those pirates in government.

    THEN…Uncle Sam…do what the rest of us have to do, live on a budget!! Return to CONSTITUTIONAL governance.

    Finally a Constitutional Amendment that ALL laws passed apply equally to ALL citizens..and YES that includes the assholes in government.

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