Running out of tax options: How about a VAT?

While President Obama has pledged that he won't raise taxes on families earning less than $250,000, his advisers are beginning to realize this won't be possible without vastly increasing taxes on the wealthiest -- to a top income tax rate of about 70 percent.

That won't exactly fly, so what else can Obama do? Former Federal Reserve chairman Paul Volcker, and other tax experts, are calling for a value-added tax or VAT.

That would mean that everything you buy would cost more. Unlike sales taxes, VATs are added throughout the production of goods, so the price charged for those goods will likely rise to cover the costs of that tax. While Volcker is not recommending that taxes be raised until the economy recovers, he does recognize that if spending can't be cut, revenues must be increased.

Another person who raised the issue of a VAT this week was John Podesta, who heads the liberal think tank Center for American Progress. He believes taxes on the wealthiest and corporations will not solve the entire problem. The shortfall in Federal revenues is too high to make up the difference.

But the big question is: how high would that VAT be? Some who are discussing the option believe the government can make this more politically acceptable if tax rates are lowered at the same time.

In fact, that's exactly the strategy California Governor Arnold Schwarzenegger is pushing with something like a VAT called a Business Net Receipts Tax. His bipartisan tax commission wants California tax rates to be cut from 7 to 3 percent, and wants California to eliminate the corporate income tax and the 5 percent sales tax. These two taxes would be replaced by the Business Net Receipts Tax. The idea won favor with The Wall Street Journal, which supported the plan in an editorial.

The big problem with a VAT is that it tends to hit those with lower incomes the hardest, since they tend to use all of their income for consumption. If prices are higher on most items, their spending power will be much lower. Additionally, income taxes are lower for those in lower-income brackets, so a cut in income tax rates wouldn't make a big difference for them. However, they would end up paying a larger share of their income in taxes with a VAT system.

Would you support a value-added tax if it means lower income taxes?

Lita Epstein has written more than 25 books including The Complete Idiot's Guide to Tax Breaks and Deductions.
Read Full Story