Is a value-added tax the answer to U.S. debt?
It doesn't look to get any better as Congress just voted in a $447 billion spending bill in a year where revenues are down. That doesn't include the projected cost of the health care bill, tax credit extensions and other budget-altering items slated for consideration. It's clear that something has to change.
Congress is, of course, collectively scratching their heads and wondering what to do next. You can only tax the rich so much. And raising taxes on the middle class would break a campaign promise -- not something that you want to do as the 2010 elections approach.
With so much emphasis on raising revenue, it's not surprising to see that an old idea is getting a fresh look: the consumption tax.
The most popular version of the consumption tax is the value-added tax, or the VAT. Some variation of a VAT is used in 150 other countries, including heavily in Europe and Asia.
A VAT is a tax collected on goods and services. It differs slightly from a sales tax in that it taxes the value added at each stage of production, rather than merely the final value at the sale. The idea is that spreading the burden of the tax over a number of different businesses and consumers might reduce the potential for fraud and thus, boost collections. In the Internet age, this is especially appealing; estimates are that billions of dollars are lost in potential tax revenue to online sales which avoid sales tax.
Proponents of such a tax in the U.S. point to other countries which have used the VAT to their advantage with little in the way of administrative costs. Countries with rates of high unemployment but growing economies, such as India, increasingly look to the VAT to compensate for lost income-tax revenue. Many European countries have relied heavily on the VAT for years: the French have used the VAT as a primary source of income since the 1950s. The French VAT now accounts for 52% of that government's revenues.
Opponents of the tax note that the tax would ultimately mean no change for the consumer since, in a capitalist economy, the costs would merely be passed along. And while taxpayers in some states already pay sales tax on necessities, a federal sales tax on goods and services is widely viewed as regressive, affecting most those who can least afford to pay it.
Policy arguments aside, the most daunting obstacle to the VAT is the 67,204-page federal tax code. The implementation of a VAT would require a complete overhaul of the existing federal tax code, something our Congress has been loathe to do. There's been little in the way of major reform in more than 20 years. In contrast, almost every modern nation which has adopted the VAT has made significant changes to their existing income tax systems.
Economists and politicians differ on what changes to the tax code would make the most sense if the federal government adopted a VAT. While some argue that it should replace the entire federal income tax system, that doesn't make economic sense: no other comparable developed country has managed to entirely replace their income tax with a VAT. The argument instead would focus on burden-shifting. In other words, instead of "can we replace the income tax with a VAT?" the real question is, "which components of the income tax would be replaced by the VAT?"
It has been argued that the nature of the VAT would lend itself to an elimination of the tax on passive investments, such as dividends and interest. Yale law professor Michael J. Graetz suggested in 2008 that a VAT might allow an exemption from income tax for families earning less than $100,000. Still others point to countries like Ireland, which has used the VAT as a means to lower its corporate tax rates to attract investors.
There are no easy answers. The latest data indicates that 47% of U.S. households will likely owe no tax in 2009, which means that the majority of the tax burden will be carried by just over half of the population. That kind of tax burden just can't be sustained over the long run, especially if we want any chance of paying down our debt. Revenue will have to come from somewhere: is a VAT the answer?