The VAT-Man Cometh?

Recently, progressives have made noise about introducing a value-added tax (VAT) in the United States. The VAT is an indirect tax—that is, Americans wouldn’t pay the tax directly to government, but would pay it to businesses as part of the retail price of things we buy, and businesses would then remit the tax to Uncle Sam.

A VAT is set at a fixed rate—say, 10 or 15 percent—added to the price of a good at every step of production, with a deduction allowed for the amount of VAT paid during earlier stages of production. The more steps there are in transforming raw materials into complex consumer goods, the higher the resulting consumer price as a result of those multiple layers of taxation.

Many countries have VATs, including Canada, Mexico, and the European Union. One might say that a VAT is an emblem signifying that a country’s government consumes a large percentage of its GDP, for VATs seem to go hand-in-hand with big-budget nanny states.

The reason for this phenomenon is simple: Any government that seeks to be all things to all people, and therefore seeks to spend ubiquitously, must inevitably seek to tax ubiquitously. Such governments have insatiable appetites for revenue. Because VATs are cash cows, diverting huge sums of money from consumers to government, they are favorites of big-spending governments.

Unfortunately, though, VATs have significant negative economic consequences.

Because they inflate consumer prices, quantities demanded fall. Most often, the marginal buyers who can no longer afford to pay the higher price are poorer citizens. When government policy raises prices (see “Government Intervention and Higher Prices”), the first victims are poor people.

The second victims of a VAT are the workers who will lose their jobs as a result of falling demand for the newly higher-priced goods.

Many affluent Americans may not curtail their consumption, but because more of their money is diverted to the government treasury, their savings must correspondingly decline. This results in decreased capital accumulation, which, in turn, slows business expansion, development, and formation. It also slows the growth rate of labor productivity, hence retarding economic progress for workers.

The desire of today’s big spenders in Washington to greatly increase their revenues is reminiscent of how FDR financed his spending binge during the Great Depression. During the 1930s, federal revenues from the income tax fell the more tax rates were raised. (Congress, take note.) To raise more revenue, FDR and Congress increased excise taxes—taxes embedded in the price of common consumer goods like gasoline, milk, and cigarettes. The effectiveness of those taxes as generators of government income derived from the fact that those taxes are difficult to avoid, unless you can live without milk, gasoline, etc.

VATs are essentially excise taxes. They are economically destructive and hit society’s most vulnerable members the hardest. Here let me offer both a political strategy to resist the imposition of a VAT and an alternative proposal for opponents of a VAT to rally around:

The strategy is a recommendation to Republicans to not obsess about or campaign for balanced budgets. This is not to say that deficits don’t matter. They do, and they’ve got to go.

The problem with focusing on a balanced budget is that it sets up a dynamic of balancing spending cuts and tax increases. Tax increases, as we have already seen, depress economic conditions. Who can get excited about that kind of economic plan? Deficits need to be eliminated by cutting spending, however unpopular that may be in certain quarters.

As economists for the past two centuries have made plain, the real burden of government is not what it taxes but what it spends, because whatever it spends comes at the expense of citizens, whether via taxes, borrowing, or creating additional Federal Reserve Notes. Reducing the burden of government means slashing government spending, not raising taxes.

Here is a counterproposal: Instead of adding yet another “stealth” tax—the VAT—to the many excise taxes already in place, let’s have Congress pass a truth-in-labeling law.

Let’s require all excise taxes and all other hidden taxes (e.g., payroll, real estate, franchise, excise) that are embedded in the price of consumer goods to be listed in plain sight. Put the dollar amount of those taxes on price signs, price tags, and at the point of sale. Then, Americans will be able to clearly see how much they are paying in indirect taxes to government.

What’s holding you back, Congress? You aren’t afraid of the truth, are you?

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  • SeanReynoldsNZ

    I thought that the whole idea of the “fair-tax” was essentially a VAT, or GST (Goods and Services Tax) as it is known in Australia and New Zealand. So if so, could someone explain what the problem is with introducing the VAT if there is also a corresponding decrease in income tax to accompany it?

    The point is that a VAT is easily avoided upfront because you only pay it when you spend giving you an incentive to save and invest that does not exist with income taxes. It also needs to be combined with a tax on purchasing foreign currency to encourage people to invest within their country.

    Just a thought, but I think that Dr Hendrickson did not run a full analysis.

  • momof11

    I haven’t heard anything about lowering the income tax…

  • Joe DeVet

    I see the comments, and I’m going to vote in favor of Dr. Hendrickson’s analysis.

    He may not have repeated VAT proponents’ list of benefits for a VAT. However, in a very important way, he did the correct kind of broad analysis. And it is this: regardless of theoretical benefits of a VAT over an income tax, the POLITICAL reality of the VAT in the USA is that it would be added on top of the income tax…further killing economic incentives and the job-creation engine.

    I do believe he’s right on target with that analysis. Bet you $100 that the coming VAT proposals will not be tied to an elimination of the income tax. Don’t ask for a reduction in the income tax, because creeping increases will surely follow. What would be needed to make the VAT even minimally creditable would be the elimination of the income tax as a PRE-requisite.

    Don’t hold your breath. And don’t take my bet if you need to feed your family!

  • goral

    Not only does the bloated gov’t have to tax ubiquitously, but it must tax everything. (ahm!)
    You New Zealanders do have a sense of humor. After the VAT is in place the other taxes will be lowered….. Stop! I’m holding my stomach and I have tears in my eyes.
    Actually, truthfully, the side ache is from the state income tax that I’m filling out right now. Ex-gov. Weiker the tax hiker told us that the sales tax would go down when he rammed through the income tax. It did, it’s back up.
    Ahphewehh! I never suspected that.
    They do take us for complete and helpless idiots.

    All of production is being taxed right now. All inventory is taxed along the way.
    My brother-in-law just lost an audit with the IRS on unfinished parts that he produces.
    Volker the banker wants this tax. Obama the non-producer wants this tax. They’re trying to sell it on the basis of taxing imported goods. How transparent! Obama knows that he can’t fund socialized medicine without another tax.
    No, the taxes are going up, we’re going down.

  • Arkanabar Ilarsadin

    Demand cuts in spending. Demand cuts in spending in YOUR state. Demand cuts in spending in YOUR Congressional district. Demand cuts in subsidies to the industry YOU work in. Demand cuts in spending that YOU benefit from.

    In short, demand that Congress stop justifying picking the public’s pockets by giving you a piece of the action, by demanding that they cut your piece of the action from the budget.

  • SeanReynoldsNZ

    Would have followed up my comments earlier if I could have found the article again.

    Anyway, when the GST was introduced to New Zealand, it was concurrent with a point in time where the top tax rates were being reduced. At present there is an increase in GST in NZ happening from 12.5% to 15% that is concurrent with a reduction in company tax from 33% to 30% to stop the exodus of companies to Australia where the tax rates are lower.

    When I think about it though, this is fair. A company will either reinvest its profits to make the business more competitive, or pay it out as dividends that will lead to further consumption that will generate further employment and economic activity.

    The other thought is that it is difficult to evade the GST / VAT. If you’re a crack dealer in the underworld, you still need to buy groceries, get your haircut, and put fuel in your car. And you pay GST / VAT on those purchases.