Tuesday, April 13, 2010

VAT on the horizon

Several months ago, a friend met with a high government official and expressed concern that the new health care bill would be more expensive than people were saying. "Oh yes," said the official, "In several years, the United States will pass a value-added tax to cover the cost."

After the bill passed, Charles Krauthammer wrote this column in the National Review saying the same thing:

American liberals have long complained that ours is the only advanced industrial country without universal health care. Well, now we shall have it. And as we approach European levels of entitlements, we will need European levels of taxation.

I believe that a VAT is a move in the right direction. (I distinguish for the moment between amounts of taxation and the form of taxation.) Current tax policy in the United States discourages saving and investment and rewards consumption. Think of the double taxation on what you earn as salary and then what you earn as interest on your savings; think of income taxes on corporate profits and then again on the dividends you collect. A VAT avoids those problems.

The problem with a VAT is that it is regressive in nature, affecting lower income people more than wealthier people because lower income people spend a bigger percentage of their income on consumables. But you can adjust for that with income-based rebates or exemptions.

But, there is the danger that this tax will be able to be increased with little public scrutiny. It will not necessarily be visible because it is added at each stage of production, and so Congress could just jack it up whenever it wants. Also, you don't hear talk of reducing other taxes as this new one is introduced. That is why some people are nervous, like the gentleman quoted here:

Jon Hurst, president of the Retailers Association of Massachusetts, said he fears a value-added tax would simply be used to fund new programs....

The costs of health care reform were intentionally designed not show up in a big way until well into the next Presidential term. It is thus likely that it will be a few years before the debate begins in earnest, but it is on the horizon.


Anonymous said...

It may well be that "The costs of health care reform were intentionally designed not show up in a big way until well into the next Presidential term". However, it is increasingly clear that the sheer volume of changes in terms of writing new rules and regs, and implementing these changes by both the feds and the states; also mandated a delayed effective date. As it is, implementation is likely to be chaotic; witness the brouhaha over the HIT changes alone.

I also do not use Charles Krauthammer as my source of thought and reflection. He has done nothing since the election but sit up nights thinking of new ways to criticize the President. This has been noted by numerous commenters on his WaPo column.


Anonymous said...

I also don't agree with a lot of what he says, but where there is a good observation, I don't mind quoting it.

Barry Carol said...

I fully expect the U.S. to implement a VAT within the next five years, not to pay for healthcare, but as part of a broader plan, including entitlement reform, to address the federal fiscal imbalance. It will likely be in addition to all the other taxes we already pay. From an economic standpoint, it should do less economic harm than significantly increasing marginal income tax rates which have clear disincentive effects on productive activity.

The highest VAT rate in Europe today is 25% (Denmark) with numerous other countries not far behind. The average rate is probably in the upper teens. I suspect we would want to exempt necessities like food purchased in supermarkets, gasoline and heating oil, medical care, and, probably college tuition and government purchases. I’m also not sure how the tax would be applied to capital market transactions like stock and bond purchases and sales, loans, etc. The broadest based Value Added Taxes in Europe raise about 0.4% of GDP for each one percentage point of tax rate.

The VAT lends itself best to taxing manufactured goods which are becoming less and less important as a percentage of economic activity relative to services. I think the tax could be easily avoided by small businesses and independent contractors such as plumbers, carpenters, electricians, landscapers, barbers, beauticians, personal trainers, doctors, lawyers and others who are essentially selling their time and expertise as opposed to physical products like cars and furniture. Services provided by large entities like hotel chains and restaurant chains are more likely to collect and pay the tax because they’re much more likely to be audited. On the positive side, the VAT would capture at least some money from people who are currently working off the books and not paying income or payroll taxes.

I disagree regarding the double taxation argument. While nobody knows for sure, many of us believe that corporate income taxes are just another cost of doing business that are built into the price of their products and services. There is no reason why interest and dividend income should not be taxed at the same rates as income from wages. There is a legitimate issue regarding capital gains that relates to the fact that value is often built over many years. It’s not fair, with a progressive tax structure, to tax a business or real estate that was owned for decades as though all the gain was earned in one year. That issue goes away if the top marginal rate is low enough as it was after the 1986 reforms (28%).

Finally, to protect us from runaway taxation, there should be an Alternative Maximum Tax that ensures that no taxpayer, no matter how wealthy, pays more than, say, 33% of gross income in combined federal income, payroll, excise and value added taxes. Sorry for the long post, but I find this subject especially interesting and provocative.

Anonymous said...

Excellent analysis, as usual, Barry; thanks. I for one need education in these matters.


mcconrad said...

Anyone in healthcare and beyond needs to read Zeke Emmanuel's "Healthcare, Guaranteed." This would've been an effective, transparent approach to reform.

Cleary Squared said...

Great insight to the VAT, Barry.

The EU countries are required to have a 15% VAT with an "exception" VAT of no lower than 5%. The VAT you're talking about is called MOMS (the full name is in the Wiki article Paul highlighted) and with very few exceptions it's 25%.

I would support a VAT if it completely abolished income taxes and was the sole tax to collect that would make the government run smoothly and efficiently. A VAT at Denmark's level would be excessive, but even with a VAT at 5% with certain exceptions, it would be a huge moneymaker for the government and it would give a giant incentive for earners to save money. No more sweating out the IRS on tax day...pay your share at the register and you're golden.

On the other hand, I think there is a legitmate complaint that a VAT are regressive the lower and middle classes. The VAT would force those who pay no income tax or receive tax credits to "give back" the money the government gave them in the form of consumption taxes. The credits the government gives would slowly but surely return to the government in a VAT scheme, and on top of a higher income tax and mandatory healthcare to boot.

Anonymous said...

From Facebook:

Arthur: Sorry Paul, have to disagree with you on this one - i lived with VAT at 15% for many years in the UK, (its now 17.5% and set to rise). Its a real sneaky tax as it is already in the price and NOT added at the register. Once the government taps into this it will not be spent on healthcare, and there will be NO reduction in other forms of tax, there certainly wasn't any reductions in other forms of tax in the UK when it was introduced there. I would like to see some real progress in cutting SPENDING before we raise any taxes, including spending on 2 disastrous wars.

Anonymous said...

From Facebook:

Sherman: If you think about it, in the US, healtcare has for decades been a regressive form of hidden cost for every phase of production, manufacturing and distribution of every good and service in this country. It is already regressive, and if we do not exchange the healtcare burden with a VAT to fund it, but rather, leave both, then we do nothing but compound the regressive nature and spread the gap between the haves and have-nots.