On November 14, 2011, MLI director of research Jason Clemens wrote an article for Freedom Politics (U.S.) on the option of a value-added tax (VAT) for the United States. His article is copied below.
By Jason Clemens, FreedomPolitics.com, November 14, 2011
The debate over Herman Cain’s proposal for a national sales tax and the broader issue of whether a valued-added tax (VAT) should be part of tax reform are becoming fiercer as the GOP nomination gets into full swing. Unfortunately, the debate about the VAT is more ideology and emotions than facts. As Americans become more interested in reforming the country’s dysfunctional tax system, it becomes increasingly important to understand the VAT opportunity.
Economists favor VATs, or consumption taxes, over other taxes because they are less distortionary and thus impose lower costs on society. Put simply, consumption taxes don’t impair the incentives for work effort, savings, investment and entrepreneurship the way other taxes, particularly income and capital-based taxes, do. Countries can raise the same amount of revenues using consumption taxes but with less adverse effects than if other more costly and damaging taxes are used.
The VAT debate has centered on the European experience, which makes sense given their widespread use. The argument against the VAT based on the European experience is twofold. One, the VAT has not reduced the deficit. And two, the rates of the VAT have increased markedly over time. Both assertions about the European experience are correct. These failures of the European VATs don’t negate the benefits but point out policies to be avoided.
Canada’s experience with its VAT is instructive. Canada introduced a VAT, the goods and services tax (GST), in 1991 at a rate of 7 percent. A critical difference between Canada and Europe is that the VAT is visible to consumers in Canada. The visibility of the Canadian VAT explains why it has never been increased and was recently reduced to 5 percent.
If the U.S. introduces a VAT, it absolutely has to be visible to consumers or risk repeating the European experience.
VATs can contribute to deficit elimination and smaller government. Despite revenues from the Canadian VAT, governments in Canada over the last two decades have retrenched rather than expanded, and in doing so enjoyed a decade-long period of balanced budgets.
Another key consideration for the U.S. is that a VAT would bring the middle-class back into the contributor column for federal taxes. According to the Tax Policy Center, 46 percent of Americans do not pay income taxes. Even when payroll and other taxes are included, there is a distinct lack of contribution for those at the lower and middle sections of the income distribution. For instance, the middle 60 percent of households (excluding the top and bottom 20 percent) earned 42 percent of income in 2011 but only contributed 30 percent of total federal taxes. Perhaps more poignantly, the bottom 40 percent of households earned 12 percent of income and paid a little under 3 percent of total federal taxes.
The problem with this skewing of taxes and the non-existent contributor status of so many Americans is that it has paralyzed political decision-making. Because so many Americans do not contribute, or contribute only token amounts, they have a developed a preference for government programs and services completely detached from whether or not the services make sense or contribute to society.
The reason for the detachment is that they have no skin in the game. A permanent demand for greater government based on a zero cost to these households has been created. Introducing a VAT would bring these households back into the contributor column and would force greater scrutiny of government programs and services. Such a reform would lead to better collective decision-making in U.S. politics.
There are serious risks associated with introducing a VAT. The European experience demonstrates that it can lead to larger deficits and much larger welfare states. They also, however, point to the solutions wherein the U.S. can avoid the European mistakes while improving the tax system to foster economic growth and prosperity. The right VAT makes sense for the U.S.
Jason Clemens is the director of research at the Canadian-based Macdonald-Laurier Institute (www.macdonaldlaurier.ca). Prior to joining MLI, Mr. Clemens spent three years in the United States as a senior researcher at a California-based think tank.