The Texas 18th District Blog

Support The VAT (Value Added Tax) – Bruce Bartlett, Forbes

Saturday, October 24th, 2009

Nancy Pelosi,  Speaker of the House of Representatives (D-Ca),  mentioned a week ago that this would be a good time to consider adding a value added tax (VAT).

(I fear that it would be in addition to other taxes not instead of them.  But this is a good explanation of how they would work)

A few years ago, I concluded that the magnitude of our looming fiscal problem was so enormous that higher taxes were inevitable–and that was long before the recent crisis made matters vastly worse. Moreover, I concluded that the magnitude of this tax increase is so great that it would seriously cripple the economy if accomplished through higher rates on an already dysfunctional income tax system. Reluctantly, I concluded that a value-added tax (VAT) is the best way to raise the revenue that would, in any case, be raised.

When I first made this suggestion in a Los Angeles Timesarticle in 2004, I was building on a large body of tax analysis showing that the VAT is the best known way of raising revenue. When I say “best” I mean that it raises large revenues from low rates and has minimal disincentive effects. In economists’ speak, it has a very small dead weight or welfare cost–the economic output lost by the tax over and above the revenue collected.

Based on the experience in other countries, I estimate that a U.S. VAT could realistically tax about a third of the gross domestic product (GDP), which would raise close to $50 billion per percentage point. If we adopted Europe’s average VAT rate of 20%, we could raise $1 trillion per year in 2009 dollars.

Back in the early 1980s, practically every leading conservative economist supported a VAT for the United States. Norman Ture, one of the godfathers of supply-side economics, and Murray Weidenbaum, chairman of the Council of Economic Advisers under Ronald Reagan, wrote many articles, books and papers supporting the VAT. The conservative American Enterprise Institute published a book in 1987 saying that the VAT was the key to deficit reduction.

Perhaps the strongest evidence that the VAT was considered the conservative tax reform is that it is the foundation of the flat tax, which is still supported by practically every serious conservative tax reformer. To see why this is the case, I have to explain a little bit about how the VAT works.

The VAT is a kind of sales tax. But unlike the retail sales or excise taxes we are familiar with, the VAT is embedded in the prices of goods. There are two ways it can be calculated. The first is called the credit-invoice method and is the way VATs typically work in Europe. Under this method, taxes are assessed on goods at each stage of production or distribution. However, at each stage, a producer or distributor gets a credit for the taxes paid at earlier stages, which they subtract from the gross tax to calculate the net tax payment.

Obviously, this requires everyone involved in production and distribution to keep careful records of taxes paid so that they can claim credit for them; otherwise they are liable for the full burden of the tax. For this reason, the VAT is largely self-enforcing. Also, it means that taxes can be rebated at the border on exports. That is, exporters get credit for all the taxes embedded in the goods they sell but do not have to collect taxes on sales themselves. Similarly, VAT is assessed on the full value of imports.

World trade law prohibits taxes from being rebated at the border unless the precise amount of tax embedded in a good is known. Since there is no certainty on who bears the burden of the corporate tax, it may not be rebated. Replacing the corporate tax with a VAT would unquestionably improve the competitiveness of all U.S. exporters.

The purpose of this system is to prevent cascading–taxes levied on taxes–when goods move through multiple countries on their way to the final consumer. It also allows different tax rates to be applied in different countries, and consumers will only pay the rate that applies in their country regardless of where goods were produced. Thus border adjustability ensures tax neutrality.

The second type of VAT is called the subtraction-method VAT. Under this method, sellers subtract the full amount of the cost of their inputs including VAT from their sales and calculate the VAT on the difference. Mathematically, the two methods are identical. The key difference is that the subtraction method is much simpler because businesses don’t need to keep special records beyond those they keep already. The main drawback is that it requires a uniform rate on all goods. Subtraction-method VATs are also border adjustable.

For full article click here

Tags: Congress, economy, Nancy Pelosi, Taxes, Value Added Tax, VAT
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