Don’t Get Seduced by a Value-Added Tax

In theory, the VAT is a relatively non-destructive tax. Like the flat tax and national sales tax, it is a single-rate, “consumption-base” levy. Several people have asked me, then, why I am so vociferously opposed to such a measure. The answer is simple: I do not object to a VAT as a replacement for the current income tax. But that is not a realistic option. Instead, politicians are salivating for a VAT because it is a very efficient way of generating more money to spend. And the last thing I want is to make it easier for politicians to transfer a larger share of national output from the productive sector of the economy to the government. This video compares the flat tax and national sales tax, but it also applies to the VAT.

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Seventy Minutes of Dan Mitchell

Some people complain that my youtube videos are too long, and they average only about seven minutes, so it is with some trepidation that I post here a link to my recent speech in Norway. But if you are looking for a thorough explanation of how government intervention caused the financial crisis AND the need to fix fiscal policy by slashing government spending and implementing a flat tax, there are worse ways of spending seventy minutes.  A supposed friend already has joked the the first minute, featuring an introduction in Norwegian by the leader of the Progress Party, is the best part of the video.  But I’ll let you be the judge.

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Beware the VAT: Greedy Politicians Seeking a New Source of Revenue

The Washington Post reports that there is growing interest among politicians for a form of national sales tax known as the value-added tax (VAT). But rather than use the VAT to replace the income tax, the politicians want a new source of revenue to expand the burden of government. The story explains:

With… President Obama pushing a trillion-dollar-plus expansion of health coverage, some Washington policymakers are taking a fresh look at a money-making idea long considered politically taboo: a national sales tax. Common around the world, including in Europe, such a tax — called a value-added tax, or VAT — has not been seriously considered in the United States. But advocates say few other options can generate the kind of money the nation will need… At a White House conference earlier this year on the government’s budget problems, a roomful of tax experts pleaded with Treasury Secretary Timothy F. Geithner to consider a VAT. A recent flurry of books and papers on the subject is attracting genuine, if furtive, interest in Congress. And last month, after wrestling with the White House over the massive deficits projected under Obama’s policies, the chairman of the Senate Budget Committee declared that a VAT should be part of the debate. “There is a growing awareness of the need for fundamental tax reform,” Sen. Kent Conrad (D-N.D.) said in an interview. “I think a VAT and a high-end income tax have got to be on the table.” …”While we do not want to rule any credible idea in or out as we discuss the way forward with Congress, the VAT tax, in particular, is popular with academics but highly controversial with policymakers,” said Kenneth Baer, a spokesman for White House Budget Director Peter Orszag. Still, Orszag has hired a prominent VAT advocate to advise him on health care: Ezekiel Emanuel, brother of White House chief of staff Rahm Emanuel and author of the 2008 book “Health Care, Guaranteed.” Meanwhile, former Federal Reserve chairman Paul A. Volcker, chairman of a task force Obama assigned to study the tax system, has expressed at least tentative support for a VAT. “Everybody who understands our long-term budget problems understands we’re going to need a new source of revenue, and a VAT is an obvious candidate,” said Leonard Burman, co-director of the Tax Policy Center, a joint project of the Urban Institute and the Brookings Institution, who testified on Capitol Hill this month about his own VAT plan.

Not surprisingly, the Washington Post did not bother to quote any free-market people who oppose giving politicians a new source of money. For what it is worth, I wrote a piece for National Review in 2005 that explains why a VAT is a terrible idea. The core arguments are just as relevant today as they were then:

A VAT might have some theoretically attractive features, but it is a perniciously effective way of raising revenues and inevitably leads to bigger government. The best evidence comes from Europe. Back in the mid-1960s, the burden of government in Europe wasn’t that much higher than it was in the United States. Tax revenues consumed about 30 percent of gross domestic product in Europe. The U.S. had a small advantage: The tax burden, including state and local governments, was about 27 percent of GDP. But then European governments started adopting the VAT. Denmark was the first to do so in 1967. France and Germany followed, with many other European nations imposing the tax within 5 years. For politicians, the VAT was great news. Besides being a new source of revenue, the VAT has been a disturbingly easy tax to increase since it’s built into the price of products and hidden from consumers. Moreover, even small increases generate a big pile of revenue because the tax base is so broad. The tax has become so easy to raise that VAT rates in Europe average more than 20 percent. For taxpayers, however, the news has been disastrous. Thanks to this levy, the burden of government in Europe today is much higher than it is in the U.S. On average, taxes consume about 41 percent of Europe’s economic output. While other taxes have also climbed, the VAT certainly has helped finance the explosion of social welfare spending that creates such a drag on European economies. In the U.S., by contrast, the total tax burden as a share of GDP is about where it was 40 years ago — 27 percent… Many European governments…claimed that more destructive taxes would be reduced or repealed once the VAT was implemented. In the short term, this was true: As late as 1975, taxes on income and profits were lower in the EU than they were in the U.S. But this was a transitory phenomenon. Income-tax rates quickly began climbing and almost immediately jumped above U.S. levels. Ironically, the VAT facilitated higher tax rates on income since politicians often argued that a higher VAT had to be accompanied by higher income-tax burdens to ensure the tax burden wasn’t being shifted to lower-income taxpayers. There is only one scenario that would make a VAT acceptable. If U.S. lawmakers were willing to repeal the 16th Amendment and abolish all taxes on income, a VAT would be an acceptable risk. But until that happens, taxpayers should vigorously resist the Europeanization of America.

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More Lafffer Curve Evidence on the Lunacy of Class-Warfare Tax Policy

When will the politicians learn that hate and envy are not a basis for sound tax policy? The hapless U.K. Prime Minister wants to raise the top personal tax rate from 40 percent to 50 percent. But his class-warfare plan is not going to work since the geese that lay the golden eggs can fly across the border. The Financial Times reports that 30 percent of London’s financial services professionals are thinking of leaving for places such as Switzerland and Hong Kong:

City finance professionals are so worried about the future that nearly 30 per cent are planning to leave London, according to a survey by eFinancialCareers, a jobs website. …Many observers believe employment in the City will recover gradually from next year and hope London can hang on to its position as a leading financial centre if the regulatory response to the crisis is not too heavy-handed. Of those surveyed, 45 per cent thought London’s leading position was under threat, while a third felt it was not. Increased taxes were seen as the main threat, followed by the potential impact of heavier European regulation. “Concerns about the relative competitiveness of the City in the face of impending changes to the regulatory framework coupled to upheavals in the tax system are having an immediate impact on the desirability of London as a location in which to work,” said John Benson, chief executive of eFinancialCareers. 

The Governor of New York is equally foolish. He has proposed a big tax hike on the state’s most successful people, but New York is not a prison (at least not yet). As such, one of the richest men in New York has decided to escape the state’s greedy politicians by moving to Florida. This is another example of why higher tax rates are so destructive. When people are tired of being fleeced, they can move their labor and/or capital. They can choose to be less productive. And they can hire lobbyists, lawyers, and accountants to find creative loopholes. Writing for the New York Post, Mr. Golisano is very happy that his money no longer will be funding tax-and-spend politicians in Albany:

Politicians like to talk about incentives — for businesses to relocate, for example, or to get folks to buy local. After reviewing the new budget, I have identified the most compelling incentive of all: a major tax break immedi ately available to all New Yorkers. To be eligible, you need do only one thing: move out of New York state. Last week I spent 90 minutes doing a couple of simple things — registering to vote, changing my driver’s license, filling out a domicile certificate and signing a homestead certificate — in Florida. Combined with spending 184 days a year outside New York, these simple procedures will save me over $5 million in New York taxes annually. …One thing’s certain: That money won’t continue to fund Albany’s bloated bureaucracy, corrupt politicians and regular special-interest handouts. How did the state get to this point? By spending, spending and spending some more. New York’s budget was $72.7 billion in 1999. Ten years later it ballooned to $131.8 billion. Each year, on average, the budget has risen at an astounding 6 percent compounded annual rate — more than double inflation (2.8 percent). …This problem didn’t begin with the current recession. New York faced a $6 billion shortfall before the economic downturn. However, in the face of economic turmoil, Gov. Paterson, Assembly Speaker Sheldon Silver and Senate Majority Leader Malcolm Smith looked to the unions and special interests, who answered with one voice: raise taxes. That was irresponsible — and may just prove to be counterproductive, since the top 1 percent of earners account for about 50 percent of state revenue and are the ones who can and will leave. Among other hikes in taxes and fees, they raised the marginal tax rate on the most successful (and most mobile) New Yorkers to 8.97 percent, the second-highest rate in the nation. Bottom line? By domiciling in Florida, which has no personal-income tax, I will save $13,800 every day. That’s a pretty strong incentive. Like I said, I love New York. But I’m not going to pay any more for the waste, corruption and inefficiency that is New York state government.

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Obama’s proposed IRS Rules Spell Disaster for Overseas Americans, Will also Lead to Less Investment in America

The U.K.’s Daily Telegraph reports that British banks may turn away any America clients as a result of an Administration proposal to modify the already-onerous Qualified Intermediary rules and make them even worse. This makes life more difficult for overseas Americans, which will compromise the competitiveness of U.S. firms trying to win market share around the world. It also will discourage foreign financial institutions from investing in America since pulling out of the U.S. market is an easy way to get out from under the IRS’s unfair extraterritorial regulatory reach.

British banks and stockbrokers may refuse to take on American clients if new international tax proposals outlined by President Obama are passed. The decision, which would make it hard for Americans in London to open bank accounts and trade shares, is being discussed by executives at Britain’s banks and brokers who say it could become too expensive to service American clients. The proposals, which were unveiled as part of the president’s first budget, are designed to clamp-down on American tax evaders abroad. However bank bosses say they are being asked to take on the task of collecting American taxes at a cost and legal liability that are inexpedient. …One executive at a top UK bank who didn’t want to be named for fear of angering the IRS said: “It’s just about manageable under the current system – and that’s because we’re big. The danger to us is suddenly being hauled over the coals by the IRS for a client that hasn’t paid proper taxes. The audit costs will soar. We’ll have to pay it but I know plenty of smaller players won’t.” The British Bankers Association (BBA) and APCIMS had a meeting with European counterparts 10 days ago to discuss the crisis. A delegation is set to meet the US Treasury’s Internal Revenue Service on 16th June to demand they drop the reforms. …President Obama’s proposals are built on the so-called Qualified Intermediary system which was intended to ensure Americans paid the correct tax wherever they were domiciled. Foreign financial institutions that handle American money have to fill in a US tax form on behalf of the client that has to be audited too.

This story illustrates the powerful liberalizing impact of tax competition. Because of globalization, it is now much easier for jobs and capital to cross national borders. This means nations (like the U.S., unfortunately) that adopt bad policy suffer greater consequences than would have been the case in the past. Nations that reduce the burden of government, by contrast, enjoy even larger benefits. This video explains the process:

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Taking on the Terminator

Appearing on Larry Kudlow’s show, I comment on California’s profligate fiscal policy, noting that Schwarzenegger is turning California into an American version of France.

For a more detailed explanation of how California’s tax-and-spend policies have harmed the state, see this great new video from Reason TV.

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Explaining Obama’s Misguided Scheme to Undermine American Companies

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Don’t Blame Rush Limbaugh

There is an ongoing debate among conservatives and libertarians about how best to resuscitate the cause of limited government. In a recent post at the Cato Institute Blog, my colleague Brink Lindsey defended another Cato colleague, Jerry Taylor, who caught some flak for criticizing conservative talk radio at National Review online. Both Brink and Jerry argue that Limbaugh, et al, undermine the case for good policy because of sloppy arguments and unappealing styles.

This  is  a much-needed discussion, especially since the GOP’s decade-long embrace of statist economic policy has dramatically undermined the cause of liberty.

To add my two cents to the mix,  I disagree with part of their analysis. The problem is not Rush Limbaugh or any other talk show host. Talk radio, after all, existed when Republicans were riding high and promoting small government in the 1990s.

The real problem is that today’s GOP politicians are unwilling to even pretend that they believe in limited government. In such an environment, it is hardly a surprise that anti-tax and anti-spending voters decide that talk show hosts are de facto national leaders.

This does not mean that Rush Limbaugh is always right or that Sean Hannity never engages in demagoguery. But I suspect if any of us had to be live on the air three hours every day and support our families by attracting an audience, our efforts to be entertaining might result in an occasional mistake – either factually or rhetorically. Heck, when I had to be on the air for just one hour each day in the mid-1990s for the fledgling conservative television network created by the late Paul Weyrich, I’m sure I had more than my share of errors.

This being said, I agree with Brink’s main points about conservatism being adrift. How come there were no tea parties when Bush was expanding the burden of government? Why didn’t conservative think tanks rebel when Bush increased the power of the federal government? Where were the supposedly conservative members of the House and Senate when Bush was pushing through pork-filled transportation bills, corrupt farm bills, a no-bureaucrat-left-behind education bill, and a massive entitlement expansion?

I sometimes wonder if the re-emergence of another Reagan would make a difference, but Brink and others offer compelling reasons to believe that the problems is much deeper.

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Revenge of the Laffer Curve

Steve Moore and Art Laffer have an excellent column in today’s Wall Street Journal. They explain that high-tax states drive repel entrepreneurs and investors, leading to a pronounced Laffer Curve effect. Productive people either leave the state or choose to earn and report less taxable income. And because growth is weaker than in low-tax states, there also is a negative impact on lower-income and middle-class people:

Here’s the problem for states that want to pry more money out of the wallets of rich people. It never works because people, investment capital and businesses are mobile: They can leave tax-unfriendly states and move to tax-friendly states. …Updating some research from Richard Vedder of Ohio University, we found that from 1998 to 2007, more than 1,100 people every day including Sundays and holidays moved from the nine highest income-tax states such as California, New Jersey, New York and Ohio and relocated mostly to the nine tax-haven states with no income tax, including Florida, Nevada, New Hampshire and Texas. We also found that over these same years the no-income tax states created 89% more jobs and had 32% faster personal income growth than their high-tax counterparts. …Dozens of academic studies — old and new — have found clear and irrefutable statistical evidence that high state and local taxes repel jobs and businesses. …Examining IRS tax return data by state, E.J. McMahon, a fiscal expert at the Manhattan Institute, measured the impact of large income-tax rate increases on the rich ($200,000 income or more) in Connecticut, which raised its tax rate in 2003 to 5% from 4.5%; in New Jersey, which raised its rate in 2004 to 8.97% from 6.35%; and in New York, which raised its tax rate in 2003 to 7.7% from 6.85%. Over the period 2002-2005, in each of these states the “soak the rich” tax hike was followed by a significant reduction in the number of rich people paying taxes in these states relative to the national average.

Interestingly, the Baltimore Sun last week published an article noting that the soak-the-rich tax imposed last year is backfiring. There are fewer rich people, less taxable income, and lower tax revenue. To be sure, some of this is the result of a nationwide downturn, but the research cited by Moore and Laffer certainly suggest that the state revenue shortfall will continue even after than national economy recovers:

A year ago, Maryland became one of the first states in the nation to create a higher tax bracket for millionaires as part of a broader package of maneuvers intended to help balance the state’s finances and make the tax code more progressive. But as the state comptroller’s office sifts through this year’s returns, it is finding that the number of Marylanders with more than $1 million in taxable income who filed by the end of April has fallen by one-third, to about 2,000. Taxes collected from those returns as of last month have declined by roughly $100 million. …Karen Syrylo, a tax expert with the Maryland Chamber of Commerce, which lobbied against the millionaire bracket, said she has heard from colleagues who are attorneys and accountants that their clients moved out of state to avoid the new tax rate. She said that some Maryland jurisdictions boast some of the highest combined state and local income tax burdens in the country. “Maryland is such a small state, and it is so easy to move a few miles south to Virginia or a few miles north to Pennsylvania,” Syrylo said. “So there are millionaires who are no longer going to be filing Maryland tax returns.”

With President Obama proposing higher tax rates for the entire nation, perhaps this is a good time to remind people about the three-part video series on the Laffer Curve that I narrated. If you have not yet had a chance to watch them, the videos are embedded here for your viewing pleasure:

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Obama’s Job-Killing Tax Hike on U.S. Companies Trying to Compete Abroad

The President’s international tax proposal can be characterized as protectionism, but the target is American firms, not their foreign competitors. Crazy.

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Greetings from Norway

I will be speaking to a policy conference on the financial crisis in Oslo tomorrow, organized by the Progress Party, which is the main opposition party. If anyone wants to wake up at 6:00 a.m., you can watch me live at http://www.frp.no/no/FrP_TV/.

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Debating Obama’s Tax Proposal to Hamstring American Companies Competing Abroad

I had two opportunities earlier this week on CNBC to explain why it is not a good idea to further increase the discriminatory tax on American multinational firms. On Street Signs, hosted by the ever-popular Erin Burnett, I squared off against Christian Weller of the Center for Anti-American Progress (sorry, the temptation to modify their name was too strong). I like Christian, both because we hung out a bit at a conference in Paris years ago, and because he is not shy about stating his desire for bigger government, so it is a straightforward debate. I’m not sure who scored more points, but I hope it was an enlightening discussion.

Later in the day, I appeared on Larry Kudlow’s show and got to cross swords with Robert Reich. Larry is a great guy and is right on all this issues to my knowledge, so hopefully the two of us did a decent job explaining why it’s not a good idea to impose much higher taxes on American companies when their foreign competitors already enjoy a tax advantage. Reich is an effective debater, though, so you’ll have to judge for yourself which side prevailed.

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President Obama Proposes Scheme to Make American Companies Less Competitive

In an article for Forbes, I explain why the President’s new proposal to increase the tax penalty on American companies competing in global markets is spectacularly misguided. Here’s the key passage:

If deferral is eliminated, that may prevent an American company from taking advantage of a profitable opportunity to build a factory in some place like Ireland. But U.S. tax law does not constrain foreign companies operating in foreign countries. So there would be nothing to prevent a Dutch company from taking advantage of that profitable Irish opportunity. And since a foreign-based company can ship goods into the U.S. market under the same rules as a U.S. company’s foreign subsidiary, worldwide taxation does not insulate America from overseas competition. It simply means that foreign companies get the business and earn the profits.  If deferral is curtailed or eliminated, several bad things will happen. American-based companies will become less competitive since they will face a higher tax rate. Those U.S. companies also will lose market share around the world since foreign companies will have an even bigger tax advantage. America will have fewer exports, since a big chunk of our exports are the goods that American companies sell to their foreign subsidiaries. And American workers will have fewer jobs because of the reduction in exports.

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Don’t turn America into another France

Veronique de Rugy, my long-time friend (and fellow Board member of the Center for Freedom and Prosperity), is the narrator of a new video explaining why the United States should not become a European-style welfare state. Produced jointly by the Center for Freedom and Prosperity and Reason TV, the video warns that the Bush-Obama era of big government is making America like Veronique’s home nation of France.

Coincidentally, I am sitting in my hotel room in Paris, having given speeches Wednesday and Thursday to semi-receptive audiences. France is a nice place to visit, but Veronique’s video shows that it is not a very good place to live for productive people.

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