Libertarians are sometimes accused of being unrealistic and impractical because we occasionally talk about unconventional ideas such as competitive currencies and privatized roads.
But having a vision of a free society doesn’t mean we’re incapable of common-sense political calculations.
For example, my long-run goal is to dramatically shrink the size and scope of the federal government, both because that’s how the Founding Fathers wanted our system to operate and because our economy will grow much faster if labor and capital are allocated by economic forces rather than political calculations. But in the short run, I’m advocating for incremental progress in the form of modest spending restraint.
Why? Because that’s the best that we can hope for at the moment.
Another example of common-sense libertarianism is my approach to tax reform. One of the reasons I prefer the flat tax over the national sales tax is that I don’t trust that politicians will get rid of the income tax if they decide to adopt the Fair Tax. And if the politicians suddenly have two big sources of tax revenue, you better believe they’ll want to increase the burden of government spending.
Which is what happened (and is still happening) in Europe when value-added taxes were adopted.
And that’s a good segue to today’s topic, which deals with a common-sense analysis of the value-added tax.
Here’s the issue: I’m getting increasingly antsy because some very sound people are expressing support for the VAT.
I don’t object to their theoretical analysis. They say they don’t want the VAT in order to finance bigger government. Instead, they argue the VAT should be used only to replace the corporate income tax, which is a far more destructive way of generating revenue.
And if that was the final – and permanent – outcome of the legislative process, I would accept that deal in a heartbeat. But notice I added the requirement about a “permanent” outcome. That’s because I have two requirements for such a deal.
1. The corporate income tax could never be re-instated.
2. The VAT could never be increased.
And this shows why theoretical analysis can be dangerous without real-world considerations. Simply stated, there is no way to guarantee those two requirements without amending the Constitution, and that obviously isn’t part of the discussion.
So my fear is that some good people will help implement a VAT, based on the theory that it will replace a worse form of taxation. But in the near future, when the dust settles, the bad people will somehow control the outcome and the VAT will be used to finance bigger government.
Here are examples to show why I am concerned.
Here’s some of what Tom Donlan wrote for Barron’s.
…the U.S. imposes the highest corporate tax rate in the developed world. Make no mistake, corporations pay no tax. That is a tax on American consumers, American workers, and American shareholders. Don’t think that the corporate income tax eases your personal tax burden. Add your share of the corporate income tax to the other taxes you pay. Better yet, create a business tax we can all understand. A value-added tax is a tax on consumption. We would pay it according to the amount of the economic resources we choose to enjoy, and we would not pay it when we choose to save and invest in making the economy bigger and more productive. We would pay it on imported goods as much as on those domestically produced. The makers of goods for export would receive a rebate on their value-added tax. Trading the corporate income tax for the value-added tax is one of the best fiscal deals the U.S. could make.
I agree in theory.
America’s corporate tax system is a nightmare.
But I think giving Washington a new source of tax revenue is an even bigger nightmare.
Professor Greg Mankiw at Harvard, writing for the New York Times, also thinks a VAT is better than the corporate income tax.
…here’s a proposal: Let’s repeal the corporate income tax entirely, and scale back the personal income tax as well. We can replace them with a broad-based tax on consumption. The consumption tax could take the form of a value-added tax, which in other countries has proved to be a remarkably efficient way to raise government revenue.
Once again, I can’t argue with the theory.
But in reality, I simply don’t trust that politicians won’t reinstate the corporate tax. And I don’t trust that they’ll keep the VAT rate reasonable.
At this point, some of you may be thinking I’m needlessly worried. After all, journalists and academic economists aren’t the ones who enact laws.
I think that’s a mistaken attitude. You don’t have to be on Capitol Hill to have an impact on the debate.
Besides, there are elected officials who already are pushing for a value-added tax! Congressman Paul Ryan, the Chairman of the House Budget Committee, actually has a “Roadmap” plan that would replace the corporate income tax with a VAT, which is exactly what Donlan and Mankiw are proposing.
…this plan does away with the corporate income tax, which discourages investment and job creation, distorts business activity, and puts American businesses at a competitive disadvantage against foreign competitors. In its place, the proposal establishes a simple and efficient business consumption tax [BCT].
At the risk of being repetitive, Paul Ryan’s plan to replace the corporate income tax with a VAT is theoretically very good. Moreover, the Roadmap not only has good tax reform, but it also includes genuine entitlement reform.
But I’m nonetheless very uneasy about the overall plan because of very practical concerns about the actions of future politicians.
In the absence of (impossible to achieve) changes to the Constitution, how do you ensure that the corporate income tax doesn’t get re-imposed and that the VAT doesn’t become a revenue machine for big government?
By the way, this susceptibility to the VAT is not limited to Tom Dolan, Greg Mankiw, and Paul Ryan. I’ve previously expressed discomfort about the pro-VAT sympathies of Kevin Williamson, Josh Barro, and Andrew Stuttaford.
And I’ve written that Mitch Daniels, Herman Cain, and Mitt Romney were not overly attractive presidential candidates because they’ve expressed openness to the VAT.
This video sums up why a value-added tax is wrong for America.
Last but not least, let me preemptively address those who will say that corporate tax reform is so important that we have to roll the dice and take a chance with the VAT.
I fully agree that the corporate income tax is a self-inflicted wound to American prosperity, but allow me to point out that incremental reform is a far simpler – and far safer – way of dealing with the biggest warts plaguing the current system.
Lower the corporate tax rate.
Replace depreciation with expensing.
Replace worldwide taxation with territorial taxation.
So here’s the bottom line. If there’s enough support in Congress to get rid of the corporate income tax and impose a VAT, that means there’s also enough support to implement these incremental reforms.
There’s a risk, to be sure, that future politicians will undo these reforms. But the adverse consequences of that outcome are far lower than the catastrophic consequences of future politicians using a VAT to turn America into France.
P.S. You can enjoy some good VAT cartoons by clicking here, here, and here.
P.P.S. I also very much recommend what George Will wrote about the value-added tax.
P.P.P.S. I’m also quite amused that the IMF accidentally provided key evidence against the VAT.
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[…] which is less destructive than higher income tax rates and more double taxation. But just as I wrote about the value-added tax, the issue isn’t whether we replace a horrible tax with a less-horrible tax. The debate is […]
Jim:
Efficient taxes allow for transparency. A single tax rate brings heavy political pressure for reduction. A direct tax on salaries will bite the most.
The current system is so convoluted, that no one knows what percentage they pay.
The European VAT is combined with many other taxes and is set at a seemingly low rate, so incremental increases can be obscured. Forcing an American VAT to have the same rate as that on earned income and allowing for deductions on all previously taxed salaries and components would eliminate the pernicious flaws in the VAT.
Reblogged this on Utopia – you are standing in it! and commented:
Efficient taxes lead to higher taxes. The way to keep government small is to starve it of taxes that raise lots of revenue.
Daniel, would you accept a VAT tax if the Sixteenth Amendment to the U.S. Constitution was concurrently repealed?
What did you expect? Right wing conservatives are obtuse morons and antisocial pests of whom most favor the Abrahamic despotism project in one form or another, even if they aren’t very pious. And some of them, like Geert Wilders in the Netherlands, have a reverence for Abrahamic theism even though they aren’t even believers. So, it’s folly to expect them to favor “a free society”. They favor paternalism, despotism, and servitude always and everywhere no matter what high minded hot air about freedom comes out of their mouths.
Now, there is a way to prevent reinstatement of the corporate income tax: Simply abolish incorporation. No more corporations no matter what excuse offered is offered by apologists. Let businesspeople solve their own organizational and capitalization problems. If they can’t, or won’t, that will be natur’es way of saying that they don’t deserve commercial success and riches.
You shouldn’t need to be told that corporations are proclaimed by government, and you shouldn’t have to be told that the primary motive of corporations is to socialize costs and risks of ownership through the doctrine of limited liability while vastly increasing the possibilities for profit. Incorporation has nothing, Nothing, NOTHING to do with a free market, i.e. an unrigged market.
Q: So, what are you waiting for??
A: You may be a closeted right wing conservative, and a tool of the Cato to boot.
P.S. The automobile companies won’t peacefully tolerate a private roads movement, for its success implies many fewer good roads—esp. superhighways—to be clogged with cars. Further, the car buyers who remain would be much more price sensitive to new cars for several reasons. For example, a private road operator is certain to charge more per mile for heavy vehicles. So, the buying decision will favor smaller, less expensive cars which provide the auto racketeers with smaller margins. Another reason for automaker hostility is that having to pay for roads directly makes the cost of car ownership much more obvious to a car owner. At present some of the cost is masked through tax redistribution, which even if tweaked with a VAT in favor of income taxes would remain horribly slanted in favor of the socialist road system. (So expect your VAT utopia never to materialize even if you get your Constitutional amendment.) Other obstructionists include construction companies and concrete companies and rebar companies; none of these want private roads. However, people who love the idea of passenger railroad service present a very different picture. We should expect the most reasonable among them to support abolition of superhighway socialism, not to mention abolition of socialists airports. Getting those Fascistic rackets out of the way would provide the breathing room that private railroads need to operate without subsidies.
P.P.S. Don’t expect to reach great heights by eating milquetoast and setting the bar low.
While Dan and most of his readers would like to see total revenues (/spending) reduced, this discussion is about keeping revenue neutral with a bias toward rate reduction in the future. Obviously, the history of the VAT in Europe is all about rate increases.
The best solution for downward bias would be a single tax rate, with earned income taxed in the flat tax mode. While people would be aware of increases in prices from an increase in either a FairTax or a VAT, nothing will be as obvious as the percentage taken out of salary in one lump sum.
On the corporate side, things get very complicated. First, you do not want taxes cascaded, so taxes on taxes must be avoided. The FairTax model does not deal with this well, whereas the VAT anticipates deductions for domestically produced components, which might be expanded to include gross salaries as a pre-taxed component. [It might even require deduction of any future corporate taxes and profits on which the corporate taxes were based.]
This American VAT would differ from the European version in that it would be set at the same flat rate as earned income, and it would deduct all pre-taxed expenses.
This VAT could also be removed for exported items, however, the tax on salaries would remain embedded in prices. This is a compromise. Rather than favoring producers at the expense of US consumers with a complete refund of all taxes on exports, better the single tax rate be lowered to reflect a broader taxable base.
As Yogi Berra put it: “In theory, theory and practice are the same. In practice, they’re not.”