The Value-Added Tax Should Be Political Poison for Advocates of Limited Government

It’s not my role to pick sides in political fights, but I am very interested in trying to make bad ideas radioactive so that politicians won’t be tempted to do the wrong thing.

This is why I’m a big fan of the no-tax-hike pledge. The folks in Washington salivate at the prospect of getting more of our money, but they are less likely to act on their desires if they’re scared that breaking their promises means they’ll lose the next election.

It’s also why I want the value-added tax (VAT) to become a third-rail issue. Simply stated, it would be a catastrophic mistake to give Washington an additional source of tax revenue. Especially since the European evidence shows that it’s a money machine to expand the welfare state.

Given my concerns, I was understandably distressed that two lawmakers (and presidential candidates) who normally support smaller government, Rand Paul and Ted Cruz, decided to include the VAT in their tax reform proposals.

But maybe I’ll get my wish after all. It seems that support for the VAT is becoming a big problem.

A report in the Wall Street Journal discusses this development.

The crux of the current dispute is Mr. Cruz’s business flat tax proposal. Under the plan, businesses would pay a 16% tax on their adjusted gross revenues after first subtracting payments to other businesses, but not profits or wages. Economically, that’s equivalent to a value-added tax.

It’s not just equivalent. It is a value-added tax, specifically a “subtraction-method” VAT.

Which is why Senator Cruz is vulnerable to criticism from both political rivals and advocates of small government..

“Republican candidates today try to hide their support for the value-added tax by renaming it a Business Flat Tax,” Mr. Rubio said. “But don’t be fooled. If it acts like a VAT, taxes like a VAT, and grows government like a VAT—it’s a VAT.” …Conservatives have long been dubious about value-added taxes, worrying that they might grow over time because less transparent taxes can be politically easier to increase, especially after their creators leave office.

There’s also a story in Politico about the VAT suddenly becoming a big part of the GOP nomination fight.

On Monday, Sen. Marco Rubio (R-Fla.) lobbed an opening salvo in what’s likely to become a new front of disagreement in the GOP primary race: taxes. “Believe it or not, multiple Republican candidates for president support new taxes on the American people,” Rubio said at an economic town hall in Sarasota, Florida. “Some even support imposing a new tax that generations of conservatives have fought against, called a Value Added Tax.” …Cruz has gone to great lengths to avoid calling this idea a value-added tax, or VAT—which has suspiciously European connotations—instead terming it a crisply Republican-sounding “business flat tax.” But economists widely agree it’s a VAT. …Stephen Moore defended the plan (and also another similar proposal from Sen. Rand Paul). That provoked strong responses from National Review’s Ramesh Ponnuru and the Cato Institute’s Daniel Mitchell.

There’s also been strong responses from folks who are perplexed that pro-VAT politicians are pretending that they don’t support a VAT.

Here’s how Josh Barro opened his column on this topic in the New York Times.

Like Rand Paul before him, Ted Cruz is promoting a tax plan that relies heavily on a value-added tax, or VAT. And like Mr. Paul, Mr. Cruz is not calling his VAT a VAT.

For what it’s worth, I don’t care what it’s called. I’m just worried that otherwise sensible people think it might be a good idea to give a new source of tax revenue to Washington.

Sort of like giving an alcoholic the keys to a liquor store. Or a book of matches to a pyromaniac.

Diana Furchtgott-Roth of the Manhattan Institute also is uncomfortable with the notion of giving Washington a major source of additional tax revenue.

…once the VAT is put in place, it is practically impossible to get rid of it. In countries that have it, the VAT rises over time incrementally and gives government immense power. Cruz and Paul are in favor of smaller government, but their suggested VATs would expand government clout. …parliaments, congresses, and assemblies don’t get rid of other taxes. They add the VAT on top of existing levies. …Due to their hidden nature, VATs tend to grow over time… From 1975 to the present, VAT rates have risen in the U.K. from 8% to 20%. …when imposed in 1967, Denmark’s VAT was 10%; it is now 25%… In 1968, Germany levied a 10% VAT…their VAT has risen “only” to 19%… Cruz and Paul make the VAT the centerpiece of their tax-reform plans. But America needs to move away from European policies, not towards them.

And former Congressman Chris Chocola (and former head of the Club for Growth) has similar concerns. He’s a supporter of Marco Rubio, so he obviously has a political interest in undermining other candidates in the GOP race, but what he wrote for National Review is spot on.

Liberals have dreamed of imposing a VAT for decades. Democratic leader Nancy Pelosi says that “a value-added tax plays into” her vision of tax reform. President Obama has called a VAT a “novel” idea. The Left loves that a VAT can raise enormous sums of money for the government in a hidden way. Because it’s embedded in the cost of everything we buy, Washington can increase the VAT rate and then blame businesses for the higher consumer prices they bring. …in fact, high consumption taxes are what allowed European governments to grow so large. Once countries like France realized that there was a limit to how much money they could squeeze from the income tax, they used the VAT to extract resources from a broader swath of the population.

Bartlett Cleland of the Institute for Policy Innovation adds to these arguments.

The VAT is attractive to those who…[w]ant to grow government… Whether or not those proposing such taxes are interested in expanding the scope of government is almost irrelevant, because once the tools for such expansion are in place they can be used by future politicians to grow government subtly.  Similarly, whether a tax is labeled as a VAT or not is also irrelevant if the function is the same—for example by not allowing companies to deduct wages.

Last but not least, Irwin Stelzer makes a very important observation in an article for the Weekly Standard.

The VAT would give politicians and lobbyists an entirely new tax system that could be used (just like the income tax) to swap loopholes for campaign cash.

…a VAT…will not eliminate income taxes, or the IRS, or the K Street lobbyists that thrive on writing special provisions into the code to advantage their clients at the expense of the ordinary taxpayer. It will, instead, massively multiply the number of rules-writing revenue agents and further enrich their special-privilege-seeking lobbyists.

With this in mind, he poses a hypothetical question.

…if you believe that (1) a consumption tax would completely replace all income taxes, rather than be added to our current tax code, (2) arguments on behalf of children, health advocates, safety advocates, the elderly, and others would fall on deaf political ears, and (3) the K Street crowd would quietly sublet their spaces to worthier tenants and, like the obsolete old soldiers they will have become, simply fade away, then by all means support an American value-added tax.

Stelzer offers some sage advice in his conclusion.

…lack of transparency is the politicians’ friend and makes it far easier to raise VAT rates than income tax rates. Perhaps it would be best if presidential wannabes would get on with the hard, tedious work of reforming our hideous tax code rather than adding a consumption tax to our burdens.

Speaking of which, the folks at National Review have a solution to this mess. They correctly note that a VAT would be a huge mistake.

…a key feature of Cruz’s plan: its reliance on a value-added tax. …The wage earner would pay the tax through either lower wages or higher prices or both (relative to what they would be without this new tax). …The effective tax on labor income would be much higher than the headline…rate. …It is the hidden nature of the tax that has traditionally worried conservatives. Most people would not know what their wages would have bought them if this tax were lower, or if it did not exist. …it might prove much easier for politicians— say, a liberal successor to President Cruz — to raise this tax over time… The fact that European countries use this tax to finance their swollen welfare states reinforces this fear.

So they outline a way to fix what’s wrong with the plans that contain a VAT.

…there is a way for Cruz to retain the economic and fiscal advantages of his proposal while eliminating this danger. (This road lies open for Senator Paul, too.) …let businesses deduct wages when they pay their taxes and use the income tax to make up for it. This modification would keep the effective rate of taxes on labor income the same; it would just make it transparent. …it would make it a little less likely that over time government would grow larger and larger and taxes climb higher and higher.

Let’s close with (at least to me) a very persuasive point.

I wrote two months ago that one of America’s most statist presidents, Richard Nixon, supported a VAT.

Now let’s see what one of America’s best presidents, Ronald Reagan, had to say about that levy.

…a value-added tax actually gives a government a chance to blindfold the people and grow in stature and size. …the other thing with that tax is, it’s hidden in the price of a product. And that tax can quietly be increased, and all the people know is that the price went up, and they don’t know whether the price went up because somebody got a raise, or whether the company wanted to increase profits, or whether it was government. …I think I’ve said before, taxes should hurt in the sense that people should be able to see them and know what they’re paying.

Amen.

If you need more information, here’s my video on the VAT.

P.S. If you don’t believe Irwin Stelzer’s argument that a VAT would morph into a Byzantine mess, check out this recent article from the EU Observer that’s entitled, “EU’s new VAT rules forcing thousands out of business.”

P.P.S. And if you don’t believe the VAT is a money machine for bigger government, check out this data from the IMF.

P.P.P.S. Marco Rubio is right to criticize plans that include a VAT, but that doesn’t mean his plan is free of warts. For what it’s worth, the candidate with the best plan is Ben Carson. Not that anyone’s decision should be based solely on tax policy.