My views on the value-added tax are very simple and straightforward.
If we completely eliminated all income-based taxes, I would be willing to accept a VAT (or even a national sales tax) as a revenue source for government.
But unless that happens, I’m unalterably opposed because it’s far too risky to give politicians two major sources of tax revenue. 
Just look at what happened in Europe (and Japan). Before the VAT, the burden of government spending wasn’t that much higher in Europe than it was in the United States. Once VATs were adopted, however, that enabled a vast expansion of the welfare state.
This is why I’m worried about the Rand Paul and Ted Cruz tax plans. On paper, both plans are very good, dramatically lowering income tax rates, significantly curtailing double taxation, and also abolishing the corporate income tax. But I don’t like that they both propose a VAT to help make up the difference. It’s not that I think they have bad intentions, but I worry about what happens in the future when a bad President takes office and has the ability to increase both the income tax and the value-added tax. When the dust settles, we’re France or Greece!
By contrast, if we do some type of tax reform that doesn’t include a VAT, the worst thing that could happen when that bad president takes office is that we degenerate back to the awful tax code we have today. Which would be unfortunate, but not nearly as bad as today’s income tax with a VAT on top.
Bad since I’ve already addressed this issue, let’s focus on a part of the Paul and Cruz tax plans that has received very little attention.
Both of them propose to get rid of the payroll tax, which is the part of your paycheck that goes to “FICA” and is used to help fund Social Security and Medicare.
Alan Viard of the American Enterprise Institute has a column in U.S. News & World Report that explores the implications of this repeal.
Would you like to see the FICA item on your pay stub go away and be able to keep the 7.65 percent that the payroll tax takes out of your paycheck? If so, Republican presidential candidates Rand Paul and Ted Cruz have a deal for you – each of them has proposed getting rid of the tax. The senators’ plans would also eliminate the other 7.65 percent that the government collects from your employer, which you ultimately pay in the form of lower wages.
That sounds good, right? After all, who wouldn’t like to keep 15.3 percent of their income that is now being siphoned off for entitlement programs.
But here’s the catch. As Alan explains, other revenue sources would be needed to finance those programs, particularly Social Security.
The payroll tax finances two large benefit programs – 6.2 percent goes to Social Security and 1.45 percent goes to Medicare Part A. If the payroll tax went away, we would have to find another way to pay for those benefits. Paul and Cruz would turn to a value added tax, known as a VAT. …using it to pay for Social Security would have repercussions for the program that the candidates haven’t thought through. …once the payroll tax was gone, Social Security would no longer be a self-financed program with its own funding source. Instead, it would draw on the same general revenues as other government programs.
Viard thinks there are two problems with using VAT revenue to finance Social Security.
First, it means that there’s no longer a limit on how much money can be spent on the program.
…having a separate funding source for Social Security has been good budgetary policy. It’s kept the program out of annual budget fights while controlling its long-run growth – Social Security spending is limited to what current and past payroll taxes can support.
Second, replacing the payroll tax with a VAT eliminated the existing rationale for how benefits are determined.
And that will open a potential can of worms.
…what would happen to the benefit formula if the payroll tax disappeared and Social Security was financed by general revenue from the VAT? Paul and Cruz haven’t said. …One option would be to switch to a completely different formula, maybe a flat monthly benefit for all retirees. …that would be a big step, cutting benefits for high-wage workers and posing tricky transition issues.
I imagine there are probably ways to address these issues, though they might wind up generating varying degrees of controversy.
But I’m more concerned with an issue that isn’t addressed in Viard’s article.
I worry that eliminating the payroll tax would make it far harder to modernize Social Security by creating a system of personal retirement accounts.
With the current system, it would be relatively easy to give workers an option to shift their payroll taxes into a retirement account.
If the payroll tax is replaced by a VAT, by contrast, that option no longer exists and I fear reform would be more difficult.
By the way, this is also the reason why I was less than enthused about a tax reform plan proposed by the Heritage Foundation that would have merged the payroll tax into the income tax.
Yes, I realize that genuine Social Security reform may be a long shot, but I don’t want to make that uphill climb even more difficult.
The bottom line is that I don’t want changes to payroll taxes as part of tax reform, particularly when it would only be happening to offset the adverse distributional impact of the VAT, which is a tax that shouldn’t be adopted in the first place!
Instead, let’s do the right kind of tax reform and leave the payroll tax unscathed so we’ll have the ability to do the right kind of Social Security reform.
P.S. Some of you may be wondering why Senators Paul and Cruz included payroll tax repeal in their plans when that leads to some tricky issues. The answer is simple. As I briefly noted above, it’s a distribution issue. The VAT unquestionably would impose a burden on low-income households. That would not be nice (and it also would be politically toxic), so they needed some offsetting tax cut. And since low-income households generally don’t pay any income tax because of deductions, exemptions, and credits, repealing the payroll tax was the only way to address this concern about fairness for the less fortunate.
P.P.S. Since we have a “pay-as-you-go” Social Security system, with benefits for current retirees being financed by current workers, some people inevitably ask how those benefits will be financed if younger workers get to shift their payroll taxes into personal retirement accounts. That’s what’s known as the “transition” issue, and it’s a multi-trillion-dollar challenge. But the good news (relatively speaking) is that coming up with trillions of dollars over several decades as part of a switch to personal accounts will be less of a challenge than coming up with $40 trillion (in today’s dollars) to bail out a Social Security system that is actuarially bankrupt.
P.P.P.S. It goes without saying (but I’ll say it anyhow) that class-warfare taxation is Obama’s (and Hillary’s) ostensible solution to Social Security’s shortfall.
International Liberty 
[…] Moreover, Carter and Davis don’t even pretend that the income tax might be abolished. They prefer instead to go after the payroll tax, which is far less damaging. […]
[…] Ted Cruz, Rand Paul, Payroll Taxes, and the Value-Added Tax … […]
I have a response to @greg’s comment. It’s what Dan wrote a few years ago. The politicians will have no problem hiking the VAT. They’ll just raise the income tax at the same time for “fairness.”
https://danieljmitchell.wordpress.com/2010/02/18/a-value-added-tax-is-not-the-answer-unless-the-question-is-how-to-finance-bigger-government/
Fixing Entitlements should be part of an entire revamp of the “safety-net”.
Current the safety-net includes welfare, unemployment and disability insurance, Medicaid, Social Security, and Medicare. These programs were poorly designed, and the first three encourage people not to work.
It’s time to recognize that the 21st century will require a different approach. We want a mobile workforce that can rapidly shift with a rapidly changing economy. Individuals should not have their healthcare or pensions tied to one company and everyone should be incentivized to be as productive as their talents allow.
A Basic Income that cannot be lost based on income should cover every citizen. For those that cannot work, the safety-net is there; for those temporarily out of work, the safety-net is there [without the disincentives to work]; and for those working, the safety-net replaces current tax deductions and exclusions.
A Basic Income should add enough political support so a true flat tax can be implemented, since effective tax rates would be more progressive than the current system. Redistribution of income would be effectively capped, by tying the Basic Income to the poverty level. Arguments for a “living wage” would disappear. While high income individuals would probably pay more, the marginal rate would be capped, and everyone would be treated equally.
A Basic Income of 100% of the poverty level, would necessarily eliminate financial poverty for citizens. It would be paid for by eliminating federal welfare and the federal nanny state and eliminating current tax deductions, along with dollar for dollar reductions in the programs mentioned above. For example, part of the Basic Income could be deposited to a Health Savings Account. If it was an annual $3,000/adult citizen, they would have enough to buy modest health insurance, or Medicaid and Medicare costs could be reduced by a $3,000 deductible, making both more efficient. While reducing unemployment insurance payouts would not help pay for the Basic Income, it would reduce costs to employers and reduce the incentive to stay out of work until benefits run out.
With a Basic Income replacing a portion of Social Security, the outstanding entitlement liability would be reduced, and retirees would not be completely dependent on personal retirement accounts in the future, but rather they would have a government guaranteed base.
As a result of going direct to citizens, we could dismantle the entire bureaucratic morass that supports the current system.
First of all, Cruz should be eliminated from any Presidential discussion because he is owned by Goldman, and failed to disclose the Goldman and Citi loans, that his wife would have certainly been aware of.
A flat tax does not prevent corporations from moving off shore, which labor cannot do very easily. A VAT is insane, as all stages of value creation must be tracked and taxed. A fair/sales tax ONLY is the most efficient and effective.
Armstrong debated this issue with Steve Forbes and I think the case for a Fair Tax is much stronger – http://www.armstrongeconomics.com/archives/26378.
Either way, a corrupt govt can always raise a Federally imposed tax, which is why a fair tax is needed that eliminates all federally imposed taxes. Their needs to be a constitutional ammendment that limits federal spending at 7% of GDP, except during a declared war. This will enable govt to print the interest free money it needs, and eliminates the deficit spending that has imposed taxation without representation by raising current taxes to pay for debts incurred before I was born. The accumulated debts and other liabilities can NEVER be paid back, regardless of the system, which is why debt-equity swaps must be done, along with write downs, and anything that can be privatized, should be, especially schools.
http://www.armstrongeconomics.com/archives/38438.
Ending FICA payments is an absolutely necessary component for fixing the entitlements system, which has been sold as an insurance arrangement, but in actuality is a Ponzi scheme.
This does not relieve us from the obligations to seniors and future retirees who have paid into the system, but it will stop larger future liabilities from continuing to accumulate. The difference between the amounts to be paid out and the amounts in the “Trust Funds” will need to come out of general revenues, as will the phony Trust Fund paper.
Obviously, current retirees are fully vested and should continue to receive anticipated benefits. Those not yet retired are only partially vested.
For example, someone who has paid in for 30 years out of a 45 year expected work life has only paid enough FICA to receive 30/45 of the benefits. This can be done in two ways, either the dollar amount of the benefit is cut to 2/3, or the benefits are pushed back in time. The second option is better both from a cash flow basis and more in keeping with the idea of protecting those who live longer than expected.
Isn’t it smart politics? If Progressives were to increase the VAT, Reps can say “See, you are increasing a regressive tax on the poor”
Excellent analysis and examination. Unfortunately I believe your objection to VAT hinges on one assumption, that if adopted it can be increased at the whim of politicians. I would suggest that if it were adopted as a constitutional amendment specifying the rate and what items it applies to with the stipulation that the rate can only be altered by the popular vote of the American people once every 15 years you would foil greedy politicians.
As far as entitlement programs go they will destroy the government unless the current ones are abandoned and voluntary programs are substituted in their place. Social Security is doomed and always has been. Medicare was the first step toward single payer and we only need look at the UK or Canada to see how that turned out.
Unfortunately our politicians see Social Security as an unlimited pot to steal from. They also use it to defraud the intelligent. Social Security yields 2% annually, or far less than investing in something as awful as government bonds. Utilities average 7% a year. Little wonder anyone who had the option to opt out did and did far better than participating in Social Security.
One last thing, the Supreme Court has declared on three distinct instances that the American people have no claim on Social Security benefits. If you trust your government I have a wonderful investment opportunity for you with a prince in Nigeria.
“With the current system, it would be relatively easy to give workers an option to shift their payroll taxes into a retirement account.”
And those same workers would then pay a tax of a different name to pay for the benefits of SS. All you are proposing is letting them out of benefits. They will still have to pay for the system.