This is a very strange political season. Some of the Senators running for the Republican presidential nomination are among the most principled advocates of smaller government in Washington.
Yet all of them have proposed tax plans that, while theoretically far better than the current system, have features that I find troublesome. Marco Rubio, for instance, leaves the top tax rate at 35 percent, seven-percentage points higher than when Ronald Reagan left town.
Meanwhile, both Ted Cruz and Rand Paul (now out of the race) put forth plans that would subject America to value-added tax.
This has caused a kerfuffle in Washington, particularly among folks who normally are allies. To find common ground, the Heritage Foundation set up a panel to discuss this VAT controversy.
You can watch the entire hour-long program here, or you can just watch my portion below and learn why I want Senator Cruz to fix that part of his plan.
Allow me to elaborate on a couple of the points from my speech.
First, a good tax system is impossible in a nation with a big welfare state. If the public sector consumes 50 percent of economic output, that necessarily means very high marginal tax rates.
Second, all pro-growth tax reform plans tax income only one time, either when earned or when spent, which means those plans all are consumption-base taxes in the jargon of public finance economists. Which is also just another way of saying that these tax plans get rid of double taxation.
On this basis, a VAT is fine in theory. Moreover, it could even be good in reality (or, to be technical, far less destructive than the current system in reality) if all income taxes were totally abolished.
Third, since Cruz’s plan leave other taxes in place, I’m worried that future politicians would do exactly what happened in Europe – use the new revenue source to finance an expansion of the welfare state.
Proponents of the Cruz VAT correctly point out that the plan simultaneously will abolish both the corporate income and the payroll tax, which sort of addresses my concern.
But keep in mind this is only an acceptable swap if you think, 1) the plan will survive intact as it move through the legislative process, and 2) the VAT won’t raise more money than the taxes that are abolished.
I’m not sure either assumption is valid.
Last but not least, proponents of the Cruz VAT plan keep denying that the plan includes a VAT. If you recall from my remarks, I think this is silly. It is a VAT.
To bolster my argument, here’s what Alan Viard wrote for the American Enterprise Institute.
Cruz’s proposed VAT would have a 16 percent tax-inclusive rate, and Paul’s proposed VAT would have a 14.5 percent tax-inclusive rate. Both VATs would be administered through the subtraction method rather than the credit invoice method used by most countries with VATs. The use of the subtraction method would not alter the fundamental economic properties of the VAT. A VAT is equivalent to an employer payroll tax plus a business cash flow tax.
Let’s close by citing some very wise words from Professor Jeffrey Dorfman of the University of Georgia (Go Dawgs!). Here are the key parts of his column for Forbes.
Conservatives are worried about national consumption taxes for several reasons, principally: these taxes’ ability to raise large sums of revenue and the ease with which politicians can raise the rates. Because national consumption taxes are efficient and can be applied to a larger base than is typical of state and local sales taxes they can raise large sums of money. While liberals think this is a plus, conservatives are rightly wary of taxes that could supply government with more money. More importantly, conservatives are suspicious of the semi-hidden nature of consumption taxes and the ability to raise them incrementally.
Bingo.
The bottom line is that even if we decide to call the VAT by another name, it won’t alter the fact that some of us think it’s too risky to give politicians an additional revenue source.
[…] their plans. In the short run, either plan would have been much better than the current system. But I was critical because I worried the inclusion of VATs would eventually give statists a tool to further increase […]
[…] their plans. In the short run, either plan would have been much better than the current system. But I was critical because I worried the inclusion of VATs would eventually give statists a tool to further increase […]
[…] about the role of the VAT in enabling much bigger government. This helps to explain why I’m so fixated on smothering every VAT proposal in its infancy, even when proposed with ostensibly good intentions (for instance, the Rand Paul tax plan and Ted […]
[…] adjustability normally is a feature of a “destination-based” value-added tax (which, thankfully, is not part of the GOP plan), so it’s not completely clear how the tax-on-imports portion […]
[…] There are good arguments for those proposals, but the most powerful objection is that politicians can’t be trusted to permanently eliminate or reduce existing income […]
[…] There are good arguments for those proposals, but the most powerful objection is that politicians can’t be trusted to permanently eliminate or reduce existing income […]
[…] There are good arguments for those proposals, but the most powerful objection is that politicians can’t be trusted to permanently eliminate or reduce existing income […]
[…] this is why we should be stalwart in our opposition to the value-added tax. The experience with the income tax shows that politicians will expand the burden of government […]
[…] this is why we should be stalwart in our opposition to the value-added tax. The experience with the income tax shows that politicians will expand the burden of government […]
Comment above:
mixing…payment of the tax by consumers with collection of the tax, on either income or final product or service price.
Matthew:
Other than the problems raised in my sloppy comment above, here is an additional problem that you have high-lighted. If you allow politicians to exempt certain expenditures, you will end up with a hodge-podge of different tax rates that will be worse than the current tax code.
For example, what percentage tax would you put on the following: hamburger, kale, soda, education, medicine, alcohol, rent, heating oil, solar panels, and jewelry? Should a subsidy (negative tax) be applied to some favored items?Lobbyists will have a field day.
Every item with a reduced tax increases the tax rate elsewhere, since you are constricting the taxable base.
I agree with the FairTax people that there should be only one tax rate that applies to all purchases and a prebate/basic income should compensate for differences in the ability to pay.
I would be all for a consumption tax if it stood alone at the point of sale and if all other forms of tax were abolished. This is a tax that is as regressive or progressive as the individual spending cash wants it to be. Basic staples that are a disproportionate share of the poor’s budget (such as food) could be exempt. The vast complexity of our current tax system would be reduced to nothing, reducing the waste and rent-seeking of tax lawyers, accountants, and lobbyists.
Sorry “discussion” not decision.
Dan:
Your decision of the VAT continues to be sloppy.
Taxes are paid by the consumer, embedded in the price paid. Taxes are collected based on income or the final price of the product. It is in fact the corporation collecting most taxes, through withholding on income or withholding a portion of the final price. This also applies to components purchased from suppliers. The primary difference between tax plans is where and when taxes are collected. It is wrong to say taxes are paid “either when earned or when spent”, since you are mixing
The VAT would not be “good in reality…if all income taxes were totally abolished”, because you would still have the legacy portion of gross wages that had gone to taxes which becomes a raise in take-home pay, thereby compounding the amount of tax collected and dramatically increasing prices. In addition, because there would be no tax on government supplied services, for-profit businesses would bear all the tax burden.
Dorfman’s comment that the VAT would be applied to a larger base than state and local sales taxes is true, because the VAT would also be applied against services. State and local sales taxes are not applied against services because of the difficulty in collection, and that’s at around 5% not the 16%+ envisioned by these plans.
A VAT would be fine, if earned income is taxed at a flat rate, and gross salaries are a deductible expense; and the tax rate for the VAT is kept the same as the tax on earned income, so government cannot “sneak in” a rate increase.
Thanks for this blog post regarding VAT; I really enjoyed it and am definitely recommending this blog to my friends and family. I’m a 15 year old with a blog on finance and economics at shreysfinanceblog.com, and would really appreciate it if you could follow, read and comment on some of my articles, and perhaps follow, reblog and share some of my posts on social media. Thanks again for this fantastic post.
The current income tax violates the Equal Protection Clause. The original proponents understood this and that is why income taxation became the 16th Amendment to the Constitution. The only way to ensure that a Flat or VAT Tax replaces rather than supplements income taxation is to repeal the 16th Amendment.
[…] Reposted from International Liberty […]
A VAT is the fairest way to tax different types of business across different taxing jurisdictions. A 4% VAT (the lowest in the world) and 8% C corporation rate could replace job killing payroll taxes and resolve most corporate tax problems.
I agree that the suggested VATs of Ted Cruz, Paul Ryan and Rand Paul with rates of 8 to 16 percent were too high. Canada does just fine with a 5% VAT.