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Archive for the ‘VAT’ Category

While he’s not as outwardly radical as Elizabeth Warren, Bernie Sanders, and Kamala Harris, Andrew Yang has joined together two very bad ideas – universal handouts and a value-added tax.

Needless to say, I was not overflowing with praise when asked to comment.

At the risk of understatement, giving every adult a $12,000-per-year entitlement would be a recipe for bigger government and more dependency.

Even Joe Biden understands that this would erode societal capital.

And the ever-sensible Swiss, in a 2016 referendum, overwhelmingly rejected universal handouts.

Needless to say, it also would be a catastrophic mistake to give Washington several new sources of revenue to finance this scheme. A big value-added tax would be especially misguided.

Let’s take a closer look at Yang’s plan. As I noted in the interview, the Tax Foundation crunched the numbers.

Andrew Yang said he wants to provide each American adult $1,000 per month in a universal basic income (UBI) he calls a “Freedom Dividend.” He argued that this proposal could be paid for with…a combination of new revenue from a VAT, other taxes, spending cuts, and economic growth. …We estimate that his plan, as described, could only fund a little less than half the Freedom Dividend at $1,000 a month. A more realistic plan would require reducing the Freedom Dividend to $750 per month and raising the VAT to 22 percent.

If you’re interested, here are more details about his plan.

…individuals would need to choose between their current government benefits and the Freedom Dividend. As such, some individuals may decline the Freedom Dividend if they determine that their current government benefits are more valuable. The benefits that individuals would need to give up are Supplemental Nutritional Assistance Program (SNAP), Temporary Assistance for Needed Families (TANF), Supplemental Security Income (SSI), and SNAP for Women, Infants, and Child Program (WIC). To cover the additional cost of the Freedom Dividend, Yang would raise revenue in five ways: A 10 percent VAT…A tax on financial transactions…Taxing capital gains and carried interest at ordinary income rates…Remove the wage cap on the Social Security payroll tax…A $40 per metric ton carbon tax.

By the way, Yang has already waffled on some of his spending offsets, recently stating that the so-called Freedom Dividend wouldn’t replace existing programs.

In any event, the economic and budgetary effects would be bad news.

…his overall plan would reduce the long-run size of the economy and the tax base. The three major taxes in his plan (VAT, carbon tax, and payroll tax increase), while efficient sources of revenue, would tend to reduce labor force participation by reducing the after-tax returns to working. Using the Tax Foundation Model, we estimate that the weighted average marginal tax rate on labor income would increase by about 8.6 percentage points. The resulting reduction in hours worked would ultimately reduce output by 3 percent. We estimate that Yang would lose about $124 billion each year in revenue due to the lower output.

Here’s how the Tax Foundation scores the plan.

As you can see, the VAT, the financial transactions tax, the higher capital gains tax, and the increase in the payroll tax burden don’t even cover half the cost of the universal handout.

P.S. When the Tax Foundation say a tax is an “efficient source of revenue,” that means that it would result in a modest level of economic damage on a per-dollar-collected basis. This is why they show a rather modest amount of negative revenue feedback (-$124 billion).

I think they’re being too kind. Extending the Social Security payroll tax to all income would result in a huge increase in marginal tax rates on investors, entrepreneurs, and other high-income taxpayers. As explained a few days ago, those are the people who are very responsive to changes in tax rates.

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There’s general agreement among public finance experts that personal income taxes and corporate income taxes, on a per-dollar-collected basis, do the most economic damage.

And I suspect there’s a lot of agreement that this is because these levies often have high marginal tax rates and often are accompanied by a significant bias against income that is saved and invested.

Payroll tax and consumption taxes, by contrast, are thought to be less damaging because they generally don’t have “progressive rates” and they are “neutral,” meaning they rarely involve any double taxation of saving and investment.

But “less damaging” is not the same as “no damage.”

Such taxes still drive a wedge between pre-tax income and post-tax consumption, so they do result in less economic activity (what economists refer to as “deadweight loss“).

And the deadweight loss can be significant if the overall tax burden is sufficiently onerous (as is the case in many European nations).

Interestingly, the (normally pro-tax) International Monetary Fund just released a study on this topic. It looked at the impact of taxes on work in the new member states (NMS) of the European Union. Here’s a summary of what the authors wanted to investigate.

Given demographic and pension pressures facing many EU28 countries amidst low labor market participation rates together with still high tax wedges, the call to review public policies has gained renewed prominence in the EU political debate. …tax wedges remain high and participation rates, while having increased importantly in a few countries over 2000-17 , are still around or below 70 percent in many of them. This hints at the need for addressing structural problems to improve economic fortunes. In this paper we focus our attention on hours worked (per working age population). …At country level, hours worked reflect labor supply decisions and could be thought of a measure of labor utilization. Long-run changes in labor supply are driven by incentives, of which taxes are perceived to be central. Assessing the importance of taxation on hours is key to provide new insights for potential policy actions.

And here’s what they found.

We study the role of taxes in accounting for differences in hours worked across NMS over the 1995-17 period… We find that consumption and labor taxes significantly discourage labor supply and can explain close to 21 percent of the observed variation of hours across NMS. …Higher tax rates reduce households’ net labor income and real purchasing power, inducing them to substitute consumption for leisure, which cannot be taxed. …Our findings show that, conditional on other factors, taxes are an important determinant of hours. Point estimates suggest a high elasticity of hours to taxes (close to 0.5), which is robust to the inclusion of other factors.

What’s interesting about the new member states of Eastern Europe is that many of them have flat taxes and low corporate rates.

So the personal and corporate income taxes are not a major burden.

But they so have relatively high payroll taxes (a.k.a., social insurance taxes) and relatively onerous value-added taxes.

So it’s hardly a surprise that these levies are the ones most associated with deadweight loss.

We find that social security contributions deter hours the most, followed by consumption taxes and, to a lesser extent, personal income taxes. …Consumption and personal income taxes are found to affect hours per worker, but not employment rates. On the other hand, social security contributions are negatively associated with employment rates, but do not seem to affect hours per worker. …In line with the literature, we document that women’s employment rate is more sensitive to changes in tax policies. We find the elasticity of employment rate to social security contributions to be 7 percent larger for women vis-à-vis men.

Here’s one of the charts from the study.

And here’s an explanation of what it means.

Figure 4 shows the evolution of hours and effective taxes. Hours worked increased substantially for Group 1, while it remained stable in Group 2 (Panel (a)). In both groups, the effect of the GFC is noticeable as hours sharply declined after 2008. Panel (b) shows the evolution of the average effective tax rate in each group. Interestingly, countries in Group 1, which observed an increase in hours, had lower effective tax rates (below 40 percent) throughout the period. In addition, we observe a negative correlation between hours and taxes for most of the sample. For Group 1, the large increase in hours – between year 2000 and the GFC – happened at the same time taxes declined

Here’s another chart from the IMF report.

And here’s some of the explanatory text.

Figure 5 depicts the relationship between hours worked and taxes across countries. In Panel (a), we observe a negative correlation between hours and taxes in levels for each group, with the negative correlation being stronger in Group 2 than in Group 1 (it has a steeper slope). Panel (b) shows total log changes in hours and taxes throughout the period. It also displays a negative correlation.

Looking at the conclusion, a key takeaway from the study is that there is a substantial loss of economic activity because of theoretically benign (but in reality onerous) taxes on consumption and labor.

Our modelling exercise shows that taxes influence the long-run trend in hours and our econometric exercise shows that the findings are robust to the inclusion of other labor market determinants. Furthermore, we document an elasticity of hours to overall taxes close to 0.5. We find that differences in tax burden can explain up to 21 percent in the variation of hours worked across NMS. The main takeaway of this study is that excessive tax burden, either in the form of consumption or labor taxes, can lead to substantial deadweight losses in terms of labor supply. .. overall tax burden – and not only labor taxes – should be considered when thinking about incentives from tax schemes.

Yes, incentives do matter.

And it’s good that an IMF report is providing good evidence for lower tax rates.

But I’m not optimistic we’ll get pro-growth changes. There’s been a lack of good reform this decade from the new member states from Eastern Europe. Combined with demographic decline (and the associated pressure for higher tax rates), this does not bode well.

P.S. While the professional economists at the IMF often produce good research and sensible advice, the bureaucracy’s political leaders almost always ignore those findings and instead push for bad tax policy. Including in the new member states from Eastern Europe.

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A couple of weeks ago, I used a story about a local tax issue in Washington, DC, to make an important point about how new tax increases cause more damage than previous tax increases because “deadweight losses” increase geometrically rather than arithmetically.

Simply stated, if a tax of X does Y amount of damage, then a tax of 2X will do a lot more damage than 2Y.

This is the core economic reason why even left-leaning international bureaucracies agree that class-warfare taxes are so destructive. When you take a high tax rate and make it even higher, the damage grows exponentially.

As such, I was very interested to see a new study on this topic from the World Bank. It starts by noting that higher tax rates are the wrong way to address fiscal shortfalls.

…studies have used the narrative approach for individual or multi-country analyses (in all cases, focusing solely on industrial economies, and mostly on industrial European countries). These studies find large negative tax multipliers, ranging between 2 and 5. This recent consensus pointing to large negative tax multipliers, especially in industrial European countries, naturally entails important policy prescriptions. For example, as part of a more comprehensive series of papers focusing on spending and tax multipliers, Alesina, Favero, and Giavazzi (2015) point that policies based upon spending cuts are much less costly in terms of short run output losses than tax based adjustments.

The four authors used data on value-added taxes to investigate whether higher tax rates did more damage or less damage in developing nations.

A natural question is whether large negative tax multipliers are a robust empirical regularity… In order to answer this highly relevant academic and policy question, one would ideally need to conduct a study using a more global sample including industrial and, particularly, developing countries. …This paper takes on this challenge by focusing on 51 countries (21 industrial and 30 developing) for the period 1970-2014. …we focus our efforts on building a new series for quarterly standard value-added tax rates (henceforth VAT rates). …We identify a total of 96 VAT rate changes in 35 countries (18 industrial and 17 developing).

The economists found that VAT increases did the most damage in developing nations.

…when splitting the sample into industrial European economies and the rest of countries, we find tax multipliers of 3:6 and 1:2, respectively. While the tax multiplier in industrial European economies is quite negative and statistically significant (in line with recent studies), it is about 3 times smaller (in absolute value) and borderline statistically significant for the rest of countries.

Here’s a chart showing the comparison.

Now here’s the part that merits close attention.

The study confirms that the deadweight loss of VAT hikes is higher in developed nations because the initial tax burden is higher.

Based on different types of macroeconomic models (which in turn rely on different mechanisms), the output effect of tax changes is expected to be small at low initial levels of taxation but exponentially larger when initial tax levels are high. Therefore, the distortions and disincentives imposed by taxation on economic activity are directly, and non-linearly, related to the level of tax rates. By the same token, for a given level of initial tax rates, larger tax rate changes have larger tax multipliers. …In line with theoretical distortionary and disincentive-based arguments, we find, using our novel worldwide narrative, that the effect of tax changes on output is indeed highly non-linear. Our empirical findings show that the tax multiplier is essentially zero under relatively low/moderate initial tax rate levels and more negative as the initial tax rate and the size of the change in the tax rate increase. …This evidence strongly supports distortionary and disincentive-based arguments regarding a nonlinear effect of tax rate changes on economic activity…the economy will inevitably suffer when taxes are increased at higher initial tax rate levels.

What makes these finding especially powerful is that value-added taxes are less destructive than income taxes on a per-dollar-raised basis.

So if taking a high VAT rate and making it even higher causes a disproportionate amount of economic damage, then imagine how destructive it is to increase top income tax rates.

P.S. The fact that a VAT is less destructive than an income tax is definitely not an argument for enacting a VAT. That would be akin to arguing that it would be fun to break your wrist because that wouldn’t hurt as much as the broken leg you already have.

I’ve even dealt with people who actually argue that a VAT isn’t economically destructive because it imposes the same tax on current consumption and future consumption. I agree with them that it is a good idea to avoid double taxation of saving and investment, but that doesn’t change the fact that a VAT increases the wedge between pre-tax income and post-tax consumption.

And that means less incentive to earn income in the first place.

Which is confirmed by the study.

Panels A and B in Figure 18 show the relationship between the VAT rate a and the perceived effect of taxes on incentives to work and invest, respectively, for a sample of 123 countries for the year 2014. Supporting our previous findings, the relationship is highly non-linear. While the perceived effect of taxes on the incentives to work and invest barely changes as VAT rates increase at low/moderate levels (approximately until the VAT rate reaches 14 percent), it falls rapidly for high levels of VAT rates.

Here’s the relevant chart from the report.

The moral of the story is that all tax increases are misguided, but class-warfare taxes wreak the most economic havoc.

P.S. Not everyone understands this common-sense observation. For instance, the bureaucrats at the Congressional Budget Office basically argued back in 2010 that a 100 percent tax rate was the way to maximize growth.

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The value-added tax was first imposed in Europe starting about 50 years ago. Politicians in nations like France approve of this tax because it is generally hidden, so it is relatively easy to periodically raise the rate.

And that’s the reason I am vociferously opposed to the VAT. I don’t think it’s a coincidence that the burden of government spending dramatically increased in Europe once politicians got their hands on a new source of revenue.

Simply stated, I don’t want that to happen in America.

Now I have new evidence to support that position.

We’ll start by crossing the Pacific to see what’s happening in Japan, as reported by Reuters.

Japanese Prime Minister Shinzo Abe vowed to proceed with next year’s scheduled sales tax hike “by all means”… Abe said his ruling Liberal Democratic Party (LDP) won last year’s lower house election with a pledge to use proceeds from the sales tax increase to make Japan’s social welfare system more sustainable. …his plan to raise the tax to 10 percent from 8 percent in October next year. Abe twice postponed the tax hike after an increase to 8 percent from 5 percent in 2014 tipped Japan into recession.

I give Prime Minister Abe credit for honesty. He openly admits that he wants more revenue to finance even bigger government.

But that doesn’t make it a good idea. Japan has been experimenting with bigger government for the past 25-plus years and it hasn’t led to good results. The VAT was just 3 percent in 1997 and the Prime Minster now wants it to be three times higher.

All of which is sad since Japan used to be one of the world’s most market-oriented nations.

You also won’t be surprised to learn that the OECD is being a cheerleader for a higher VAT in Japan.

Speaking of which, let’s look at what a new OECD report says about value-added taxes.

VAT revenues have reached historically high levels in most countries… Between 2008 and 2015, the OECD average standard VAT rate increased by 1.5 percentage points, from 17.6% to a record level of 19.2%, accelerating a longer term rise in standard VAT rates… VAT rates were raised at least once in 23 countries between 2008 and 2018, and 12 countries now have a standard rate of at least 22%, against only six in 2008… Raising standard VAT rates was a common strategy for countries…as increasing VAT rates provides immediate revenue.

And here’s a chart from the study that tells you everything you need to know about how politicians behave once they have a new source of tax revenue.

Incidentally, there’s another part of the report that should be highlighted.

For all intents and purposes, the OECD admits that higher taxes are bad for growth and that class-warfare taxes are the most damaging method of taxation.

…increasing VAT rates…has generally been found to be less detrimental to economic growth than raising direct taxes.

What makes this excerpt amusing (at least to me) is that the bureaucrats obviously want readers to conclude that higher VAT burdens are okay. But by writing “less detrimental to growth,” they are admitting that all tax increases undermine prosperity and that “raising direct taxes” (i.e., levies that target the rich such as personal income tax) is the worst way to generate revenue.

Which is what I’ve been pointing out!

Last but not least, I’ll recycle my video explaining why a VAT would be very bad news for the United States.

Everything that has happened since that video was released in 2009 underscores why it would be incredibly misguided to give Washington a big new source of tax revenue. And that’s true even if the people pushing a VAT have their hearts in the right place.

The only exception to my anti-VAT rigidity is if the 16th Amendment is repealed, and then replaced by something that unambiguously ensures that the income tax is permanently abolished. A nice goal, but I’m not holding my breath.

P.S. One of America’s most statist presidents, Richard Nixon, wanted a VAT. That’s a good reason for the rest of us to be opposed.

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I never saw The Nightmare Before Christmas, a 1993 film. But that’s fine, because I am already dealing with my own nightmare with the holiday just around the corner.

What’s haunting me in the specter of a value-added tax, which some reporters now think is a clear and present danger (my concern, not theirs).

We’ll start with this disconcerting report a couple of days ago from Politico.

Is the real lesson from tax reform that Americans rely too much on the income tax to fund their government? …Most other industrial nations lighten the load on their income tax by combining it with some form of consumption taxes… “If you want a code that is predictable and simple and competitive with rates on the global market place, you have to bring in other sources of income, other than the income tax,” said Sen. Ben Cardin (D-Md.). “A progressive consumption tax is the most logical way to move forward but we’re not there yet. I think ultimately we’ll get there.”

By the way, there’s a huge mistake in the above excerpt.

I don’t know if it’s because of dishonesty of incompetence, but the reporter is wrong to claim that other nations “lighten the load of their income tax.” Here’s a chart, based on OECD data, comparing the burden of personal income tax for the U.S. and Western Europe.

In other words, governments adopt VATs because politicians want to spend more.

And what sort of spending will we get?

Our statist friends are salivating at the thought of financing a bigger welfare state.

As a rule, the regressive nature of consumption taxes makes them less attractive to Democrats. But given concerns about climate change, a carbon tax is one consumption tax that has begun to attract some following. And economist Henry Aaron at the non-profit Brookings Institution said Democrats are “short-sighted” if they reject consumption taxes… Given the aging population and desire to do more to help workers adjust to technologies that threaten their jobs, the needs are there. “The bulk of redistribution occurs on the expenditure side of the budget,” Aaron said. “Those of us who want more progressivity would rather see a progressive tax … but the impact on income redistribution is going to be overwhelmed by what is done with revenue on the expenditure side. That’s going to completely overwhelm any regressivity in the collection mechanism.”

And here are some excerpts from a Yahoo column from earlier this month.

We’re being warned that politicians will use the next fiscal crisis to impose a VAT.

…at some point, the United States will have to reduce annual deficits that could swell to $1 trillion per year as early as 2019. Republicans would prefer to solve that problem by cutting social spending. But that seems unlikely. To make a difference, cuts in programs such as Social Security and Medicare would have to be vast, which would outrage voters. A more likely solution is a national consumption tax, otherwise known as a value-added tax, or VAT. “A 5% VAT would raise an enormous amount of money,” says Jeremy Scott, a tax attorney who is vice president of editorial at the publisher Tax Analysts. “The next major fiscal crisis might be followed by a VAT.”

Gee, isn’t that wonderful. The politicians will spend us into a fiscal cul-de-sac, and then use that spending crisis as an excuse to seize more of our money.

And I can’t resist sharing this passage to remind folks that those of us who opposed the “border-adjustment tax” were on the side of the angels. The BAT was basically a pre-VAT.

House Republicans actually proposed a tax similar to a VAT in the tax plan they introduced in 2016, and carried into 2017 as the starting point for the Trump tax cuts. That tax alone would have raised $1.2 trillion in new revenue during the first decade and more during the second decade — a large pot of new funds that would have allowed significant cuts elsewhere in the tax code. That tax was controversial, however, and Trump declared it too complicated. So House Republicans dropped it. Still, old ideas have a way of coming back around in Washington.

Yes, it is certainly the case that bad ideas never go away in Washington.

Let’s close with an amusing poem from Reddit‘s libertarian page.

P.S. If minimalist poetry isn’t your cup of tea, you can enjoy some cartoons about the VAT by clicking herehere, and here.

P.P.S. The clinching argument is that Reagan opposed a VAT and Nixon supported a VAT. That tells you everything you need to know.

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I argued last year that leftists should be nice to rich people because upper-income taxpayers finance the vast majority of the American welfare state according to government data.

Needless to say, my comment about being “nice” was somewhat sarcastic. But I was making a serious point about the United States having a very “progressive” fiscal system. The top-20 percent basically pay for government and those in the bottom half are net recipients of that involuntary largesse.

I also pointed out a huge difference between the United States and Europe. Governments on the other side of the Atlantic impose much higher burdens on lower-income and middle-class taxpayers.

Here’s some of what I wrote.

…the big difference between the United States and Europe is not taxes on the rich. We both impose similar tax burden on high-income taxpayers, though Europeans are more likely to collect revenue from the rich with higher income tax rates and the U.S. gets a greater share of revenue from upper-income taxpayers with double taxation on interest, dividends, and capital gains (we also have a very punitive corporate tax system, though it doesn’t collect that much revenue). The real difference between America and Europe is that America has a far lower tax burden on lower- and middle-income taxpayers. Tax rates in Europe, particularly the top rate, tend to take effect at much lower levels of income. European governments all levy onerous value-added taxes that raise costs for all consumers. Payroll tax burdens in many European nations are significantly higher than in the United States.

So do this mean European politician don’t like ordinary people?

I could make a snarky comment about the attitudes of the political elite, but I’ll resist that temptation and instead point out that taxes in Europe are much higher for the simple reason that government is much bigger and that means some segment of the population has to surrender more of its income.

But here’s the $64,000 question that we want to investigate today: Why are European governments pillaging lower-income and middle-class taxpayers instead of going after the “evil rich” and “greedy corporations”?

Part of the answer is that there aren’t enough rich people to finance big government. But the most important factor is the Laffer Curve. Politicians can impose higher tax rates on upper-income taxpayers and companies, but that doesn’t necessarily translate into higher revenue. Simply stated, well-to-do taxpayers have considerable ability to earn less income and/or report less income when tax burdens increase, and they do the opposite when tax burdens decrease.

That’s true in the United States, and it’s true in European countries such as Sweden, France, Russia, Denmark, and the United Kingdom.

So even if politicians want to fleece upper-income taxpayers, that’s not a successful method of generating a lot of revenue.

Which is why a shift from a medium-sized welfare state (such as what exists in the United States) to a large-sized welfare state (common in Europe) means huge tax increases on ordinary taxpayers.

I’ve made this point before, but now I have some additional evidence thanks to a new report from the Organization for Economic Cooperation and Development. The Paris-based bureaucracy is probably my least-favorite international organization because of its advocacy for statism, but it collects and publishes lots of useful statistics about fiscal policy in the industrialized world.

And here are three charts from the new study that tell a very persuasive story (and a depressing story for ordinary taxpayers).

First, we can see how the average tax burden has increased substantially over the past 50 years.

And who is paying all that additional money to politicians?

As you can see from this second chart, income tax revenues have become a less-important source of revenue over time while social insurance taxes (mostly paid by lower-income and middle-class taxpayers) have become a more-important source of revenue.

The third chart shows the evolution of the value-added tax burden. This levy takes a big bite out of the paychecks of ordinary people and the rate keeps climbing over time (and if we looked just at European governments that are part of the OECD, the numbers are even more depressing).

Now let’s put this data in context.

The United States now has a medium-sized welfare state financed mostly by upper-income taxpayers.

But because of dramatic demographic changes, we are doomed to have a large-sized welfare state. At least that’s what will happen if we don’t reform entitlement programs.

And if we leave policy on auto-pilot and there’s a substantial increase in the burden of government spending, it’s simply a matter of time before politicians figure out new ways of taking more money from lower-income and middle-class taxpayers.

Yes, they may also impose higher rates on “rich” taxpayers, but that will be mostly for symbolic purposes since those levies won’t generate substantial revenue.

Last but not least, don’t forget that European fiscal burdens will mean anemic European economic performance.

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Whenever I see an otherwise sensible person express support for a value-added tax, it triggers a Pavlovian response. And it’s not a favorable reaction.

But I just read a pro-VAT column and I liked it.

So what happened? Have I surrendered to big government? Did I ingest some magic mushrooms?

Actually, I think you’ll agree that I’m still the same lovable guy. Yes, Professor John Cochrane of the University of Chicago (also a Cato adjunct scholar) has a column in the Wall Street Journal that embraces a VAT. But unlike all of the others I just cited, he includes a condition that is mandatory, necessary, vital, and non-negotiable. It’s so important that it deserves the opposite of fine-print treatment.

…eliminate entirely the personal and corporate income tax, estate tax and all other federal taxes. …it is essential that the VAT replace rather than add to the current tax system, as it does in Europe.

Amen. John hits the nail on the head.

The VAT isn’t theoretically bad. Like the flat tax, it would have one rate. There also would be no double taxation of saving and investment. And it also can be designed to have no loopholes.

In other words, the good news is that the VAT – when compared to the internal revenue code – is a less-destructive way of generating revenue.

The bad news, though, is that the VAT is capable of generating a lot of revenue. And as we’ve seen in Europe, that’s a recipe for enabling a larger burden of government spending.

Which is why the idea of a VAT should only be on the table if the plan would first abolish all other federal taxes. Which is what John is proposing.

Except I’d take it one step farther. Just like I’ve argued when contemplating a national sales tax, I’d only allow the VAT if we first repeal the 16th Amendment and replace it with something so ironclad that even John Roberts and Ruth Bader Ginsberg couldn’t rule in favor of an income tax at some point in the future.

By the way, John is right that the economy would grow faster if the income tax was totally abolished. The current system is filled with warts.

Much of the current tax mess results from taxing income. Once the government taxes income, it must tax corporate income or people would incorporate to avoid paying taxes. Yet the right corporate tax rate is zero. Every cent of corporate tax comes from people via higher prices, lower wages, or lower payments to shareholders. And a corporate tax produces an army of lawyers and lobbyists demanding exemptions. An income tax also leads to taxes on capital income. Capital income taxes discourage saving and investment. But the government is forced to tax capital income because otherwise people can hide wages… The estate tax can take close to half a marginal dollar of wealth. This creates a strong incentive to blow the family money on a round-the-world cruise, to spend lavishly on lawyers, or to invest inefficiently to avoid the tax. …A reformed tax code should involve no deductions—including the holy trinity of mortgage interest, employer-provided health insurance, and charitable deductions. The interest groups for each of these deductions are strong. But if the government doesn’t tax income in the first place, these deductions vanish without a fight.

By the way, I will quibble with a couple of things he wrote.

First, I don’t necessarily think the correct corporate tax rate is zero. What’s important is eliminating either the corporate tax or the tax on dividends. That way the income is only taxed once. And since it’s probably administratively easier to tax the income once at the business level rather than once at the shareholder level, I’m not fixated on abolishing the corporate tax.

Second, it’s very important to get rid of double taxation (what he calls “capital income”), but you don’t need a VAT to make that happen. There’s no double taxation with a flat tax.

Third, he should have explicitly included the state and local tax deduction in his list of loopholes to abolish (I’m guessing he assumed it would be the first deduction on the chopping block and therefore didn’t need to be mentioned).

There’s another part of John’s column that deserves attention. He points out that you need to have small government if you want a low tax burden.

…if the federal government is going to spend 20% of gross domestic product, the VAT will sooner or later have to be about 20%. Tax reform is stymied because politicians mix arguments over the rates with arguments over the structure of taxes. This is a mistake. They should first agree to fix the structure of the tax code, and later argue about rates—and the spending those rates must support.

At the risk of being pedantic, I think the VAT rate would have to be significantly above 20 percent, both because the tax base will be smaller than GDP and also because there will be loopholes or rebates. But the point he’s making is spot on. You can’t have a low tax rate and a big government. I’ve made the same point when writing about Belgium and Germany, nations where middle-class taxpayers are pillaged because the welfare state is too big.

My bottom line on this issue is that Professor Cochrane has produced a column showing that a VAT is theoretically worth considering, but only if all other federal taxes are permanently abolished.

But since that’s not going to happen any time soon, I don’t think there’s any reason to ease up on my dogmatic (and pragmatic) opposition to that levy.

P.S. My clinching argument is that Reagan opposed a VAT and Nixon supported a VAT. That tells you everything you need to know.

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