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Archive for the ‘VAT’ Category

Our nation very much needs fundamental tax reform, so it’s welcome news that major public figures – including presidential candidates – are proposing to gut the internal revenue code and replace it with plans that collect revenue in less-destructive ways.

A few months ago, I wrote about a sweeping proposal by Senator Marco Rubio of Florida.

Today, let’s look at the plan that Senator Rand Paul has put forward in a Wall Street Journal column.

He has some great info on why the current tax system is a corrupt mess.

From 2001 until 2010, there were at least 4,430 changes to tax laws—an average of one “fix” a day—always promising more fairness, more simplicity or more growth stimulants. And every year the Internal Revenue Code grows absurdly more incomprehensible, as if it were designed as a jobs program for accountants, IRS agents and tax attorneys.

And he explains that punitive tax policy helps explain why our economy has been under-performing.

…redistribution policies have led to rising income inequality and negative income gains for families. …We are already at least $2 trillion behind where we should be with a normal recovery; the growth gap widens every month.

So what’s his proposal?

…repeal the entire IRS tax code—more than 70,000 pages—and replace it with a low, broad-based tax of 14.5% on individuals and businesses. I would eliminate nearly every special-interest loophole. The plan also eliminates the payroll tax on workers and several federal taxes outright, including gift and estate taxes, telephone taxes, and all duties and tariffs. I call this “The Fair and Flat Tax.” …establish a 14.5% flat-rate tax applied equally to all personal income, including wages, salaries, dividends, capital gains, rents and interest. All deductions except for a mortgage and charities would be eliminated. The first $50,000 of income for a family of four would not be taxed. For low-income working families, the plan would retain the earned-income tax credit.

Kudos to Senator Paul. This type of tax system would be far less destructive than the current system.

That being said, it’s not perfect. Here are three things I don’t like.

  1. The Social Security payroll tax already is a flat tax, so it’s unclear why it should be wrapped into reform of the income tax, particularly if that change complicates the possibility of shifting to a system of personal retirement accounts.
  2. There would still be some double taxation of dividends, capital gains, and interest, though the destructive impact of that policy would be mitigated because of the low 14.5 percent rate.
  3. The earned-income credit (a spending program embedded in the tax code) should be eliminated as part of a plan to shift all means-tested programs back to the states.

But it’s important not to make the perfect the enemy of the good, particularly since the debate in Washington so often is about bad ideas and worse ideas.

So the aforementioned three complaints don’t cause me much heartburn.

But there’s another part of the Paul plan that does give me gastro-intestinal discomfort. Here’s a final excerpt from his column.

I would also apply this uniform 14.5% business-activity tax on all companies…. This tax would be levied on revenues minus allowable expenses, such as the purchase of parts, computers and office equipment. All capital purchases would be immediately expensed, ending complicated depreciation schedules.

You may be wondering why this passage is worrisome. After all, it’s great news that the very high corporate tax rate is being replaced by a low-rate system. Replacing depreciation with expensing also is a huge step in the right direction.

So what’s not to like?

The answer is that Senator Paul’s “business-activity tax” doesn’t allow a deduction for wages and salaries. This means, for all intents and purposes, that he is turning the corporate income tax into a value-added tax (VAT).

In theory, this is a good step. After all, the VAT is a consumption-based tax which does far less damage to the economy, on a per-dollar-collected basis, than the corporate income tax.

But theoretical appeal isn’t the same as real-world impact.

Simply stated, the VAT is a money machine for big government.

All of which helps to explain why it would be a big mistake to give politicians this new source of revenue.

Indeed, this is why I was critical of Herman Cain’s 9-9-9 plan four years ago.

It’s why I’ve been leery of Congressman Paul Ryan’s otherwise very admirable Roadmap plan.

And it’s one of the reasons why I feared Mitt Romney’s policies would have facilitated a larger burden of government.

These politicians may have had their hearts in the right place and wanted to use the VAT to finance pro-growth tax reforms. But I can’t stop worrying about what happens when politicians with bad motives get control.

Particularly when there are safer ways of achieving the same objectives.

Here’s some of what I wrote last year on this exact topic.

…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.

To wrap things up, there’s no doubt that Senator Paul has a very good proposal. And I know his heart is in the right place.

But watch this video to understand why his proposal has a very big wart that needs to be excised.

For what it’s worth, I’m mystified why pro-growth policy makers don’t simply latch onto an unadulterated flat tax.

That plan has all the good features needed for tax reform without any of the dangers associated with a VAT.

P.S. You can enjoy some good VAT cartoons by clicking here, here, and here.

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I warned just last week about the dangers of letting politicians impose a value-added tax.

Simply stated, unless the 16th Amendment is repealed and replaced with a new provision forever barring the re-imposition of any taxes on income, a VAT inevitably would be a new source of revenue and become a money machine to finance ever-larger government.

Just look at the evidence from Europe if you’re not convinced.

That’s why the VAT is bad in reality.

Now let’s talk about why the VAT (sometimes called a “business transfer tax”) is theoretically appealing.

First and foremost, the VAT doesn’t do nearly as much damage, per dollar raised, as our current income tax. That’s because the VAT is a single-rate tax (i.e., no class warfare) with no double taxation of income that is saved and invested.

In some sense, it’s a version of the national sales tax, except the revenue is collected on the “value added” at each stage of the production process rather than in one fell swoop when consumers make their purchases.

And it’s also conceptually similar to the flat tax. Both have one rate. Both have no double taxation. And both (at least in theory) have no special preferences and loopholes. The difference between a flat tax and the VAT is that the former taxes your income (only one time) when you earn it and the latter taxes your income (only one time) when you spend it.

In other words, the bottom line is that it is good (or, to be more accurate, less bad) to have a tax system with a low rate and no double taxation. And in the strange world of public finance economists, a system with no double taxation is called a “consumption-base tax.” And the flat tax, sales tax, and VAT all fit in that category.

So why, then, if supporters of limited government prefer a consumption-base tax over the internal revenue code, is there so much hostility to a VAT?

The answer is simple. We don’t trust politicians and we’re afraid that a VAT would be an add-on tax rather than a replacement tax.

Which explains why it’s better to simply turn the existing tax code into a consumption-base tax. After all, the worst thing that could happen is that you degenerate back to the current system.

But if you go with a VAT, the downside risk is that America becomes France.

There’s a story in today’s Wall Street Journal that illustrates why consumption-base taxation is both a threat and opportunity. Here are some introductory excerpts.

U.S. lawmakers on both sides of the aisle increasingly are finding appeal in an ambitious concept for overhauling the nation’s income-tax system: a tax based on consumption, a tool long used around the world. …As the name implies, consumption-style taxes hit the money taxpayers spend, rather than income they receive. One prominent feature of consumption systems is that they generally tax savings and investment lightly or not at all. That, in turn, encourages more investment and innovation, and ultimately more growth, many economists contend.

The reporter is wrong about consumption systems, by the way. Income that is saved and invested is taxed. It’s just not taxed over and over again, which can happen with the current system.

But he’s right that there is bipartisan interest. And he correctly points out that some politicians want an add-on tax while others want to fix the current system.

The tax-writing Senate Finance Committee is giving new consideration to the consumption-tax idea with the hope that its promised boost to economic growth would ease the way to a revamp. …Some of these proposals would have consumers pay another tax in addition to existing state and local sales taxes, while others would merely reshape the current system to tilt it more toward consumption. …Enactment of a broad-based federal consumption tax would align the U.S. with a global trend.

A Democratic Senator from Maryland wants to augment the current tax code by imposing the VAT.

Mr. Cardin introduced legislation last year to create a type of consumption tax known as a value-added tax and at the same time lower business taxes and scrap income taxes completely for lower-income Americans.

While some GOP Senators want to modify the current system to get rid of most double taxation.

Republicans on the working group also are interested in the concept, including a proposal put forward recently by GOP Sens. Marco Rubio of Florida and Mike Lee of Utah. That plan would make several changes to the tax code that would move the nation closer to a consumption-based system. …Many GOP members “believe that there are economic benefits to moving away from taxation of income and toward taxation of consumption,” a Senate aide said.

And the story also notes the objections on the left to consumption-base taxation, as well as objections on the right to the VAT.

Some liberals are concerned that consumption taxes affect poor people disproportionately, while unduly benefiting the rich, unless adjustments are made. For their part, conservatives fear that some types of consumption tax—particularly value-added taxes—would make it too easy to dial up government revenue collection.

So what’s the bottom line? Is it true, as the headline of the story says, that “Proposals for a consumption tax gain traction in both parties”?

Yes, that’s correct. But that’s not the same as saying that there is much chance of bipartisan consensus.

There’s a huge gap between those who want a VAT as an add-on tax and those who want to reform the current system to get rid of double taxation.

This doesn’t mean we shouldn’t worry about the prospect of an add-on VAT. As I warned last year, there are some otherwise sensible people who are sympathetic to this pernicious levy.

Which is why I repeatedly share this video about the downside risk of a VAT.

And you get the same message from these amusing VAT cartoons (here, here, and here).

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Even though I fret about a growing burden of government and have little faith in the ability (or desire) of politicians to make wise decisions, I somehow convince myself that good things will happen.

Here’s some of what I wrote two years ago, when asked whether I thought America could be saved from a Greek-style fiscal collapse.

I think there’s a genuine opportunity to save the country. …we can at least hold the line and prevent government from becoming bigger than it is today. Sort of a watered-down version of Mitchell’s Golden Rule. The key is the right kind of entitlement reform.

But in that same article, I also issued this warning.

I may decide to give up if something really horrible happens, such as adoption of a value-added tax. Giving politicians a big new source of revenue, after all, would cripple any incentive for fiscal restraint.

To be blunt, imposing a big national sales tax – in addition to the income tax – would be a horrible defeat for advocates of limited government. A VAT would lead to more spending and more debt.

And that’s when folks might consider looking for escape options because America’s future will be very grim.

Here’s a video I narrated on why the value-added tax is awful public policy.

Thankfully, I’m not the only one raising the alarm.

In a recent editorial, the Wall Street Journal wisely opined on the huge downside risk of a value-added tax.

It’s the hottest trend among tax collectors, raising a gusher of revenue for spendthrift governments worldwide. …a new report from accounting firm Ernst & Young says that VAT “systems are spreading” around the world and “rates are rising.”

By the way, the comment about “rates are rising” is an understatement, as illustrated by the table prepared by the Heritage Foundation.

Politicians love VATs both because they generate huge amounts of revenue and because the tax is hidden in the price of products and thus can be increased surreptitiously.

The WSJ explains.

The VAT is a sort of turbo-charged national sales tax on goods and services… Politicians love it because it is the most efficient revenue-raiser known to man, and its rates can be raised gradually to finance new entitlements or fill budget holes. The VAT is typically introduced with a low rate but then moves up over time until it swallows huge chunks of national economies. …Because VATs are embedded in the price of products, they can often rise unnoticed by the consumer, which is why liberals love them as a vehicle for periodic stealth tax hikes.

And in this case, “periodic” is just another way of saying “whenever politician want more money.”

And if recent history is any indication, “whenever” is “all the time.”

E&Y says standard VAT rates now average a knee-buckling 21.6% in the European Union, up from 19.4% in 2008. Average standard rates in the industrial countries of the Organization for Economic Cooperation and Development have climbed to 19.2% from 17.8% in 2009. Japan is another example of the VAT upward ratchet. The Liberal Democratic Party tried to introduce the tax for years and finally succeeded with a 3% rate in 1989. Eight years later the shoguns raised it to 5%. Last year it climbed to 8%, whacking consumption and sending the economy back to negative growth.

The Japanese experience is especially educational since the VAT is a relatively new tax in that nation.

And here’s a chart showing what’s happened in the past few years to the average VAT rate in the European Union.

Now let’s look at another chart that is far more worrisome.

It shows that the burden of government spending in Europe, before VATs were adopted, wasn’t that much different than the fiscal burden of the public sector in the United States.

But once the VAT gave politicians a new source of revenue, spending exploded.

By the way, you won’t be surprised to learn that politicians increased spending even more  than they increased taxes.

So not only did VATs lead to more spending, they also led to more debt. I guess that’s a win-win from the perspective of statists.

Let’s now return to the WSJ editorial. Proponents sometimes claim that VATs are neutral and efficient. That may be somewhat true in theory (just as an income tax, in theory, might be clean and simple), but in the real world, VATs simply make it possible for politicians to auction off a new source of loopholes.

…while VAT systems are often presented as models of simplicity that theoretically treat all goods and services alike, politicians can’t resist picking winners and losers, creating higher or lower rates for industries at their whim. “The politicians always start running with exemptions,” says E&Y’s Gijsbert Bulk.

Here’s the bottom line.

Americans, be warned. …don’t think it can’t happen here. Liberals campaign on soaking the rich, but they know there’s only so many rich to soak. To finance the growing entitlement state, they need a new broad-based tax that hits the middle class, where the big money is. That means either a VAT or a new energy tax, like the BTU tax Bill and Hillary Clinton proposed in 1993 or the cap-and-tax scheme that President Obama wanted.

The WSJ is correct. We need to be vigilant in the fight against the VAT.

But what makes this battle difficult is that some putative allies are on the wrong side.

Tom Dolan, Greg Mankiw, and Paul Ryan have all expressed pro-VAT sympathies. The same is true 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 expressed openness to the VAT.

P.S. Some of you may be asking why leftists are so anxious for a VAT since they traditionally prefer class-warfare based tax hikes that extract revenue from the rich.

But here’s one of the dirty secrets of Washington. They may not admit it in public, but sensible leftists understand that there are Laffer-Curve constraints on extracting more revenue from upper-income taxpayers.

They’re familiar with the evidence from the 1980s about the sometimes-inverse link between tax rates and tax revenue and they are aware that “rich” people have substantial control over the timing, level, and composition of their income.

So if you want to collect more money, you have to go over lower-income and middle-income taxpayer.

Which is exactly what the IMF inadvertently revealed in a study showing that VATs are the “effective” way of financing bigger government.

P.P.S. I should have written that leftists generally don’t admit that they want higher taxes on the general population. Because every so often, some of them confess that their goal is to rape and pillage the middle class.

P.P.P.S. You can enjoy some good VAT cartoons by clicking here, here, and here.

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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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Regular readers know that good fiscal policy takes place when government spending grows slower than the private economy.

Nations that maintain this Golden Rule for extended periods of time shrink the relative burden of government spending, thus enabling more growth by freeing up resources for the productive sector of the economy and creating leeway for lower tax rates.

And when countries deal with the underlying disease of too much spending, they automatically solve the symptom of red ink, so it’s a win-win situation whether you’re a spending hawk or a so-called deficit hawk.

With this in mind, let’s look at some interesting new research from the Heritage Foundation. They’ve produced a report entitled Europe’s Fiscal Crisis Revealed: An In-Depth Analysis of Spending, Austerity, and Growth.

It focuses on fiscal policy over the past few years and is an important contribution in two big ways. First, it shows that the Keynesian free-lunch approach is counterproductive. Second, it shows that the right kind of fiscal consolidation (i.e., spending restraint) generates superior results.

Here are some excerpts from the chapter by Professor Alberto Alesina of Harvard of Veronique de Rugy of the Mercatus Center. They look at some of the academic evidence.

The debate over the merits of austerity (the implementation of debt-reduction packages) is frustrating. Most people focus only on deficit reduction, but that can be achieved in many different ways. Some ways, such as raising taxes, deeply hurt growth… The data show that austerity has been implemented in Europe. However, with some rare exceptions, the forms of austerity were heavy on tax increases and far from involving savage spending cuts. …spending-based adjustments are more likely to reduce the debt-to-GDP ratio, regardless of whether fiscal adjustments are defined in terms of improvements in the cyclically adjusted primary budget deficit or in terms of premeditated policy changes designed to improve a country’s fiscal outlook. …Other research has found that fiscal adjustments based mostly on the spending side are less likely to be reversed and, as a result, have led to more long-lasting reductions in debt-to-GDP ratios. …successful fiscal adjustments are often rooted in reform of social programs and reductions in the size and pay of the government workforce rather than in other types of spending cuts. …tax increases failed to reduce the debt and were associated with large recessions. …growing evidence suggests that private investment tends to react more positively to spending-based adjustments. For instance, data from Alesina and Ardagna and from Alesina, Favero, and Giavazzi show that private-sector capital accumulation increases after governments cut spending.

The basic message of the Alesina-de Rugy chapter is that bad outcomes are largely unavoidable when nations spend themselves into fiscal trouble, but the damage can be minimized if policy makers impose spending restraint.

The Heritage Foundation’s Salim Furth is the editor of the report, and here’s some of what he wrote in Chapter 3, which looks at what’s happened in recent years as countries dealt with fiscal crisis.

Tax austerity is very harmful to growth, while spending cuts are partially replaced by private-sector activity, making them less harmful. …Estimating growth effects on private GDP, the difference between tax and spending multipliers grows predictably. A two-dollar decline in private GDP is associated with every dollar of tax increases, but spending cuts are associated with no change in private GDP.  …fiscal consolidation that relied 60 percentage points more on spending cuts was associated with 3.1 percentage points more GDP growth from 2009 to 2012, when average growth was just 3.3 percent over the entire period. In other words, a country that had a fiscal consolidation composed of 80 percent of spending cuts and 20 percent of tax increases would grow much more rapidly than a country in which only 20 percent of the consolidation was spending cuts and 80 percent was tax increases. The association is slightly stronger for private GDP.

Salim then cites a couple of powerful examples.

…the difference between Germany’s 8 percent growth from 2009 to 2012 and the 1 percent growth in the Netherlands is largely accounted for by Germany’s cut-spending, cut-taxes approach and the Netherlands’ raise-spending, raise-taxes approach. The U.K. and Italy enacted similarly-sized austerity packages, but Italy’s was half tax increases while the U.K. favored spending cuts. Neither country excelled, but over half of the gap between the U.K.’s 3 percent growth and Italy’s negative growth is explained by Italy’s tax increases.

By the way, it’s not as if Germany and the United Kingdom are stellar examples of fiscal restraint. It’s just that they’re doing better than nations that traveled down the path of even bigger government.

Regarding supposed Keynesian stimulus, Salim makes a very important point that more government spending seems positive in the short run, sort of like the fiscal version of a sugar high.

But that sugar high produces a bad hangover. Nations that try Keynesianism quickly fall behind countries with more prudent policy.

Government spending boosts GDP instantly and then crowds out private spending slowly. The incentive effects of taxation may take effect over several years, but they are permanent and especially pronounced in investment. If anything, this recent crisis shows how brief the short run is: Countries whose spending-focused stimulus put them one step ahead in 2010 were already two steps behind in 2012.

There’s a lot more in the report, so I encourage readers to give it a look.

I particularly like that it emphasizes the importance of properly defining “austerity” and “fiscal consolidation.” These are issues that I highlighted in my discussion with John Stossel.

Another great thing about the report is that it has all sorts of useful data.

Though much of it is depressing. Here’s Chart 2-9 from the report and it shows all the countries that have increased top marginal tax rates between 2007 and 2013.

Portugal wins the booby prize for the biggest tax hike, though many nations went down this class-warfare path. Including the United States thanks to Obama’s fiscal cliff tax increase.

The United Kingdom is an interesting case. It raised its top rate by 10 percentage points, but then cut the rate by 5 percentage points after it became apparent that the higher rate wasn’t collecting any additional revenue.

We should give credit to the handful of nations that have lowered tax rates, several of which replaced discriminatory systems with simple and fair flat taxes.

Though it’s also important to keep in mind where each nation started. Switzerland lowered it’s top rate by only 0.4 percentage points, which seems small compared to Denmark, which dropped its top rate by 6.7 percentage points.

But Switzerland started with a much lower rate, whereas Denmark has one of the world’s most punitive tax regimes (though, paradoxically, it is very laissez-faire in areas other than fiscal policy).

Let’s look at the same data, but from a different perspective. Chart 2-10 shows how many nations (from a list of 37) raised top rates or lowered top rates each year.

The good news is that tax cutters out-numbered tax-hikers in 2008 and 2009.

The bad news is that tax increases have dominated ever since 2010.

Many of these post-2009 tax hikes were enabled by a weakening of tax competition, which underscores why it is so important to preserve the right of jurisdictions to maintain competitive tax systems.

And don’t forget that tax policy will probably get even worse in the future because of aging populations and poorly designed entitlement programs.

Let’s close with some more numbers.

Here’s Table 2-5 from the report. It shows changes in the value-added tax (VAT) beginning in December 2008.

The key thing to notice is that there’s no column for decreases in the VAT. That’s because no nation lowered that levy. Practically speaking, this hidden form of a national sales tax is a money machine for bigger government.

But you don’t have to believe me. The International Monetary Fund unintentionally provided the data showing that VATs are the most effective tax for financing bigger government.

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I’m a supporter of a single-rate tax regime, especially if there’s no double taxation of income that is saved and invested.

That’s why I like the flat tax.

But I’ve expressed concern about the national sales tax, even though it’s basically the same as a flat tax (the only real difference is that the flat tax takes a bite out of your income when it is earned, while the sales tax takes a bite of your income as it is spent).

The reason for my skepticism is that I don’t trust politicians. I fear that they will adopt a sales tax, but never replace the income. As a result, we’ll wind up like Europe, with much bigger government.

And also much more red ink – even though politicians claim tax hikes and new taxes will lead to balanced budgets.

I’m not just being paranoid. Not only is this what occurred in Europe, the same thing is now happening in Japan.

Here’s some of what the Wall Street Journal has to say about “reforms” to the value-added tax in the land of the rising sun.

Japan on Tuesday increased its consumption tax to 8% from 5%. An increase to 10% is written into the law for next year, and don’t imagine for a minute that this will be the last. Welcome to the value-added-tax ratchet, which only goes in one direction—up. Tokyo first imposed a 3% consumption tax in 1989, after politicians had tried for a decade to enact one. …The new tax was billed as part of a tax reform, but the reform never materialized.

And as I warned in a prior column, the VAT has become a recipe for bigger government in Japan.

The new tax didn’t solve Japan’s deficit woes, as the debt to GDP ratio climbed to 50%, so in 1997 politicians increased the rate to 5%. Again politicians promised the increase would be offset by income-tax reforms. Again the reform proved illusory. …The additional revenue still didn’t satisfy Tokyo’s spending ambitions, and debt has since climbed well above 200% of GDP despite the VAT increase. …So now the rate is going up again in the name of, you guessed it, shoring up government finances as the population ages.

The OECD likes this development, which is hardly a surprise, but it’s bad news for those of us who favor growth and opportunity.

Japan’s experience points up the broader political problem with a value-added tax wherever it has been imposed. Economists tout the VAT for generating revenue without creating disincentives to work and invest. But in practice the consumption levy merely becomes one more tax in addition to current taxes and thus one more claim by the political class on the private economy. …The lesson for tax reformers elsewhere, not least in America, is to beware the VAT because once it is imposed it is only going up.

And it’s worth noting that the Europeans also have been increasing the VAT in recent years.

Simply stated, this is a levy to finance bigger government.

I elaborate in my video on the VAT.

P.S. You can see some amusing – but also painfully accurate – cartoons about the VAT 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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It’s no secret that I dislike the value-added tax.

But this isn’t because of its design. The VAT, after all, would be (presumably) a single-rate, consumption-based system, just like the flat tax and national sales tax. And that’s a much less destructive way of raising revenue compared to America’s corrupt and punitive internal revenue code.

But not all roads lead to Rome. Proponents of the flat tax and sales tax want to replace the income tax. That would be a very positive step.

Advocates of the VAT, by contrast, want to keep the income tax and give politicians another big source of revenue. That’s a catastrophically bad idea.

To understand what I mean, let’s look at a Bloomberg column by Al Hunt. He starts with a look at the political appetite for reform.

There is broad consensus that the U.S. tax system is inefficient, inequitable and hopelessly complex. …a 1986-style tax reform — broadening the base and lowering the rates — isn’t politically achievable today. …the conservative dream of starving government by slashing taxes and the liberal idea of paying for new initiatives by closing loopholes for the rich are nonstarters.

I agree with everything in those excerpts.

So does this mean Al Hunt and I are on the same wavelength?

Not exactly. I think we have to wait until 2017 to have any hope of tax reform (even then, only if we’re very lucky), whereas Hunt thinks the current logjam can be broken by adopting a VAT and modifying the income tax. More specifically, he’s talking about a proposal from a Columbia University Law Professor that would impose a 12.9 percent VAT while simultaneously creating a much bigger family allowance (sometimes referred to as the zero-bracket amount) so that millions of additional Americans no longer have to pay income tax.

Hunt likes this idea.

The Graetz initiative offers something for both sides. It starts, he suggests, with countering the observation once offered by former Treasury Secretary Larry Summers that liberals fear a value-added tax because it’s regressive and conservatives fear it because it’s a money machine. Graetz’s measure overcomes both objections.

Regarding the final sentence of that excerpt, he’s half right. Folks on the left will be happy to know that there will be a lot more redistribution through the tax code.

Graetz addresses the regressivity of most sales taxes, not by exempting food, drugs and other necessities as most of the older European systems do, but with a system of credits and offsets… He provides a payroll tax cut and expanded child-care credits focused on low- and moderate-income workers.

But what do advocates of small government get out of the deal?

Well, they do get something in the short run. Graetz wants to use the VAT money to reduce the burden of the income tax. Rates for households are lowered, with the top rate falling to 31 percent. And the best part of the plan may be that it reduces America’s uncompetitive corporate tax rate to 15 percent.

But I’m more worried about the long run, particularly after looking at evidence from Europe and Japan.

What’s in the plan, for instance, that would prevent the VAT from becoming a “money machine”? Or what guarantees would be put in place to prevent politicians from re-expanding the income tax?

Unfortunately, there don’t appear to be any safeguards. Professor Graetz has expressed some support for supermajority rules to protect against tax hikes, but he’s quoted in the article explicitly stating that a VAT could be used to generate more money to prop up the welfare state.

The Tax Policy Center found that his proposal succeeds in raising the same amount of revenue as current law. If revenue is to be part of any longer-term deficit reduction, Graetz observes, the value-added tax or the income taxes could be tweaked. “Actually, this would put us in a better situation to address the fiscal crunch down the road,” he says.

That statement scares the heck out of me. We desperately need the right kind of entitlement reform to save America from becoming another doomed welfare state. But what are the odds of getting good changes if politicians think they can continuously kick the can down the road by raising the VAT every couple of years.

Before you know it, we’re Greece!

If you don’t believe me about the VAT being a money machine, perhaps you’ll be more trusting of analysis from the International Monetary Fund. That bureaucracy actually supports the VAT, but the IMF inadvertently revealed in some research last year that the VAT is far more effective at generating new revenue than the income tax.

And that’s true for poor nations and rich nations.

This video from the Center for Freedom and Prosperity, narrated by yours truly, explains why the VAT would finance the road to serfdom.

Last but not least, it’s worth pointing out that Professor Graetz’s proposal has become more punitive over time. Check out this portion of a Tax Policy Center study showing that the VAT rate has been increased and that a new class-warfare tax rate has been added to the proposal.

VAT Graetz

So if the proposal has become more onerous on paper, imagine how much worse it will get once politicians get their hands on it.

P.S. If you want short explanations of the flat tax, sales tax, VAT, and current system, check out these Heartland Institute videos.

P.P.S. To be fair, there’s very little indication that Prof. Graetz wants bigger and more expensive government. He’s proposing a VAT for the same reason Cong. Paul Ryan has proposed a VAT. They think the revenue can be used to reduce the burden of the income tax. They’re not wrong in theory. They just don’t appreciate the danger of giving politicians a new source of revenue.

P.P.P.S. George Will correctly warns that the VAT should be off the table until and unless the 16th Amendment is repealed. And Robert Samuelson gives several reasons why this levy should be rejected.

P.P.P.P.S. Some advocates say the VAT is needed to forestall higher income tax rates, but that certainly hasn’t been the case in Europe.

P.P.P.P.P.S. You can enjoy some amusing VAT cartoons by clicking herehere, and here.

P.P.P.P.P.P.S. Al Hunt has always been a nice guy on the few occasions I’ve interacted with him, but it didn’t help my reputation when he wrote in the Wall Street Journal back in 1994 that I was a “responsible economic expert on the right.” That sounds like praise, but folks on the left generally only say nice things about their opponents when they’re being incompetent or selling out.

P.P.P.P.P.P.P.S. I’ll close with some good news. The U.S. Senate overwhelming rejected the concept of a VAT back in 2010, though I think the 85-13 vote overstates the level of opposition. Many left-wing Senators only voted no because it was a non-binding measure. But we don’t get many victories in Washington, so I’ll take it.

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