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Posts Tagged ‘Value-Added Tax’

I’m not the biggest fan of Paul Krugman in his role as a doctrinaire advocate of leftist policy (he used to be within the mainstream and occasionally point out the risks of government intervention in his former role as an academic economist).

It’s not just that he believes in big government. He also has an unfortunate habit of misinterpreting (the charitable explanation) data when advocating higher taxes and more spending.

  • In 2015, he cherry-picked job numbers to make it seem as if Obama’s policies were producing good employment data.
  • Earlier that year, Krugman asserted that America was outperforming Europe because our fiscal policy was more Keynesian, yet the data showed that the United States had bigger spending reductions and less red ink.
  • In 2014, he asserted that a supposed “California comeback” in jobs somehow proved my analysis of a tax hike was wrong, yet only four states at the time had a higher unemployment rate than California.
  • And here’s my favorite: In 2012, Krugman engaged in the policy version of time travel by blaming Estonia’s 2008 recession on spending cuts that took place in 2009.

As you can see, he’s not exactly a paragon of sound thinking and careful analysis.

But there must be a blue moon in the forecast because the New York Times columnist has an accurate criticism of Donald Trump’s tax plan.

Before sharing Krugman’s critique, here’s the position of the Trump campaign, which asserts that the World Trade Organization has rigged the rules against America by allowing nations to give rebates to exporters so that there is no value-added tax (VAT) on good and services sold to consumers in other nations.

…there is a more subtle tax problem pulling US corporations offshore. It relates to the unequal treatment of the US income tax system by the World Trade Organization (WTO). …While the US operates primarily on an income tax system, all of America’s major trading partners depend heavily on a “value-added tax” or VAT system. Under current rules, the WTO allows America’s trading partners to effectively create backdoor tariffs to block American exports and backdoor subsidies to penetrate US markets. Here’s how this exploitation works: VAT rates are typically between 15% and 25%. …Under WTO rules, any foreign company that manufactures domestically and exports goods to America (or elsewhere) receives a rebate on the VAT it has paid. This turns the VAT into an implicit export subsidy. At the same time, the VAT is imposed on all goods that are imported and consumed domestically so that a product exported by the US to a VAT country is subject to the VAT. This turns the VAT into an implicit tariff on US exporters over and above the US corporate income taxes they must pay. Thus, under the WTO system, American corporations suffer a “triple whammy”: foreign exports into the US market get VAT relief, US exports into foreign markets must pay the VAT, and US exporters get no relief on any US income taxes paid. The practical effect of the WTO’s unequal treatment of America’s income tax system is to give our major trading partners a 15% to 25% unfair tax advantage in international transactions.

In the wonky jargon of public finance, VATs are said to be “border adjustable.” And here’s Krugman’s caustic observation about the above argument.

I’ve been writing about Donald Trump’s claim that Mexico’s value-added tax is an unfair trade policy, which is just really bad economics. …a VAT has the same effects as a sales tax. Now, nobody thinks that sales taxes are an unfair trade practice. …Trump wasn’t saying ignorant things off the top of his head: he was saying ignorant things fed to him by his incompetent economic advisers. …Should we be reassured that Trump wasn’t actually winging it here, just taking really bad advice? Not at all.

I don’t know whether it’s fair to criticize Trump’s economic advisers (after all, are they the ones who developed this position, or were they simply told to justify what Trump was saying?), but I certainly agree with Krugman that other nations don’t gain a trade advantage simply because they have a VAT.

Here’s some of what I wrote about this issue earlier this year.

For mercantilists worried about trade deficits, “border adjustability” is seen as a positive feature. But not only are they wrong on trade, they do not understand how a VAT works. …Under current law, American goods sold in America do not pay a VAT, but neither do German-produced goods that are sold in America. Likewise, any American-produced goods sold in Germany are hit be a VAT, but so are German-produced goods. In other words, there is a level playing field. The only difference is that German politicians seize a greater share of people’s income. So what happens if America adopts a VAT? The German government continues to tax American-produced goods in Germany, just as it taxes German-produced goods sold in Germany. …In the United States, there is a similar story. There is now a tax on imports, including imports from Germany. But there is an identical tax on domestically-produced goods. And since the playing field remains level, protectionists will be disappointed. The only winners will be politicians since they have more money to spend.

If you want more information, I also discuss the trade impact of a VAT in this video.

So, yes, Krugman is right. At least on this particular issue.

Actually, he’s even right about another part of his column, when he pointed out that if a VAT is supposedly good for competitiveness, then this should give New York (with a high sales tax) an advantage over Delaware (with no sales tax). As Krugman points out, this is absurd.

…nobody thinks that sales taxes are an unfair trade practice. New York has fairly high sales taxes; Delaware has no such tax. Does anyone think that this gives New York an unfair advantage in interstate competition?

Indeed, the answer to Krugman’s rhetorical question is that lots of people recognize that Delaware has the advantage. This is why politicians in many states (especially those with punitive sales taxes) are pushing for the so-called Marketplace Fairness Act in hopes of forcing merchants in states like Delaware to become deputy tax collectors for states like New York (this would be an odious expansion of extraterritorial tax powers for state governments).

I don’t want to get all wonky, but this fight revolves around whether consumption taxes should be levied where goods and services are sold (the origin-based approach) or whether the taxes should be collected based on where the consumer lives (the destination-based approach). High-tax governments prefer the latter because they want to make it difficult for their residents to shop where the tax burden is lower.

By the way, politicians in Europe and elsewhere impose destination-based VATs for the same reason. They don’t like tax competition. So that’s yet another reason (above and beyond the fact that they are money machines for big government) to dislike the VAT.

I suspect, incidentally, that Krugman favors destination-based consumption taxes over origin-based systems, so even though he’s right about VATs and trade, he probably compensates by being wrong on an issue that really matters.

 

 

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The value-added tax is a very dangerous levy for the simple reason that giving a big new source of revenue to Washington almost certainly would result in a larger burden of government spending.

That’s certainly what happened in Europe, and there’s even more reason to think it would happen in America because we have a looming, baked-in-the-cake entitlement crisis and many politicians don’t want to reform programs such as Medicare, Medicaid, and Obamacare. They would much rather find additional tax revenues to enable this expansion of the welfare state. And their target is the middle class, which is why they very much want a VAT.

The most frustrating part of this debate is that there are some normally rational people who are sympathetic to the VAT because they focus on theoretical issues and somehow convince themselves that this new levy would be good for the private sector.

Here are the four most common economic myths about the value-added tax.

Myth 1: The VAT is pro-growth

Reihan Salam implies in the Wall Street Journal that taxing consumption is good for growth.

Mr. Cruz has roughly the right idea. He has come out in favor of a growth-friendly tax on consumption… Rather sneakily, he’s calling his consumption tax a “business flat tax,” but everyone knows that it’s a VAT.

And a different Wall Street Journal report asserts there’s a difference between taxing income and taxing consumption.

…a VAT taxes what people consume rather than how much they earn.

Reality: The VAT penalizes all productive economic activity

I don’t care whether proponents change the name of the VAT, but they are wrong when they say that taxes on consumption are somehow better for growth than taxes on income. Consider two simple scenarios. In the first example, a taxpayer earns $100 but loses $20 to the income tax. In the second example, a taxpayers earns $100, but loses $20 to the VAT. In one case, the taxpayer’s income is taxed when it is earned and in the other case it is taxed when it is spent. But in both cases, there is an identical gap between pre-tax income and post-tax consumption. The economic damage is identical, with the harm rising as the marginal tax rate (either income tax rate or VAT rate) increases.

Advocates for the VAT generally will admit that this is true, but then switch the argument and say that there’s pervasive double taxation in the internal revenue code and that this tax bias against saving and investment does far more damage, per dollar collected, than either income taxes imposed on wages or VATs imposed on consumption.

They’re right, but that’s an argument against double taxation, not an argument for taxing consumption instead of taxing income. They then sometimes assert that a VAT is needed to make the numbers add up if double taxation is to be eliminated. But a flat tax does the same thing, and without the risk of giving politicians a new source of revenue.

Myth 2: The VAT is pro-savings and pro-investment

As noted in a recent Wall Street Journal story, advocates claim this tax is an economic elixir.

Supporters of a VAT…say it is better for economic growth than an income tax because it doesn’t tax savings or investment.

Reality: The VAT discourages saving and investment

The superficially compelling argument for this assertion is that the VAT is a tax on consumption, so the imposition of such a tax will make saving relatively more attractive. But this simple analysis overlooks the fact that another term for saving is deferred consumption. It is true, of course, that people who save usually earn some sort of return (such as interest, dividends, or capital gains). This means they will be able to enjoy more consumption in the future. But that does not change the calculation. Instead, it simply means there will be more consumption to tax. In other words, the imposition of a VAT does not alter incentives to consume today or consume in the future (i.e., save and invest).

But this is not the end of the story. A VAT, like an income tax or payroll tax, drives a wedge between pre-tax income and post-tax income. This means, as already noted above, that a VAT also drives a wedge between pre-tax income and post-tax consumption – and this is true for current consumption and future consumption. This tax wedge means less incentive to earn income, and if there is less total income, this reduces both total saving and total consumption.

Again, advocates of a VAT generally will admit this is correct, but then resort to making a (correct) argument against double taxation. But why take the risk of a VAT when there are very simple and safe ways to eliminate the tax bias against saving and investment.

Myth 3: The VAT is pro-trade.

My normally sensible friend Steve Moore recently put forth this argument in the American Spectator.

…a better way to do this…is through a “border adjustable”…tax, meaning that it taxes imports and relieves all taxes on exports. …The guy who gets this is Ted Cruz. His tax plan…would not tax our exports. Cruz is right when he says this automatically gives us a 16% advantage.

Reality: The protectionist border-adjustability argument for a VAT is bad in theory and bad in reality.

For mercantilists worried about trade deficits, “border adjustability” is seen as a positive feature. But not only are they wrong on trade, they do not understand how a VAT works. Protectionists seem to think a VAT is akin to a tariff. It is true that the VAT is imposed on imports, but this does not discriminate against foreign-produced goods because the VAT also is imposed on domestic-produced goods.

Under current law, American goods sold in America do not pay a VAT, but neither do German-produced goods that are sold in America. Likewise, any American-produced goods sold in Germany are hit be a VAT, but so are German-produced goods. In other words, there is a level playing field. The only difference is that German politicians seize a greater share of people’s income.

So what happens if America adopts a VAT? The German government continues to tax American-produced goods in Germany, just as it taxes German-produced goods sold in Germany. There is no reason to expect a VAT to cause any change in the level of imports or exports from a German perspective. In the United States, there is a similar story. There is now a tax on imports, including imports from Germany. But there is an identical tax on domestically-produced goods. And since the playing field remains level, protectionists will be disappointed. The only winners will be politicians since they have more money to spend.

I explain this issue in greater detail in this video, beginning about 5:15, though I hope the entire thing is worth watching.

Myth 4: the VAT is pro-compliance

There’s a common belief, reflected in this blurb from a Wall Street Journal report, that a VAT has very little evasion or avoidance because it is self enforcing.

…governments like it because it tends to bring in more revenue, thanks in part to the role that businesses play in its collection. Incentivizing their efforts, businesses receive credits for the VAT they pay.

Reality: Any burdensome tax will lead to avoidance and evasion and that applies to the VAT.

I’m always amused at the large number of merchants in Europe who ask for cash payments for the deliberate purpose of escaping onerous VAT impositions. But my personal anecdotes probably are not as compelling as data from the European Commission.

To give an idea of the magnitude, here are some excerpts from a recent Bloomberg report.

Over the next two years, the Brussels-based commission will seek to streamline cross-border transactions, improve tax collection on Internet sales… In 2017, the EU plans to propose a single European VAT area, a reform of rates and add specifics to its anti-fraud strategy. …“We face a staggering fiscal gap: the VAT revenues are 170 billion euros short of what they could be,” EU Economic Affairs and Tax Commissioner Pierre Moscovici said. “It’s time to have this money back.”

For what it’s worth, the Europeans need to learn that burdensome levels of taxation will always encourage noncompliance.

Though, to be fair, much of the “tax gap” for the VAT in Europe exists because governments have chosen to adopt “destination-based” VATs rather than “origin-based” VATs, largely for the (ineffective) protectionist reasons outlined in Myth 3. And this creates a big opportunity to escape the VAT by classifying sales as exports, even if the goods and services ultimately are consumed in the home market.

P.S. At the risk of being wonky, it should be noted that there are actually two main types of value-added tax. In both cases, businesses collect the tax, and the tax incidence is similar (households actually bear the cost), but there are different collection methods. The credit-invoice VAT is the most common version (ubiquitous in Europe, for instance), and it somewhat resembles a sales tax in its implementation, albeit with the tax imposed at each stage of the production process. The subtraction-method VAT, by contrast, relies on a tax return sort of like the corporate income tax. The Joint Committee on Taxation has a good description of these two systems.

Under the subtraction method, value added is measured as the difference between an enterprise’s taxable sales and its purchases of taxable goods and services from other enterprises. At the end of the reporting period, a rate of tax is applied to this difference in order to determine the tax liability. The subtraction method is similar to the credit-invoice method in that both methods measure value added by comparing outputs (sales) to inputs (purchases) that have borne the tax. The subtraction method differs from the credit-invoice method principally in that the tax rate is applied to a net amount of value added (sales less purchases) rather than to gross sales with credits for tax on gross purchases (as under the credit-invoice method). The determination of the tax liability of an enterprise under the credit-invoice method relies upon the enterprise’s sales records and purchase invoices, while the subtraction method may rely upon records that the taxpayer maintains for income tax or financial accounting purposes.

P.P.S. Another wonky point is that the effort by states to tax Internet sales is actually an attempt to implement and enforce the kind of “destination-based” tax regime mentioned above. I explain that issue in this presentation on Capitol Hill.

P.P.P.S. You can enjoy some amusing – but also painfully accurate – cartoons about the VAT by clicking here, here, and here.

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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.

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The left is very clever about accepting “compromise,” so long as the result is a larger burden of government.

This is one of the reasons why I’m so concerned about Senator Cruz’s proposal for a value-added tax. Even though he wants a VAT for good reasons (to finance lower tax rates and also to reduce the tax bias against saving and investment), my fear is that the statists will say yes, then quickly use the VAT to finance a big expansion of the welfare state.

Which is exactly what happened in Europe.

Some folks think I’m being paranoid, to which there are two responses. First, there’s the old joke that even paranoid people have enemies.

But the second and more serious response is to point out that lots of statists openly say they want a VAT to make government bigger.

Indeed, some of these folks already are semi-embracing Cruz’s VAT because of their desire to have a new source of revenue for Washington. Consider, for instance, these excerpts from an editorial in USA Today.

The VAT is a kind of national sales tax used by virtually every other nation in the world because it can raise lots of money …partly because deficits are set to explode again as Baby Boomers retire, the VAT is back. Texas Republican Ted Cruz, winner of the Iowa GOP caucuses, is proposing a VAT… The concept has a lot going for it. …Cruz’s plan is flawed, but he’s on to something. A more progressive, phased-in VAT deserves to be part of any future conversation

You don’t have to read between the lines to understand that the editors at USA Today want a VAT to expand the public sector. The editorial even favorably cites Senator Cardin and former Treasury official Michael Graetz.

Do they want a VAT for the same reasons as Senator Cruz?

Not exactly. Senator Cardin acknowledges that the VAT could lead to a spigot of new tax revenue (“enacting a consumption tax could mean enacting a new and easy-to-adjust lever to raise taxes irresponsibly”), but he claims to have a mechanism that supposedly will guard against ever-higher tax burdens.

The Progressive Consumption Tax Act addresses this concern with a circuit breaker that returns overages from the PCT to taxpayers when revenues exceed predetermined levels.

This is a joke. The politicians in Washington get to set the “predetermined levels,” so it goes without saying that those levels will go from predetermined to redetermined in a blink of an eye, just as we’ve seen in other nations.

And what about Michael Graetz’s plan? Well, here are a few excerpts from an article he wrote.

…tax increases will be necessary to…address the nation’s unsustainable fiscal condition fairly… With this plan in place, our ability to raise additional revenue would be increased…

To be fair, Graetz is not a leftist. He basically wants a VAT because it’s a less-destructive way of financing bigger government.

I agree. It’s highly likely that a $100 billion VAT hike would do less damage than a $100 billion increase in income taxes, but why on earth would anyone want higher taxes to fund bigger government, particularly when we know sensible entitlement reforms could fix the nation’s long-run fiscal problem?

No wonder Avik Roy, writing for Forbes, is so worried about a VAT.

Sen. Ted Cruz…favors replacing the corporate income tax with what Cruz calls a “business flat tax,” and what Canadians and Europeans call a “value-added tax.” But the real debate isn’t about terminology; it’s about whether or not Cruz’s approach would drive an explosion of government taxes—and spending—over the mid- to long-term.

One reason it’s a money machine is that it’s actually a hidden tax on wages and salaries.

…businesses would no longer be able to deduct the cost of labor. As my colleague Ryan Ellis has detailed, that amounts to a “16 percent wage tax withheld at the employer level under the Cruz plan.”

And that creates a very large tax base, so any increase in the tax rate transfers a lot of money from the private sector to Washington.

…the most important problem with the Cruz plan is how Democrats would take advantage of it. Cruz envisions a VAT tax rate of 16 percent. But his plan would hand progressives a simple tool to raise taxes to far higher rates in the future. …the vast majority of federal revenue will hit voters indirectly, because it will come from businesses. From a political standpoint, Cruz’s plan would pave the way to higher tax rates in the future. …every one percent increase in the VAT would yield $1.6 trillion in new revenue over a decade. The temptation for a Democratic president and Congress to raise VAT rates to higher levels will be enormous.

And Avik echoes one of my concerns, warning that a VAT will greatly undermine and perhaps even kill any opportunity for genuine entitlement reform.

Under Cruz’s tax system, there would be absolutely no pressure on Washington to reform Medicare and Medicaid. Why reform entitlements when you can simply increase the “business flat tax” rate from 16 percent to 17 percent to 18 percent to 19 percent? This is exactly what has happened in Canada and Europe, where VAT rates started out low, and have gone up and up over time.

I should point out (as he does in his column) that Avik supports Marco Rubio, so he has a political motive to trash the VAT.

Indeed, he even makes some anti-VAT arguments that strike me as unfair, so I’ve omitted them from this analysis.

But the parts I have shared are completely accurate and they are more than adequate to make a very powerful case against giving Washington a new source of revenue.

Let’s close with some wisdom from the 1980s. I wrote that one of America’s worst presidents wanted a VAT to expand the welfare state. And I also mentioned that one of the best presidents in American history was on the right side of the issue. And it’s worth listening to the Gipper’s wisdom on this issue.

P.S. Here’s a short update to my recent post about the craziness of Keynesian economics. You may recall that the economic illiterates at the International Monetary Fund said diverting money from the private sector to finance government outlays on refugees would be good for growth.

Well, we now have estimates of how much will be spent on this so-called stimulus.

Shelter, medical care and integration policies for refugees will cost the German state €22 billion in 2016, and €27.6 billion in 2017.

Gee, according to the perpetual motion machine of Keynesianism, maybe the German government should put the entire population on welfare and the economy will really boom.

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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.

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

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

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

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

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

A report in the Wall Street Journal discusses this development.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

With this in mind, he poses a hypothetical question.

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

Stelzer offers some sage advice in his conclusion.

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

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

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

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

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

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

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

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

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

Amen.

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

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

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

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

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What were the most noteworthy events from 2015?

Regarding bad news, there’s unfortunately a lot of competition. But if I’m forced to pick the very worst developments, here’s my list.

Resuscitation of the Export-Import Bank – I did a premature victory dance last year when I celebrated the expiration of the Export-Import Bank’s authority.  I should have known that corrupt cronyism was hard to extinguish. Sure enough, Republicans and Democrats conspired to re-authorize the Ex-Im Bank and transfer wealth from ordinary Americans to politically connected corporations.

Expansion of IMF authority – I also did a premature victory dance in 2014 when I lauded the fact that Congress did not approve increased bailout authority for the International Monetary Fund. Sadly, as part of the year-end spending agreement, Congress agreed to expand the IMF’s authority so it could continue to push for higher taxes around the world.

Busting the spending caps (again) – When I wrote last August that maintaining the spending caps was a key test of GOP integrity, I should have known that they would get a failing grade. Sure enough, Republicans deliberately fumbled the ball at the goal line and agreed to higher spending. Again.

Supreme Court ignores law to bail out Obamacare (again) – Back in 2012, the Supreme Court had a chance to rule whether Obamacare was an impermissible expansion of the power of the federal government. In a truly odious decision, Chief Justice John Roberts ignored the Constitution’s limits on federal powers and decided we could be coerced to buy health insurance. Last year, he did it again, this time by bailing out a key part of Obamacare by deciding to arbitrarily ignore the wording of the law.

Business-as-usual transportation bill – The desire of Congress to fund pork-barrel transportation projects is at least somewhat constrained by the amount of revenue generated by the gas tax. There was an opportunity for reform in 2015 because proposed spending was much higher than the trajectory of gas tax revenue, but rather than even engage in a discussion of good policy options, politicians merely bickered over what combination of tax hikes and budget gimmicks they could put together to keep the pork projects flowing.

Creeping support on the right for the value-added tax – When I wrote early last year that the 2016 election might create an opportunity for tax reform, I was being hopeful that we might get something close to a simple and fair flat tax. Yet probably the biggest news so far in this election cycle is that a couple of candidates who presumably favor small government – Rand Paul and Ted Cruz – have proposed to impose a value-added tax without fully repealing the income tax.

There’s very little good news to celebrate. Here’s my tragically sparse list, and you’ll notice that my list of victories is heavy on style and light on substance. But let’s take what we can get.

Semi-decent Republican budgets – The budget resolution produced by Congress technically doesn’t embrace specific policies, but the it’s nonetheless noteworthy that the House and Senate approved numbers that – at least conceptually – are based on genuine Medicaid and Medicare reform.

Support for spending caps – Notwithstanding the fact that GOP politicians won’t even abide by the limited spending caps that already exist, I’m somewhat encouraged by the growing consensus for comprehensive spending caps akin to the ones in place in Switzerland and Hong Kong. Heck, even international bureaucracies now agree spending caps are the only effective fiscal rule.

Good election results from the Wolverine State – It was great to see Michigan voters reject a gas tax increase that was supported by the political elite.

More companies escaping the IRS – I heartily applaud when companies figure out how to re-domicile in jurisdictions with better tax law to escape America’s high corporate tax rate and self-destructive worldwide tax system. And I’m glad these “inversions” continue to take place even though the Obama Administration is trying to stop them.

A glimmer of reality at the New York Times – I realize I’m scraping the bottom of the barrel in my search for good news, but the fact that the New York Times published a column acknowledging that feminist economic policies backfire against women hopefully is a sign that sensible thinking is possible in the establishment media.

Gun control flopping – It’s great to see that the left has totally failed in its effort to undermine 2nd Amendment rights.

Limits on asset forfeiture – The final bit of good news from 2015 was the just-before-Christmas announcement by the Obama Administration that the odious practice of asset forfeiture would be modestly curtailed.

I would offer predictions for 2016, but since my big prediction from last year that we would have gridlock was sadly inaccurate, I think I’ll avoid making a fool of myself this year.

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