Posts Tagged ‘VAT’

In early 2013, a reader asked me the best place to go if America suffered a Greek-style economic collapse.

I suggested Australia might be the best option, even if I would be too stubborn to take my own advice.

Perhaps because of an irrational form of patriotism, I’m fairly certain that I will always live in the United States and I will be fighting to preserve (or restore) liberty until my last breath.

But while I intend to stay in America, there is one thing that would make me very pessimistic about my country’s future.

Simply stated, if politicians ever manage to impose a value-added tax on the United States, the statists will have won a giant victory and it will be much harder to restrain big government.

But you don’t have to believe me. Folks on the left openly admit that a VAT is necessary to make America more like Europe.

Check out these excerpts from an article in Foreign Affairs by Professor Lane Kenworthy of the University of Arizona. He explicitly wants bigger government and recognizes the VAT is the only way to finance a European-sized welfare state.

…modern social democracy means a commitment to the extensive use of government…U.S. policymakers will recognize the benefits of a larger government role… Americans will need to pay more in taxes.The first and most important step would be to introduce a national consumption tax in the form of a value-added tax (VAT)… Washington…cannot realistically squeeze an additional ten percent of GDP in tax revenues solely from those at the top.

Pay special attention to the final sentence in that excerpt. Kenworthy is an honest statist. He knows that the Laffer Curve is real and that taxing the rich won’t generate the amount of revenue he wants.

That’s why the VAT is the key to financing bigger government. Heck, even the International Monetary Fund inadvertently provided very powerful evidence that a VAT is the recipe for bigger government.

Want more proof? Well, check out the recent New York Times column by John Harwood (the same guy who was criticized for being a biased moderator of CNBC’s GOP debate).

He starts by pointing out that Senators Cruz and Paul are proposing European-type value-added taxes.

Senator Ted Cruz of Texas and Senator Rand Paul of Kentucky do it most explicitly by proposing variations on “value-added tax” systems used by European countries.

But here’s the part that should grab your attention. He cites some folks on the left who admit that there’s no way to finance big expansions of the welfare state without a VAT.

Democratic economists…say…income trends…complicate their ability to raise enough revenue to finance government programs without increasing burdens on the middle class as well as the affluent. “We’ve come close to maxing out the amount of progressivity we can get from the existing tax system,” said Peter Orszag, President Obama’s first budget director. …as looming baby boomer retirements promise to swell Social Security and Medicare expenses beyond the current tax system’s ability to finance them, is in new thinking that expands the scope of possible solutions. “There’s no way we can keep the promises we’ve made to senior citizens and others without a new revenue source,” said Mr. Burman of the Tax Policy Center.

So if the statists are salivating for a VAT to make government bigger, why on earth are some otherwise sensible people pushing for this pernicious new tax?!?

Some journalists have asked this same question. Here are some passages from a Slate report.

…conservative policy thinkers…worry that it might accidentally set the stage for much, much higher taxes in the future should Democrats ever take back control of Washington. …Cruz would impose a new, roughly 19 percent “business flat tax.” This is his campaign’s creative rebranding of what the rest of the world typically calls a “value-added tax,” or VAT. And…it scares the living hell out of some conservatives.

The article notes that Cruz and Paul have decent intentions.

…for Cruz—and for Rand Paul, who…would similarly like to combine a VAT and flat income tax—the main appeal is that it could theoretically raise a lot of money to finance tax cuts elsewhere.

But good intentions don’t necessarily mean good results.

And just like you don’t give matches to a child, you don’t give a giant new tax to Washington.

How much could Cruz’s proposal net the government? The conservative-leaning Tax Foundation thinks $25.4 trillion over 10 years. … in the hands of a Democratic president, it could become a hidden money-making machine for the government. Passing a national sales tax would be hard, they say. But once it’s in place, slowly ratcheting it up to pay for additional spending would be relatively easy. “To be blunt, unless there’s a magic guarantee that principled conservatives such as Rand Paul and Ted Cruz (and their philosophical clones) would always hold the presidency, a VAT would be a very risky gamble,” Daniel Mitchell, a senior fellow at the libertarian Cato Institute, wrote recently. …The ironic thing here is that Ted Cruz, anti-tax preacher, may be doing his best to craft a tax plan that leaves Americans in the dark about the actual cost of running their government. Simultaneously, he might be making political room for Democrats to start talking about a VAT tax of their own.

By the way, this isn’t the first time that a Republican has broached the idea of a VAT.

One of the worst Presidents in American history, Richard Nixon, wanted a VAT to finance bigger government. Here are some passages from an article in the 1972 archives of Congressional Quarterly.

President Nixon…asked both the Advisory Commission on Intergovernmental Relations and his Commission on School Finance, a group he appointed in 1970, to study and report on a proposal for a value added tax. …The tax had the advantages that…it yielded relatively large amounts of revenue. …Two major reasons were apparent for the Nixon administration’s consideration of a value added tax. The first was the condition of federal finances. …Projected costs of existing and proposed programs were expected to absorb all revenues from existing taxes and other sources. This meant that no new programs could be inaugurated without new taxes to finance them or reduction of existing programs to release funds. Though initially pledged for education, revenues from an expanding value added tax might provide future funding for other programs.

My colleague, Chris Edwards, deserves credit for unearthing this disturbing bit of fiscal history. Here’s some of what he wrote about Nixon’s sinister effort.

Richard Nixon appears to have been the first U.S. leader to push for a VAT, which is not surprising given that he was perhaps the most statist GOP president of the 20th century. …Thankfully, the Nixon proposal went nowhere in Congress, the ACIR came out against it, and it was dropped. America’s economy dodged a bullet. If Nixon had been successful, the rate would probably have soared over time from an initial 3 percent to maybe 20 percent today—just as rates in Europe have risen—and that would have fueled growth in new and expanded entitlement programs. 

Amen. Chris hits the nail on the head.

It doesn’t really matter what the initial rate is. The VAT is an easy tax to raise because it’s so non-transparent.

Moreover adopting a VAT is a sure-fire way of enabling higher income tax rates because the statists will say it’s “unfair” to raise the VAT burden on lower-income and middle-income taxpayers unless there’s a concomitant increase in the income tax burden on the evil rich.

Which is exactly what happens in Europe. Look at how recent VAT hikes have been paired with higher income tax rates.

But here’s the chart that should scare any sensible person.

The bottom line is that the VAT is the Ebola Virus of big government.

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

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Sometimes the best way to help the cause of freedom is to stop a bad idea. And that’s why I’m vociferously opposed to a value-added tax.

Here’s what I wrote today for National Review. I start by explaining that it’s a bad idea to give Washington a big new tax to finance a larger burden of government spending.

It’s especially good news that the United States has resisted the value-added tax (VAT), which is tempting because of its revenue-generating capacity. …Hostility to the VAT is justified by the European experience. Back in the mid 1960s, the burden of government spending in Europe was only slightly above the American level. But as VATs were implemented, the welfare state expanded, and now government consumes a much higher share of economic output on the other side of the Atlantic.

European politicians embraced the VAT because it’s the only way to finance leviathan-sized government.

…there’s a limit to how much revenue can be generated by an income tax. As honest leftists will admit (at least off the record), the Laffer Curve is real. …Indeed, income-tax revenues (personal and corporate) average less than 12 percent of GDP in OECD nations. …In other words, the only effective way to finance European-sized government is to have European-style taxation. Which is exactly why the Left desperately wants a VAT.

I then express dismay that a couple of very attractive candidates have inserted this pernicious tax in their otherwise good proposals.

…some conservatives think the VAT is an acceptable risk if it’s part of a bigger tax-reform plan. Senators Rand Paul and Ted Cruz, for instance, both have proposals that would lower personal-income-tax rates, reduce double taxation of income that is saved and invested, and eliminate corporate income taxes and payroll taxes. …Paul and Cruz would offset some of the revenue loss by imposing VATs.

The two Senators actually have good plans, at least on paper. My concern is about what happens once either one of them left the White House.

…something that looks pretty on a blackboard might not be so appealing once you add the sordid reality of politics to the equation. To be blunt, unless there’s a magic guarantee that principled conservatives such as Rand Paul and Ted Cruz (and their philosophical clones) would always hold the presidency, a VAT would be a very risky gamble. …What happens in the future when a statist wins the White House? …Raising the VAT rate would be a comparatively simple option for our hypothetical left-wing president. And because it has such a broad tax base (all “value added” in the economy, including wages paid to workers), even small rate increase would generate a lot of revenue to finance bigger government. …And I’m sure this future statist president also would boost tax rates on the “rich” and also impose higher levels of double taxation.

Incidentally, any good tax reform plan can be distorted by bad politicians in the future. But the downside risk of a VAT is monumentally greater because of its revenue-generating capacity.

…there’s a downside risk to other types of tax reform. But it’s a matter of magnitude. If we did something like Ben Carson’s flat tax or the more incremental tax-reform plans of Jeb Bush and Marco Rubio, it’s obviously possible for a future leftist to undo those reforms, in which case we could degenerate back to the current system. That’s obviously bad news, but it’s not nearly as bad as what might happen with the Cruz and Paul plans. When the wrong politicians got back in charge, they’d restore all the bad features of the income tax and also use the VAT as a money machine to expand the welfare state. And when the dust settles, we’d be France.

I realize that some people won’t believe what I just wrote. Maybe you lean left and you’re used to dismissing my arguments. Or maybe you’re a huge fan of Rand Paul or Ted Cruz and you think I’m somehow trying to knock them down because of some sinister agenda.

So maybe you’ll be more persuaded when a left-leaning columnist reaches the same conclusion. Here is some of what Catherine Rampell just wrote for the Washington Post.

Ted Cruz and Rand Paul have a really compelling tax proposal. …an interesting, serious and provocative idea: a value-added tax. …The VAT is also one of the first proposals out of the International Monetary Fund’s bag of tricks for countries that need to raise money. …it’s good these candidates have given voice to The Tax That Dare Not Speak Its Name. There’s only so much revenue a country can wring out of an income tax system, particularly one as Swiss-cheesed as ours. A well-designed VAT could help get our fiscal house in order.

This must be some sign of harmonic convergence. We both recognize that Paul and Cruz are proposing a VAT, and we both understand that there’s a limit to how much money can be raised from an income tax, and we both concur that a VAT will give politicians a way of dramatically boosting the tax burden.

But we don’t really agree. Because I’m horrified about the prospect of a new tax whereas Ms. Rampell thinks the VAT would be good because she favors bigger government.

By the way, Catherine confirms one of the fears I expressed in my article. The VAT would actually lead politicians to make the income tax even worse because of their fixation on distributional issues.

The main downside of a VAT is that it hurts the poor more than the rich, because the poor spend a larger share of their incomes on basic necessities. There’s an easy way to counteract that problem, though: Just make the income tax system more progressive.

By the way, while she’s right that the VAT is a money machine for big government, I can’t resist pointing out a mistake in her column.

Unlike an income tax, it doesn’t discourage saving or working

No, that’s not true. One of the good features of a VAT (assuming all other taxes could be abolished) is that it would generate revenue in a way that minimizes the negative impact on incentives.

But it would still drive a wedge between pre-tax income and post-tax consumption.

This is also the case for the flat tax. A “good” tax system is only “pro growth” in the sense that it does less damage than the current system.

Just in case you haven’t reached the point of VAT exhaustion, here’s my video explaining why the VAT is such a bad idea.

But if you don’t want to spend a few minutes watching a video, just keep this image in mind anytime sometime tells you we should roll the dice and adopt a VAT.

P.S. None of this suggests that Rand Paul and Ted Cruz should be rejected by voters. All candidates have some warts. I like the Jeb Bush tax plan, but I’m worried by his failure to take the no-tax pledge. I like the Marco Rubio tax plan, but I’m not a big fan of his big tax credits for kids. And I could come up with similar complaints about other candidates.

All I’m saying is that Paul and Cruz have one part of their agenda that should be jettisoned.

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Some honest statists understand and acknowledge that you can’t have bigger government unless you target middle-income taxpayers.

And why do all these statists want higher taxes on ordinary people?

The answer is that they understand you can’t finance a giant welfare state unless there’s a huge increase in the tax burden on lower-income and middle-income taxpayers.

Which is exactly what’s happened in Europe.

Of course, you don’t need to favor that outcome to predict (of fear) that it will happen. My opposition to tax hikes, for instance, is precisely because I don’t want America to have a Greek-style fiscal future.

It’s a simple matter of math. The income tax simply isn’t capable of generating enough revenue to fulfill the fantasies of folks like Hillary Clinton and Bernie Sanders.

Robert Samuelson, writing in the Washington Post, explains that the middle class will need to be targeted if politicians actually want to finance an ever-expanding welfare state.

Democrats retort that raising taxes on the rich will provide needed revenues to expand progressive government. …They obviate the need for middle-class tax increases to pay for government. …of Democrats’ faith in soaking the rich. …The trouble is that the math doesn’t match the rhetoric, as a new Brookings Institution study shows. In it, economists William Gale, Melissa Kearney and Peter Orszag asked this question: What would happen if the top income tax rate were increased from 39.6 percent to 50 percent? The answer — less than you think. …it would raise about $100 billion in tax revenues…, but it’s actually slightly less than a quarter of the $439 billion budget deficit for fiscal 2015. …Even if the $100 billion were directly distributed to the poorest fifth of Americans (an average $2,650 per household), the effect on overall inequality would be “exceedingly modest,” the authors say. …tax policies don’t come close to covering the real costs of government.

In other words, there aren’t enough rich people to finance big government, even if you somehow assume that huge tax hikes don’t have negative effects on taxable income (and the evidence from the 1980s shows that upper-income taxpayers have very strong responses to changes in tax rates).

So, given all this evidence, what’s Samuelson’s bottom line?

If middle-class Americans need or want bigger government, they will have to pay for it. Sooner or later, a tax increase is coming their way.

And he’s right.

Which makes it all the more puzzling that some good lawmakers want to give the other side a value-added tax.

One of my colleagues at the Cato Institute, Chris Edwards, wrote a column on this topic for National Review. Here are some key excerpts.

Senators Ted Cruz and Rand Paul are strong advocates of limited government. …That is why their embrace of the value-added tax (VAT) in their presidential campaigns is so baffling. VATs are the revenue engine of big-government welfare states, not a proper funding source for the small federal government that both senators favor for America. …the candidates hide behind innocuous names — “business flat tax” for Cruz and “business transfer tax” for Paul.

But calling something a “business tax” doesn’t mean the burden is borne by businesses.

The tab for taxes collected from businesses is ultimately passed through to individuals in the form of lower wages, reduced dividends, or higher prices. …VATs have huge bases. That’s because — unlike income taxes — they do not allow businesses to deduct employee compensation when calculating the taxable amount. …The result would be that tax revenues from businesses under the Cruz and Paul VATs would be enormous.

In other words, the VAT is – among other things – a withholding tax on labor income. And that’s why this levy generates a huge amount of revenue.

To make matters worse, this giant tax is hidden from voters.

Because Cruz and Paul shift much of the collection to businesses, more of the tax burden gets hidden from citizens and voters. …If the government is going to take our money, it should mug us on the street in broad daylight, rather than sneak into our homes at night and burglarize us unnoticed. The VAT would encourage more burglary.

And this hidden tax also will give statists an easy method of financing an ever-expanding burden of government spending

Cruz and Paul want smaller government, but down the road, other politicians looking to shore up entitlement programs will say, “They could be financed with just a small tax increase on businesses.” But each “small” increase in the VAT rate would transfer huge amounts of additional cash from the private economy to the government.


When I wrote about Sen. Cruz’s plan and Sen. Paul’s plan, I specifically pointed out that the VATs needed to be jettisoned.

But Chris makes an even stronger case. And he’s correct. Adopting a VAT would be a cataclysmic error for advocates of limited government.

It would be a truly perverse tragedy if the other side eventually gets a VAT because well-meaning (but misguided) conservatives paved the way.

P.S. The left also is salivating for a broad-based energy tax.

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The tax-reform landscape is getting crowded.

Adding to the proposals put forth by other candidates (I’ve previously reviewed the plans offered by Rand Paul, Marco Rubio, Jeb Bush, Bobby Jindal, and Donald Trump), we now have a reform blueprint from Ted Cruz.

Writing for the Wall Street Journal, the Texas Senator unveiled his rewrite of the tax code.

…tax reform is a powerful lever for spurring economic expansion. Along with reducing red tape on business and restoring sound money, it can make the U.S. economy boom again. That’s why I’m proposing the Simple Flat Tax as the cornerstone of my economic agenda.

Here are the core features of his proposal.

…my Simple Flat Tax plan features the following: • For a family of four, no taxes whatsoever (income or payroll) on the first $36,000 of income. • Above that level, a 10% flat tax on all individual income from wages and investment. • No death tax, alternative minimum tax or ObamaCare taxes. • Elimination of the payroll tax and the corporate income tax… • A Universal Savings Account, which would allow every American to save up to $25,000 annually on a tax-deferred basis for any purpose.

From an economic perspective, there’s a lot to like. Thanks to the low tax rate, the government no longer would be imposing harsh penalties on productive behavior. Major forms of double taxation such as the death tax would be abolished, creating a much better environment for wage-boosting capital formation.

And I’m glad to see that the notion of a universal savings account, popularized by my colleague Chris Edwards, is catching on.

Moreover, the reforms Cruz is pushing would clean up some of the most complex and burdensome sections of the tax code.

But Cruz’s plan is not a pure flat tax. There would be a small amount of double taxation of income that is saved and invested, though the adverse economic impact would be trivial because of the low tax rate.

And the Senator would retain some preferences in the tax code, which is somewhat unfortunate, and expand the earned income credit, which is more unfortunate.

It maintains the current child tax credit and expands and modernizes the earned-income tax credit… The Simple Flat Tax also keeps the current deduction for all charitable giving, and includes a deduction for home-mortgage interest on the first $500,000 in principal.

But here’s the part of Cruz’s plan that raises a red flag. He says he wants a “business flat tax,” but what he’s really proposing is a value-added tax.

…a 16% Business Flat Tax. This would tax companies’ gross receipts from sales of goods and services, less purchases from other businesses, including capital investment. …My business tax is border-adjusted, so exports are free of tax and imports pay the same business-flat-tax rate as U.S.-produced goods.

His proposal is a VAT because wages are nondeductible. And that basically means a 16 percent withholding tax on the wages and salaries of all American workers (for tax geeks, this part of Cruz’s plan is technically a subtraction-method VAT).

Normally, I start foaming at the mouth when politicians talking about value-added taxes. But Senator Cruz obviously isn’t proposing a VAT for the purpose of financing a bigger welfare state.

Instead, he’s doing a swap, imposing a VAT while also getting rid of the corporate income tax and the payroll tax.

And that’s theoretically a good deal because the corporate income tax is so senselessly destructive (swapping the payroll tax for the VAT, as I explained a few days ago in another context, is basically a wash).

But it’s still a red flag because I worry about what might happen in the future. If the Cruz plan is adopted, we’ll still have the structure of an income tax (albeit a far-less-destructive income tax). And we’ll also have a VAT.

So what happens 10 years from now or 25 years from now if statists control both ends of Pennsylvania Avenue and they decide to reinstate the bad features of the income tax while retaining the VAT? They now have a relatively simple way of getting more revenue to finance European-style big government.

And also don’t forget that it would be relatively simple to reinstate the bad features of the corporate income tax by tweaking Cruz’s business flat tax/VAT.

By the way, I have the same specific concern about Senator Rand Paul’s tax reform plan.

My advice to both of them is to ditch the VAT and keep the payroll tax. Not only would that address my concern about enabling the spending proclivities of statists in the future, but I also think Social Security reform is more feasible when the system is financed by the payroll tax.

Notwithstanding my concern about the VAT, Senator Cruz has put forth a plan that would be enormously beneficial to the American economy.

Instead of being a vehicle for punitive class warfare and corrupt cronyism, the tax code would simply be the method by which revenue was collected to fund government.

Which gives me an opportunity to raise an issue that applies to every candidate. Simply stated, no good tax reform plan will be feasible unless it’s accompanied by a serious plan to restrain government spending.

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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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