The Brass Tack

Let's get down to it.

VAT, stat

Posted by srconstantin on July 18, 2009

Bruce Bartlett comes out in favor of a value-added tax. The usual argument for a VAT is that, unlike the income tax, it doesn’t penalize labor or savings, but consumption, so it can make the US more attractive for investment and more productive. The usual argument against the VAT is that it’s regressive.

Bartlett alludes quickly to some justifications that bear expanding. He compares the VAT to a carbon tax (which, after all, is also a tax on most consumption). So the arguments (usually put forward by liberals) for why a carbon price wouldn’t have to be unduly regressive — rebates, sliding scales, and the like — also work for an ordinary VAT.

Also, Bartlett says that a VAT is “broad-based,” that is, that everybody pays it. He is disturbed by the fact that many Americans don’t pay income tax: “And I think it’s bad for democracy when people get into the position when a majority can vote benefits for themselves but not pay for it.” This seems to be an argument for regressiveness for its own sake. I’m a bit unconvinced.

But the fact is, we are going to have to raise taxes simply to pay for projects currently in the pipeline. Eventually too much government debt becomes a bad thing — someday foreigners will be unwilling to buy it. And the VAT promises to be simple, non-distortionary, and good at raising revenue. Ezekiel Emanuel likes the idea. The only problem is that ordinary people will have to pay it.

And, perhaps, that it’s vulnerable to fraud.

I can also conceive of problems with implementation: it will be appealing to exclude food, heat, and so on from the tax to make it less onerous on the poor, but this could make it tempting to choose certain commodities to tax more than others, which would be distortionary. (Consider how much state revenue comes from cigarette and liquor taxes.)

Interestingly enough, it seems to be progressive rather than regressive in poor countries. And if you consider consumption as a proxy for lifetime income, rather than annual income, then even in the US a VAT is only modestly regressive. In fact, if you literally used consumption to stand for lifetime earning, assuming that consumption was perfectly smoothed over the life cycle, then the VAT is by definition proportional (flat). Will Wilkinson has philosophical reasons why we should think about consumption rather than annual income when we’re concerned about inequality and the distribution of wealth.

VAT may not be so bad, and we might need it anyhow if rolling back the Bush tax cuts is not enough to cover current and future spending.

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