Retirement and Social Security Reform
A Value-Added Tax Fuels Big Government
Wall Street Journal
August 24, 2011
By Ernest S. Christian and Gary A. Robbins
President Obama is now talking about a "balanced
approach" to deficit reduction that includes a "revenue
component" achieved by "tax reform."
Among the tax reforms getting attention is a value-added tax,
or VAT. Similar to a sales tax (more about this below), the
value-added tax has become a significant part of the revenue
systems of Europe and also has been adopted by over 100 other
nations. The VAT is believed to be a magical device that can
stuff government coffers with money without untoward economic
political consequences. It is no such thing.
In the first place, increasing taxes will reduce economic
growth. This is irrational and self-defeating policy. If the
point of the current debt-ceiling exercise is to make the
American people better off, the smart thing is to restore
long-term fiscal integrity and economic growth with a balanced
combination of spending reductions and tax cuts.
On the other hand, a VAT is the ideal choice for those whose
goal is to refinance government sufficiently to allow it not
only to continue "business as usual" but also to
expand on a grand scale.
We estimate that each percentage point of a U.S. VAT would
provide Washington over 10 years with approximately $981 billion
with which to launch new spending. So even a small VAT might
help reduce the debt-to-GDP ratio. But by making reforms to
entitlement spending less likely, VAT revenues would also
lead to a permanent increase in spending to 24% or more of
GDP (compared to the historic average of 20%).
Total federal taxes would almost certainly increase to at
least 24% of GDP (a 25% rise compared to the historic average).
As a result of the drag of taxes on growth, we estimate that
long-run output would permanently be nearly 3% lower than
currently forecast. And, as has occurred in Europe, the VAT
rate and revenues would over time inexorably increase-and
so would the damage to private-sector jobs and incomes.
We estimate that each additional $1 trillion of revenue to
the government from a VAT would cost the private economy at
least $2 trillion, composed of $1 trillion of taxes and $1
trillion of lost GDP. This loss of GDP is less than what other
economists (such as Martin Feldstein and Gregory Mankiw) have
estimated would be the case for the income tax. A VAT thus
appears less damaging at the outset, and some academics suggest
that a small VAT be used to "buy" a reduction in
the top income tax rate. But it is naïve to believe that
the VAT rate would remain low, or that the income tax rate
would not shoot back up.
In Europe, the VAT rate started out in the single digits in
France in the 1950s. But because the VAT funds Europe's ever-expanding
welfare state, the rates now range from a minimum of 15% to
a high of 25%, and they are heading upward.
In Europe, the VAT on top of the income tax is a crushing
burden. In France, where the VAT rate is 19.6%, total tax
as a percentage of GDP is 46%, versus 30% in the United States.
Britain now has a 20% VAT in addition to a 50% top rate on
its personal income tax, a 26% corporate tax and a host of
other taxes. Even if a U.S. VAT remained in the midrange of
rates compared to Europe, it could easily push the total tax
burden up to 40% of GDP.
In addition to its voracious appetite, the value-added tax
is a master of disguise. Because it is levied on the sale
of a product at each stage of production-whenever value is
added-and at the final sale, the VAT is portrayed as a tax
on consumption. The French once illustrated the VAT with an
example: The farmer passes the tax to the miller, the miller
passes it to the baker and the baker includes it in the price
of bread. Ever since, the VAT has for political purposes been
viewed as a burden on the consumer, thereby providing politicians
with an excuse for "compensating" large numbers
of favored voters with disproportionately large cash subsidies
Offsetting consumer subsidies would occur in spades in America,
where the tax system has traditionally been preoccupied with
"progressivity" and used to redistribute income.
The VAT isn't really a consumption tax, however. The truth
is that the base of the VAT is the output of labor and capital-and,
therefore, the economic burden of the VAT is, like that of
the income tax, borne mostly by those who work, invest and
produce the most output.
It is disturbing to consider a value-added tax sneaking into
our current tax code disguised as tax reform. The outcome
will be more spending, a higher combined income tax and VAT
tax burden concentrated on a minority of voters, and a spate
of special redistributional subsidies and exemptions that
would mean higher rates. These higher rates would increase
the economic output losses and continue the ongoing transfer
of income and capital from the private sector to the government.
If Republicans get sucker-punched by a VAT, America will forever
lose the opportunity to reduce spending, cut taxes, grow the
private economy, and restore the country's long-term fiscal
Mr. Christian is co-author of "The Value Added Tax:
Orthodoxy and New Thinking" (Kluwer, 1989) and director
of the Center for Strategic Tax Reform. Mr. Robbins is the
center's chief economist.