The VAT isn't an easy fix for budget woes

Discussion in 'Economics' started by Tom B, Apr 19, 2010.

  1. Tom B

    Tom B

    The VAT isn't an easy fix for budget woes

    By Robert J. Samuelson
    Monday, April 19, 2010; A15

    "There is always an easy solution to every human problem -- neat, plausible and wrong."

    -- H.L. Mencken

    The value-added tax has become the designated panacea for massive federal budget deficits. It's touted by think-tank economists and mentioned by congressional leaders. A VAT could, it's said, raise stupendous amounts of money, which, Lord knows, are needed to cover projected deficits. A VAT is likened to a "national sales tax," so once in place, most Americans would barely notice it -- just as they barely notice state and local sales taxes. How's that for friendly politics? A VAT would also discourage consumption and encourage saving and investment, making America richer in the future. What's not to like?

    Mencken (1880-1956), one of America's great wits, would chuckle. Almost every pro-VAT argument is exaggerated, misleading, incomplete or wrong. The VAT is being merchandised as an almost-painless way to avoid deep spending cuts. The implicit, though often unstated, message is that a VAT could raise so much money it could eliminate future deficits by itself. This reasoning, if embraced, would create staggering tax burdens and exempt us from a debate we desperately need.

    How big a government do we want -- and what can we afford? In closing deficits, what's the best mix between tax increases and spending cuts? What programs are outmoded, ineffective or unneeded? How much should we tax the young and middle-aged to support the elderly? Should wealthier retirees receive skimpier benefits? Should eligibility ages for benefits be raised?

    The basic budget problem is simple. For decades, the expansion of Social Security, Medicare and Medicaid -- programs mostly for the elderly -- was financed mainly by shrinking defense spending. In 1970, defense accounted for 42 percent of the federal budget; Social Security, Medicare and Medicaid were 20 percent. By 2008, the shares were reversed: defense, 21 percent; the big retirement programs, 43 percent. But defense stopped falling after Sept. 11, 2001, while aging baby boomers and uncontrolled health costs keep retirement spending rising.

    Left alone, government would grow larger. From 1970 to 2009, federal spending averaged 20.7 percent of the economy (gross domestic product). By 2020, it could reach 25.2 percent of GDP and would still be expanding, reckons the Congressional Budget Office's estimate of President Obama's budgets. In 2020, the deficit (assuming a healthy economy with 5 percent unemployment) would be 5.6 percent of GDP. To cover that, taxes would have to rise almost 30 percent.

    A VAT could not painlessly fill this void. Applied to all consumption spending -- about 70 percent of GDP -- the required VAT rate would equal about 8 percent. But the actual increase might be closer to 16 percent because there would be huge pressures to exempt groceries, rent and housing, health care, education and charitable groups. Together, they account for nearly half of $10 trillion of consumer spending. There would also be other upward (and more technical) pressures on the VAT rate.

    Does anyone believe that Americans wouldn't notice 16 percent price increases for cars, televisions, airfares, gasoline -- and much more -- even if phased in? As for a VAT's claimed benefits (simplicity, promotion of investment), these depend mainly on a VAT replacing the present complex income tax that discriminates against investment. That's unlikely because it would require implausibly steep VAT rates. Chances are we'd pay both the income tax and the VAT, making the overall tax system more complicated.

    Europe's widespread VATs aren't models of simplicity. Among the European Union's 27 members, the basic rate varies from 15 percent (Cyprus, Luxembourg) to 25 percent (Denmark, Hungary and Sweden). But there are many preferential rates and exemptions. In Ireland, food is taxed at three rates (zero, 4.8 percent and 13.5 percent). In the Netherlands, hotels are taxed at 6 percent. An American VAT would stimulate ferocious lobbying for favorable treatment.

    Higher consumer prices from the VAT could also slow the economy. The Federal Reserve would face policy dilemmas. If it tried to prevent businesses from passing along the tax to consumers, it would have to raise interest rates and risk a recession. If it tried to blunt the effect of higher prices on spending, its easy credit policy might trigger a new wage-price spiral.

    A VAT is no panacea; deficit reduction can't be painless. We'll need both spending cuts and tax increases. A VAT might be the least bad tax, though my preference is for energy taxes. But what's wrong with the simplistic VAT advocacy is that it deemphasizes spending cuts. The consequences would be unnecessarily high taxes that would weaken the economy and discriminate against the young. It would become harder for families to raise children. VAT enthusiasts need to answer two questions: What government spending would you cut? And how high would your VAT rates go?
  2. 377OHMS


    Its difficult to see how anyone can be enthusiastic about another layer of taxation.

    How about cutting spending? Or is that just out of the question anymore?
  3. There will always be too much "resistance" from government to do that. :cool:
  4. Any new tax will restrain GDP, going forward.

    Even if all new revenues are spent directly back into the economy, bureaucratic waste and inefficiency destroys ~30% of all income passed through Government hands.

    The net effect will be a drop in GDP commensurate to VAT taxes collected X 30%.

    The solution? Cut Government Spending. Out of control Government is never an excuse to raise taxes.
  5. clacy


    No doubt about it. Robbing Peter to pay Paul.

    At the end of the day, increasing taxes doesn't solve anything. You can always spend more and governments usually do.
  6. TGregg


    There's an epic understatement, much along the lines of "Chances are there is some corruption in the federal government" and "Chances are that gravity will still be working tomorrow morning."

    Sooner or later a VAT is coming and you can bet your hat they won't toss the income tax. Not a chance. Nor will they cut spending - not with all this new revenue. Nope, they'll do what they always do, spend the #@*^ out of the new money.
  7. My preference, is to have a VAT that is ONLY used to replace things that encourage offshoring of jobs and factories, namely - costs such as all medical coverage, dental coverage, product safety, life insurance, disability insurance, workmen's compensation, environmental mandates, green energy costs, perhaps even corporate taxes, all govt educational/retraining tax credits/deductions, etc.

    Many jobs go overseas, due to the reduction of benefits/perks/mandates. Mexico does not worry about toxins from fish farming. China factories obviously do not care about product safety. They want it cheap. But under the VAT, all these costs that companies try to offshore, will be paid by domestic AND foreign producers. So there is no advantage of sending the goods/services oversease from THIS point of view.

    Then these things are no longer tax deductible to workers or to companies, and the govt has more tax revenue to work with.
  8. ashatet


    People who propose VAT should go and visit Europe. I have never shopped in Europe for the fear of VAT. Things get expensive real fast. Further, VAT slows down the economy and consumption and economies of scale, thereby resulting in even higher prices.

    VAT could put an upward pressure of up to 50% on stuff. Imagine that you buy a car for 35K and pay an additional 8% of state tax and then 20% VAT. Sure that would help. As long as they leave food alone, I don't care much for VAT.

    Any money from VAT will be used to further extend the welfare programs, they will not be used for paying down the debt, I would assume.
  9. maxpi


    VAT brings the underground economy into the set of taxable entities.. I'm all for it. I'm for the Fair Tax too... anything that is a step towards repealing the income tax is great in my book. How is it the government's business what I earn or what I donate or invest in or anything at all if I'm not being investigated?
  10. pspr


    The VAT isn't going to fly in America. If government can't cut spending we will just starve it to death by convencing congress to pass a no-new-taxes law. Only vote for people strongly for downsizing government this fall.

    Including both the civilian and defense sectors, the federal government will employ 2.15 million people in 2010 and 2.11 million in 2011, excluding Postal Service workers.
    #10     Apr 24, 2010