The 10 Percent Solution
How progressives can stop worrying and love a value-added tax.
Andrea Louise Campbell
he nation’s fiscal situation is bleak. Although current deficits have garnered the most attention, of greater concern is the long-term mismatch between projected revenues and spending–gaps too great to plug with borrowing for fear of triggering a debt crisis. We all agree on the need to restore fiscal balance. But too much of the focus has been on the spending side, from Tea Partiers who rage about the size of government but have difficulty parting with their Social Security and Medicare checks, to more sober outlets like the National Academy of Sciences, whose Choosing the Nation’s Fiscal Future
report earlier this year also took an anti-spending tone. The fact is that we need to take a look at the tax side of the ledger as well.
The federal government desperately needs new revenue. To raise revenues, many progressives point to the corporate and individual income tax, urging the closing of loopholes on the corporate side and the raising of top marginal rates on the individual side. I would like nothing better myself. But the prospects for substantial new revenue from these sources are dim. Thirty years of successful conservative attacks have made the idea of raising the individual income tax politically toxic–since, after all, it’s imposed most heavily on the most vocal and organized segment of society. Meanwhile, global competition constrains increases in the corporate income tax.
Instead, we need a new source of revenue, one that can finance a robust public sector for the twenty-first century. The place to get it is a carefully designed value-added tax (VAT). Much discussed in academic circles for decades, a VAT is now on the Washington agenda, the subject of many recent Beltway conferences. Most progressives reflexively oppose a VAT as regressive, and to be sure, it can be that. But properly structured, a VAT’s regressivity can be mitigated. If a VAT is truly under consideration, it is crucial for progressives to engage the debate and bring to the table a VAT designed to achieve not just fiscal balance but progressive goals as well. The plan outlined here would capitalize on the VAT’s attractive features–chiefly its ability to raise a significant amount of revenue with relative political and economic ease–while carefully blunting its regressivity. Linked to a set of strong protections for ordinary citizens, a VAT can be a key component of a progressive package benefiting lower- and middle-income Americans.
A VAT works by taxing the “value added” by each business in the chain of production; that is, the difference between the revenues that a business receives from the sale of goods and services it produces and the amount it pays for goods and services. Let’s say we have a manufacturer who makes a good and sells it to a wholesaler for $400 (for our purposes we’ll assume the good was made without purchases from another firm). The wholesaler then sells the good to a retailer for $900, who in turn sells it to a consumer for $1,000. Under a 10 percent VAT system, the “value added” by the manufacturer is $400, for a tax of $40; the value added by the wholesaler is $500, for a tax of $50; and the value added by the retailer is $100, for a tax of $10. The total tax collected is $100. Note that this is the same as a 10 percent retail sales tax on a $1,000 item, but the tax is collected from businesses at each stage of the process. Businesses pass these taxes on to the consumer, who would pay $1,100 instead of $1,000, and still pay state and local sales taxes.
More than 145 countries have a VAT, the chief exceptions being the United States and some Persian Gulf and African countries. Economists regard the VAT as a steadier source of revenue than an income tax because consumption constitutes a more stable base than income, which tends to vary greatly from year to year for individuals and particularly for corporations. By taxing consumption, a VAT encourages investment and capital formation, which foster economic growth. In addition, evasion is more difficult and less likely than under an income tax, as each business has a financial interest in ensuring the VAT it pays on purchases is accurately recorded so that it gets credit against its VAT liability. At root, however, what makes a VAT attractive is its ability to raise a substantial amount of revenue with relative ease.
That ease derives from the VAT’s design features. Both survey-based and experimental research show that taxes that are imposed a bit at a time rather than as a lump sum are far more popular with the public. Sales taxes, paid in small increments with each purchase without an annual tallying up, are regarded much more favorably than taxes extracted in a lump sum, such as the property tax, or taxes for which the annual total is known, such as the income tax. A VAT shares the advantageous features of the sales tax and is thus a way to fund government in manageable, incremental installments.
For precisely that reason, conservatives are generally wary of the VAT as a tax that is “too good,” a “money machine” that would fuel an unchecked expansion of government. According to Curtis Dubay of the Heritage Foundation, a VAT “would forever expand the size of government” and transfer billions “from productive private hands to the wasteful hand of government.” Or, referring to the country that first instituted the tax, anti-tax crusader Grover Norquist quipped, “VAT is French for big government.” That said, some conservatives have been open to a VAT, although only as a replacement for a portion or all of the individual income tax or corporate taxes. Chris Edwards of the libertarian Cato Institute has said that a VAT is “worth considering,” but only as a substitute tax and only if listed separately on sales receipts so as to heighten its visibility and thwart future rate increases.
ISSUE #19, WINTER 2011
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