Vetting the VAT

In a recent op-ed, Henry Aaron and Belle Sawhill argued that a value added tax (VAT) – a tax on consumption imposed piece-wise in various stages of production – could help to “bend the revenue curve.” The two argue that health care reform cannot do enough to control the long-term debt, explaining that “Medicare will require increased revenue as the baby boomers retire, even if the program's structure is materially changed,” and that “revenue generated under current tax laws cannot pay for the government services -- health care and everything else.” 

We of course reminded our readers that, to the extent we can, we should combat spending growth with spending cuts. But still, given the likelihood that spending is going to grow substantially, revenue increases have to be on the table. And there is a vibrant debate out there over whether a VAT should be used to raise additional funds. Although expensive to administer and regressive, a VAT would be able to produce a good deal of revenue, encourage savings and investment, and even help to stabilize the dollar. The VAT is very popular globally, as it is used in 125 countries to raise a total of $18 trillion, according to the Tax Policy Center.

Aaron and Sawhill recommend that, upon implementation (after the economy recovers, of course), VAT revenues be put directly into a trust fund and used to finance all public health care spending. This is similar to a proposal made by Len Burman in May of last year, when, in testimony before Congress, he proposed “a value-added tax (VAT) dedicated to pay for a new universal health insurance voucher.”

Michael Graetz, meanwhile, has supported a VAT to replace part of the income tax (which would be eliminated for lower earners), arguing that such a move could make the tax system as a whole more efficient, progressive, and growth oriented, while reducing political support for distortionary “tax expenditures”.

And it seems like many other from the left and right are jumping on the VAT bandwagon. CRFB board member Rudy Penner has written that we might need a VAT to help solve our long-term budget problems. Paul Volcker mentioned to PBS in late September that the U.S. could consider a number of changes to the tax code, including the addition of a VAT, to help bring deficits down. Brad DeLong has argued that the U.S. needs a VAT to combat unaffordable spending policies and to more heavily tax the middle class. And Bruce Bartlett also seems to support a VAT, recently discussing the issue of the state of CA possibly introducing a VAT. And last week on the Charlie Rose show, even House Speaker Nancy Pelosi said she thinks it is fair for the government to look at a value added tax.

Still, the VAT definitely has its flaws and its detractors. In an op-ed in the Wall Street Journal today, Christian and Robbins lay out their argument that the addition of a VAT would introduce uncertainty into our tax system and radically change the economy – not for the better. The President’s Advisory Panel on Tax Reform, which looked for ways to reform the tax code during the last administration, could not reach a consensus on whether to recommend the option of a VAT. Many on the left are concerned about its regressive nature – since lower- and middle-income individuals tend to use a higher proportion of their income on consumption. On the right, many worry the VAT would be a “money machine” allowing government to grow far too large.

Pete Davis, who actually helped to formulate the 1979 VAT proposal of House Ways and Means Chair Al Ullman recently explained his own  “bias against adopting a VAT” . He argued that although theoretically appealing, a VAT would be expensive to administer, regressive, and would arbitrarily redistribute income between groups (for example, by “double taxing” the elderly and others who saved substantially before the VAT’s implementation). Trying to combat the regressivity with a refundable tax payment, he argues, would blunt revenue and create inequities as some would be overcompensated and some undercompensated. And even setting that aside, the transition would be painful.

At the end of the day a VAT would amount to a huge tax increase; not popular with the stereotypical ideological right, who would like to focus on cutting spending, and not popular with the stereotypical ideological left, who see a VAT as introducing vast regressivity into the tax code.  We don’t know if a VAT will ever be possible in the United States, but regardless, given our current fiscal picture, the VAT – along with other ways to efficiently increase revenue and cut spending – should remain on the proverbial table.