Is it time for the U.S. to consider a Value Added Tax? More and more tax experts think so. But the politics isn’t yet getting easier.
One problem: While more specialists are joining the VAT fan club, they can’t agree on what to do with the money. TPC’s Len Burman has proposed a VAT to supplement the income tax and pay for health care. Michael Graetz, once a top tax aide to the senior George Bush, would use one to get most Americans off the income tax. At the TPC/Tax Analysts tax reform conference on Dec. 5, Pam Olson, who was a top tax aide to the today’s President Bush, endorsed the levy as a way to buy down corporate tax rates. Once the tab comes in for the trillions of dollars Washington is spending to stimulate the economy and bail out the financial markets, I am certain others will propose a VAT simply to help pay the bills.
In the more than three decades I’ve been watching Washington's debate tax reform, the consumption tax has waxed and waned. For a while, there was a lot of interest in these levies as a replacement for the income tax. The late David Bradford’s x-tax, Bob Hall and Al Rabushka’s flat tax, and a version designed in part by Urban’s Rudy Penner all generated tremendous academic interest.
These were not European-style VATs, but, like the VAT, they were designed to tax consumption rather than income. And they had the potential to be both more efficient and simpler, at least once they made it through a painful transition. Ultimately, however, they died in a political system unwilling to accept such radical change.
While the VAT has many of the same advantages as these ideas, it also comes with some long-standing structural difficulties. It bumps into state sales taxes. It is by nature regressive since lower-income people spend a larger share of their income than the wealthy. And while it is possible to fix that problem, the solutions are not always pretty. For instance, excluding necessities such as food just drives up the rates and creates some bizarre exceptions. A better way is to give those with lower incomes refundable tax credits to partially offset the VAT. But that requires an IRS that has trouble managing one tax system to try to run two.
Some years ago, House Ways & Means Tax Counsel John Buckley struggled to build a VAT for former congressman Sam Gibbons (D-Fl). After that experience, Buckley says flatly that a VAT layered on top of the income tax is “unworkable.”
There is one more piece of the puzzle that intrigues me—a carbon tax. It too is a consumption tax, with many of the same pros and cons as the VAT. We would never enact both, but I wonder if there is some way to marry these ideas.
There is no doubt government is going to need huge dollars in coming years, and the income tax may have just about reached its limits. In such an environment, we could do worse than rethinking the idea of a consumption tax in its many forms.