A Value-Added Tax That Won’t Raise Revenues Or Boost Taxes on the Poor

By :: November 26th, 2013

For many years, Michael Graetz, now a law professor at Columbia University, has been promoting a national Value-Added Tax (VAT) that would become the principal levy paid by most Americans. VATs--and similar broad-based consumption taxes--are enormously controversial in the U.S. even though they are ubiquitous throughout the rest of the world and enjoy widespread support among many economists.

There is no chance the U.S. will adopt this tax any time soon. Yet, Graetz’s VAT will serve as something of a benchmark for any future tax reform debate, even if that rewrite is far less ambitious than his idea.  

By proposing a plan that would vastly broaden the tax base, reduce the number of individual income tax filers by 80 percent, and simplify tax preparation for nearly everyone, Graetz sets a goal. If, in the end, politicians get just halfway there, we could well have a better tax system than we do today.

Michael, who was awarded the Daniel M. Holland Medal by the National Tax Association last week, recently tweaked his plan and the Tax Policy Center ran the numbers. We found that, in 2015, despite the huge changes he’d make to the Revenue Code, his plan would raise the same amount of money as today’s tax law. Just as important, his VAT would not change the overall distribution of the tax burden by very much, and even result in small increase in average after-tax income for low-income households.

Under his plan, those low-income households would enjoy an average boost in after-tax income of about 1.2 percent, while highest-income households would see their average after-tax income fall by about 0.9 percent. Other income groups else would pay pretty much the same tax they do today. Within those groups there would be winners and losers (low income workers without kids would do better than those with children, and middle-income households that don't itemize would be better off than those that do).     

How would his VAT work? It would set a flat rate of 12.9 percent on nearly all consumption (including government purchases of goods and services). TPC estimates that 70 percent of the Gross Domestic Product would be subject to the VAT—a feature that keeps the rate relatively low.

Graetz would retain a federal income tax but use a generous system of allowances to sharply reduce the number of people who’d pay it. For married couples, the first $100,000 in income would be exempt from income tax (the exemption would be set at $50,000 for singles and $75,000 for heads of household). TPC figures these allowances would slash the number of income tax filers from 153 million to just 31 million.

Those who would still pay would face three rates (up from two in an earlier version)--14, 27, and 31 percent. Joint filers, for example, would pay a 14 percent rate on taxable income up to $100,000 (that is, the amount in excess of their $100,000 allowance). The 27 percent rate would apply to taxable income between $100,000 and $500,000 (after the allowance), and the top rate kicks in at $500,000. Graetz would also cut the corporate tax rate from 35 percent to 15 percent.  

Graetz isn’t the only tax expert who likes some form of consumption tax. At last week’s National Tax Association meeting, Michael was joined on a panel by my TPC colleague Len Burman and by Alan Viard and Bob Carroll—all of whom described other plausible consumption tax models.

Len discussed the 2010 Bipartisan Policy Center plan that would also graft a VAT on to a smaller, radically simplified income tax. BPC rebranded its consumption tax as a Deficit Reduction Sales Tax or DRST. Alan and Bob discussed a plan that would fully replace the income tax with the progressive consumption tax created more than two decades ago by the late David Bradford.    

Not everyone loves a VAT, of course. Conservatives worry that rates could be raised too easily and dislike that in some forms it would accompany an income tax. Liberals distrust what they see as the regressive nature of a consumption tax, though the TPC estimates of the Graetz and BPC plans show those fears can be addressed.   

The nice thing about being an academic, as opposed to say, the chairman of the Senate Finance Committee, is that Graetz has the freedom to suggest ideas that are unconstrained by politics and the often dreary realities of policymaking. The result: an ambitious tax reform plan that is, at least, worthy of serious consideration.


  1. Eugene Patrick Devany  ::  3:43 pm on November 26th, 2013:

    “the freedom to suggest ideas that are unconstrained by politics and the often dreary realities of policy making.”

    If the VAT were really low (4%) and revenue neutral it could replace the business portion of the job killing payroll taxes with no change in consumer prices. A VAT could also be used as part of a larger tax reform intended to restore the share of wealth of the poor and middle class that has been lost over the last 20 to 30 years.

    An “optional” 2% tax on average net wealth (excluding $15,000 cash and $500,000 retirement funds) could be paired with a flat 8% income tax (and no payroll taxes) for about 95% of the population. In the alternative, a higher 26% individual income tax rate (plus deferred capital taxes on gains, gifts and estates and no wealth tax) could be paid by anyone (but they would likely be very, very rich). A 4% VAT on business would enable a reduction of the C corporation rate to 8% and elimination of payroll taxes (so combined business tax revenue and consumer prices remain about the same).

    The phrase “dreary realities of policy making” is a bit condescending. Congress, like the tax study groups before it, have intentionally limited the scope of their proposals to those that do not alter the current redistribution of wealth from the income tax code. Rather sad when you think about it.

  2. Michael Bindner  ::  3:33 am on November 27th, 2013:

    Graetz’s plan is one of the best out there – and the latest iteration is only revenue neutral because this was the scenario thought to be most politically viable. I am sure it can be easily adjusted to reduce the deficit – either in a broad based manner or a progressive one – although the progressive one would likely slow the economy less – not that the current House Republicans would ever believe it.

    Len’s VAT plans are well known – both the one for Health Insurace Reform and his BPC plan. Also of note are the less developed plan by Lawrence B. Lindsey for a Net Business Receipts Tax – essentially a Subtraction VAT with multiple rates and credits – although there are privacy concerns with his plan for those with either high wage incomes or high non-wage income (and I am not sure how a NBRT can capture capital gains income). I also have a plan, as frequent readers undoubtedly know (combination VAT and High Income Tax with an NBRT similar to Lindsey’s).

    It would be wonderful if TPC had a forum with Michael, Lawrence, Len and Me – possibly with Bruce Bartlett moderating.

  3. SteveinCH  ::  8:53 am on November 29th, 2013:

    Yes, by all means, we should make the federal tax code more progressive. After all, it’s only the most progressive it has ever been since 1979 (and arguably since 1960 although the data is less clear given the lack of CBO analysis).

    But, more broadly, when we exit the world of academia, let us consider what Congress would likely do with a VAT. Think of all the opportunities a VAT provides Congress to “encourage proper behaviors.”

    Higher rates on carbon intense products…
    Lower rates on “necessary items”…

    For the average person in DC, the logic of such “adjustments” would be unassailable.

    It’s simply insane to create a system that allows Congress the ability to micromanage economic variables even more than they do today.

  4. Ralph H  ::  1:56 pm on November 29th, 2013:

    I must admit I like the idea of a VAT as an efficient way to collect taxes. However Steve has a great point in that we will use “social engineering” or downright lobbying to protect favored groups or industries.

    Consider how sales taxes are supplied — ever see it be charged on a legal bill, accounting fee or medical bill? Look at how we subsidize millionaires who install solar systems or buy an electric car while letting rates go up for the rest of us. Because fewer gasoline is consumed “progressive” states are looking to tax mileage (tracked by big brother). Most of us don’t care when alcohol and tobacco taxes skyrocket, but the poor sure are hit disproportionately.

    If we were to implement such a tax lets require a super majority to change rates or classes. Not going to happen

  5. A Value-Added Tax Plan All Sides Can Embrace | NEWS.GNOM.ES  ::  3:55 pm on December 1st, 2013:

    […] Tax Policy Center found that his proposal succeeds in raising the same amount of revenue as current law. If revenue […]

  6. Hines Darrel  ::  8:39 am on March 13th, 2014:

    VAT is really helpful in many ways. It can generate revenue upto a great extent. I completely agree with each and every point if this post.I would like to suggest a way to simplify to your VAT that is using VAT compliance systems.Thank you for this post.

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