A Value-Added Tax That Won’t Raise Revenues Or Boost Taxes on the Poor
By Howard Gleckman :: 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.