A federal VAT is the best way to raise net new revenue to pay for tax reform and deficit reduction at the same time.
Thinking along similar lines, I write
What I propose is that we adopt a value-added tax (VAT), also known as a consumption tax, in addition to the other taxes, while adopting a rule that says no single tax may have a double-digit marginal rate. My thinking is that with this reform, we would have all four taxes — personal income, corporate income, payroll, and VAT, each at a rate of, say, 8 percent.
My view is that real fiscal reform needs to focus on reducing the political incentives to spend and to create tax exemptions. A commitment to low rates would help both.
UPDATE: see also Tyler Cowen.
For Discussion. Could legislators commit to low rates, or would there be a time inconsistency problem?
READER COMMENTS
Kevin Bryan
Nov 16 2004 at 12:24pm
The most important tax reform that can be made is to simplify the code. Even if we have a national consumption tax, the income tax code should be simplified to something like
a) Take household income
b) Look on (included) table to find poverty baseline for your household (say, 2 adults with 2 dependents)
c) Find x% of income earned over that poverty line.
d) Add x% of cap gains
e) Have 3 or 4 deductions, but no more (perhaps charity, business expense, mortgage).
f) Send in the check
Further, the federal and state tax form should be unified (so that an individual only fills out one form, and the state forwards the money on or vice versa). The amount of money spent and time wasted filling out tax forms is a massive deadweight.
Bruce Bartlett
Nov 16 2004 at 12:53pm
The problem with Arnold’s idea for how to limit tax rates is that it ignores the distinction between effective and statutory rates. If I define the tax base so as to tax the same income over and over again, you can easily achieve confiscatory levels of taxation even with very low statutory rates.
Lawrance George Lux
Nov 16 2004 at 2:26pm
My answer is a Flat Tax without exemptions, deductions, or tax credits of any types. The Poor are intergrated into the Tax system by intergrating SS taxation into the Flat Tax, with Everyone paying into the SS Fund to a total set Dollar payment level. The Poor would be aided by clearly recognized welfare payment upon expressed need. The Individual and Business would have to underwrite their own Investment–including mortgages, while Business would not draw benefits from the SS Fund but pay their fair share for Labor assets. lgl
Toni
Nov 16 2004 at 3:31pm
I have to agree with Bartlett. Here in Finland, the different VATs, income taxes, municipal taxes and corporate taxes add up to almost twice what you have over here.
Besides, you get addred bureaucracy for multiple ways to get taxes, both on the receiver and the payer side.
spencer
Nov 16 2004 at 4:48pm
Why do I keep hearing conservatives brag about how the US economy is so much better than Europe on one hand and than turn around and claim we should copy the European –French –tax system?
Sounds very inconsistent to me.
Can someone tell me why it is not?
Bill Walker
Nov 16 2004 at 5:08pm
spencer,
Perhaps the US economy performs better than the French economy in spite of US tax code, rather than because of it. For a start, we are speaking about a much lower rate.
Aren’t you guys concerned that a VAT is inherently regressive? Surely there should be some exceptions built in for staples such as food.
spencer
Nov 17 2004 at 8:17am
Bill — nice comment, but if you look at the record of the US economy there is a negative correlation between tax rates and real GDP growth.
Lower tax rates have not lead to better growth — look at both the 1980s and recent years.
Bob Dobalina
Nov 17 2004 at 9:08am
nice comment, but if you look at the record of the US economy there is a negative correlation between tax rates and real GDP growth
Post hoc ergo propter hoc
Lawrance George Lux
Nov 17 2004 at 2:48pm
Bob,
But is there a positive correlation between lower Business taxes and economic growth? I think not. lgl
spencer
Nov 17 2004 at 3:51pm
Bob it is not a logical fallacy because capital spending or business investment has virtually nothing to do with personal income of savings.
If you look at the economic data you will find that essentially all capital spending is financed by business savings– retained earnings, etc. Because of this there is little or no reaon to expect changes in personal taxes rates to have any impact on the primary driving force of the economy — capital spending.
Tom Ault
Nov 25 2004 at 12:10am
First of all, a tax – any tax – acts as a drag on the economy. To see this, think about what would happen if the government simply took a match to whatever monies it collected instead of spending it. Offsetting this drag is the potential benefit of whatever the government spends the tax revenues on. Some things are of obvious benefit – law enforcement, national defense, roads, courts, and so on – while other are of questionable benefit, no benefit at all, or are actively harmful to the economy.
All of this should be obvious, but far too often one hears claims that are equivalent to the statement that whenever taxes can be raised without signifcantly impacting economic growth, one is obligated to do so to meet some moral imperative, such as providing free health care or housing to all of society’s members. I maintain that there are limited number of things the government can spend money on that provide a net stimulus over the result of leaving that money in private hands. Many big ticket government programs deliberately or inadvertainly provide disincentives to work and act as a net drag on the economy of themselves in addition to the drag imposed by the tax revenues collected to pay for them. Consequently, the main benefit of low tax rates is not the rates themselves but the fact that they restrain the government from implementing policies that it probably shouldn’t.
Of course, a society may choose to implement policies that are economically harmful for aesthetic reasons. For example, we might use public revenues to support those who are unable to work due to physical or mental handicap. Advocates of socialized medicine and generous welfare benefits err not necessarily in the advocacy of these programs but in that they are dishonest about their impact on the economy.
Yenko
Nov 28 2004 at 12:50am
My short answer to the For Discussion topick is “no”…simply because legislators are unable to commit to anything.
Terminator
Nov 28 2004 at 5:41pm
I’m just an economics student (minor, not even major), so bear with me if this is wrong.
But my understanding of a VAT is that it taxes each stage of the production of a given good.
So, for example, building an automobile, we would tax the production of steel bars from iron ore, we would tax the use of steel in constructing a car’s frame, we would tax the attachment of body panels and doors and windows, etc. to the frame, we would tax the addition of paint to the body, and so on, until the car rolls off the manufacturing floor — after all, each additional combination of usability (attaching a windshield to the frame, for example) is an additional “value” added to each good — and the VAT, by its very name, is a tax on the value-added to a given good.
Hence, the VAT looks to me like the economically-ideal way to strangle technological development. If you want to reduce the amount of complexity of our goods (cars, computers, etc.), what better way to do so than to destroy the market for those goods than by raising the price on them with a tax that specifically targets complex goods?
To this end, the VAT seems to me to be a monumentally-bad tax if your goal is to grow the economy (since economic growth largely comes from technological growth). To me it looks far worse than the income tax.
Again, I’m not a PhD in Economics, however. Just a CS and Econ. student…
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