Lori Montgomery and Howard Schneider, “Stabilizing U.S. debt is the greater of two G-20 challenges,” Washington Post, 06/30/10

“In an interview, IMF Managing Director Dominique Strauss-Kahn said a desire to support growth is not inconsistent with the G-20′s deficit-reduction goals. ‘Everyone has to look at fiscal consolidation, but they can do it at a different pace,’ Strauss-Kahn said. ‘It would be a disaster if all the countries were tightening. It would totally destroy the recovery. We need somehow today to go on supporting growth except for those who are really constrained.’

Strauss-Kahn said the specific targets for when and how much to cut deficits are less important than whether countries ‘implement the right measures.’ In a report for the Toronto summit, the IMF encouraged nations to adopt ‘growth-friendly’ policies as they seek to reduce deficits, for example by shifting from income and payroll taxes to consumption taxes. In the United States, that might mean adopting a value-added tax (or VAT) of up to 8 percent on all goods and services.

The idea of a VAT has been broached in Washington — most prominently by Obama economic adviser Paul A. Volcker — but has so far failed to gain political traction. Instead, the debate has focused on reductions in Social Security and health benefits, cuts in Pentagon spending and a freeze for other government programs.”

Joel Slemrod, “The ABCs of the VAT,” News & Media, Ross School of Business, University of Michigan, 05/24/10

Why are we talking about a value-added tax?
Slemrod: The reason people in the country, or at least in Washington, are talking about it is the long-term fiscal imbalance we face, which is enormous. The taxes in place relative to the spending commitments for Social Security and Medicare don’t come close to covering the cost, and this fiscal imbalance can lead to a host of economic problems. Most people think that if we’re going to close that gap, it’ll include cutting back on entitlements some and raising taxes some. If we’re going to raise taxes, one option is to collect more from the existing taxes, primarily the income tax. But the income tax is riddled with problems and is quite distortive. So there’s another tax out there, the value-added tax. Most countries use it, more than 150 of them. Of the G-20 countries, only the United States and Saudi Arabia don’t use it, and Saudi Arabia hardly needs tax revenue. It’s been around for more than 50 years, and we know it’s a proven revenue raiser. It could raise $50 billion per percentage point, which means a European-style VAT at a rate of 20 percent could raise about $1 trillion a year. We know some of the problems with it, too. So some think it should be considered as an add-on tax as part of a grand compromise to address the long-term fiscal imbalance.

So why is there so much opposition?
Slemrod: In the current political climate, it’s political suicide to favor increasing taxes. To favor a whole new tax probably carries even more political baggage with it. I don’t think a politician is going to come out for it except as part of a grand compromise where government spending is cut, entitlements are cut, and there’s some tax increase. One way a VAT may appear on the political radar screen is if the commission Obama has created to look into the long-term deficit problem recommends a VAT as one part of a compromise solution.

What kind of an impact would a VAT have on businesses, and what are their responsibilities in such a system?
Slemrod: In terms of who pays the dollars to the IRS, all businesses, in principle have to remit. In that way it’s different from a retail sales tax, which is just remitted by retailers on final sales to consumers, and different from an individual income tax where you personally file. As for its effects on businesses, the pure form of the value-added tax is much less distorting on business decisions than, say, a corporate income tax, and shouldn’t change what investments are profitable: If an investment is profitable without the value-added tax, it should be profitable with it. In contrast, with an income tax there may be some marginal investments a business wouldn’t want to make with one that it would make absent the tax. A value-added tax doesn’t have that feature.

What kind of effect would it have on consumers and retail sales?
Slemrod: Just to give a concrete example, think of a 10-percent value-added tax. It would mean a 10-percent increase in all prices for goods and services. The impact on prices, and therefore on consumer purchases, wouldn’t be much different than a 10-percent retail sales tax.

So the economic effects are the same, but the only difference is between who remits it, all businesses or retailers?
Slemrod: At first blush, that’s true. But the difference in who remits the tax is a key difference. And it’s why 150-plus countries have value-added taxes, and none have retail sales taxes over 10 percent. VAT has a key administrative advantage over a retail sales tax, one that might seem counterintuitive at first, because under a value-added tax all businesses have to remit, not just retailers. That makes it sound like a VAT would be more expensive and more complicated. But the Achilles’ heel of the retail sales tax is that it’s a tax on final sales from businesses to consumers only. It’s not supposed to be on B-to-B sales. To implement that, a retailer has to distinguish whether the buyer is a business or a consumer. In Michigan, business purchasers make use of an exemption certificate, real or electronic, to exempt them from tax, and there’s a lot of potential for abuse. If there’s abuse now at average rates of about six percent, imagine what it would be at 10 percent or 20 percent. Lots of people would be tempted to turn into a business for tax purposes. Experience suggests that the implementation issues favor a value-added tax over a retail sales tax. But other than that, the economic consequences are very similar to a retail sales tax.

What kind of an effect would that have on economy that’s still in recovery?
Slemrod: Well, I probably wouldn’t want to enact a 10-percent value-added tax now, just because it might crimp aggregate demand during a fragile recovery. I don’t think anybody is contemplating enacting a VAT this year or next year. Indeed, I’m not optimistic we’re going to see it any time in the near future. But if we were to see it in the future, it would probably be implemented over a long period of time.

How is the value-added tax handled in other countries? Do they do it in place of an income tax or in addition to the income tax?
Slemrod: It depends. In Europe, where it originated 50 years or so ago, taxes comprise a significantly higher fraction of GDP than here (as do government programs such as free daycare). The tax take is more like 40 percent of GDP, compared to 30 percent here, and in Scandinavian countries it’s close to 50 percent. These countries have a substantial value-added tax and an income tax at rates comparable to what we have here. Canada and Japan have relatively low-rate value-added taxes.

Is it a regressive tax?
Slemrod: I think it is regressive, so that the burden of the tax, as a fraction of income, is somewhat higher for lower-income households. It’s probably not as regressive as critics say. But I think on balance it’s probably slightly regressive.

What would that mean in terms of political support?
Slemrod: The regressivity of a VAT is less of an issue for most conservatives, but they don’t necessarily like it. They just dislike it less than a new, highly progressive tax. Whether Democrats can support it in view of the fact that it’s slightly regressive isn’t clear. Some favored having a value-added tax to pay for healthcare reform, which makes some sense because the benefits of the healthcare bill are skewed toward lower-income people, and so the tax would roughly offset the benefits. But it’s too late for that now — we have the healthcare bill and other ways to finance it. So to get Democratic support for a value-added tax, you might have to offset its regressivity with increased low-income support, like an earned-income tax credit. Of course, that means you’d collect less revenue.

Why is a value-added tax being discussed as an alternative to increasing the income tax?
Slemrod: We could raise more revenue with the income tax; the question is whether we want to. What we probably couldn’t do is what we’ve done this past year: raise more money almost exclusively from high-income people. There’s just not enough money out there for that. Right now about 40 percent of federal income tax revenue comes from the top one percent of income earners. So there’s a limit there. A grand compromise that cut entitlement spending and raised taxes would probably have to raise taxes from a broad swath of the population.

What would be more effective for addressing the fiscal imbalance?
Slemrod: The problem with the income tax we have is that it’s pretty creaky with all the exemptions, preferences, and credits. It’s distortive of economic activity. To increase the rates even higher just makes all of those distortions worse. Ideally one would fix the income tax and raise much of the money in a grand compromise from an improved income tax. If that’s not possible, and if one had to choose between the current income tax and a value-added tax, I would be inclined to choose the value-added tax. One worrisome aspect of the current tax structure is that a lot of government programs are delivered through the tax system. And a lot of them would never pass if they were presented as stand-alone programs. That makes the tax system way more complicated than need be. I’d prefer a tax system that is a lot simpler than the one we’ve got now.

Diane Lim Rogers, “Why the U.S. should enact a VAT: A value-added tax, or VAT, would be beneficial to the US,” The Christian Science Monitor, 05/10/10

“The intergenerational distribution of the burden of a VAT would work to offset the distributional effects of the federal entitlement programs that disproportionately benefit the elderly. Because a value-added tax is a consumption-based tax, it is economically equivalent to taxing the sum of current labor income plus one’s existing stock of wealth or savings (that’s what can be used to purchase goods and services). Economists like the tax on existing wealth for efficiency reasons, because it amounts to a “lump-sum” tax that doesn’t distort economic behavior……A tax on wealth tends to burden the rich more than the poor, which might seem fair, but it also tends to burden the old more than the young, which might not seem fair–in isolation at least. Tax policy experts have traditionally grappled with this intergenerational burden of consumption taxes in the context of replacing the income tax with a consumption tax–in which case it does seem unfair for a person entering or in retirement, who paid income taxes on his/her labor income over an entire career with the expectation that their income tax burden would go down in retirement (as his/her income would go way down), to suddenly be taxed on his/her consumption (which may remain just as high or higher in retirement compared with in working years).

Tax economists have called this a “transition cost” of switching to a consumption tax, and have often concluded that “transition relief” would have to shield the elderly from this tax on existing wealth, which unfortunately would chop the tax base way down and get rid of its most efficient component. But in the case of an add-on VAT, this fairness concern seems less concerning, especially given what the VAT would fund (health benefits that disproportionately benefit the elderly) and why that additional revenue is needed (because existing entitlement programs which disproportionately benefit the elderly are on an unsustainable path)…

…(E)xperts seemed to conclude this was an advantage, not a disadvantage, of the VAT (add-on or not)–that it would help alleviate the current intergenerational skewness in the net benefits of federal government programs, as well as which generations (younger ones) bear the burden of the debt.
But the number one reason why to like a VAT is still because there aren’t really any better ideas about how to raise more revenue, and not raising more revenue is not an option.”

Warren Buffett, “Buffett: Value Added Tax a Good Thing,” by Darryl Isherwood (interview by Liz Claman), FoxBusiness.com, 05/03/10

“Berkshire Hathaway Chief Executive Warren Buffett, Vice Chairman Charlie Munger and board member and Microsoft Chairman Bill Gates said that for the U.S. to continue to compete on the world stage, revenue must increase - and the VAT is the best option to ensure that.

‘In the end we are not taxing enough, unfortunately, or we’re spending too much, probably some of each,’ Buffett told FOX Business’ Liz Claman. ‘We’ve got a gap of 10 percentage points between what we’re raising in taxes and what we’re spending. One way or another we are going to have to close that gap in a major way, so if some of those taxes fall on me, or some fall on Berkshire, that’s probably the way it should be.”

The VAT is an efficient system, Munger said, causing as many fears about how the additional revenue will be spent as it does about the additional tax burden.  ’The people that are against it are against it because they think it will work too well, that the politicians will get too much money and do too many dumb things with it, and there is a good deal to be said for that point of view,’ he said.”

Gregory Mankiw, “Much to Love, and Hate in a VAT,” The New York Times Business Section, 05/02/10

“So why, if these two tax systems are really the same, are conservatives attracted to the flat tax and repelled by the VAT? It is because the flat tax is usually proposed as a substitute for our current tax system, whereas the VAT is often suggested as an addition to it.  The bottom line, from both political perspectives, is that a VAT is neither blessed nor evil.  It is a tool.  We can use it to advance a larger government, a more efficient tax system or some combination of the two.  That will be the key issue in the coming debate.”

David Ignatius, “The VAT may resolved debt crisis, but for politicians it’s too soon to be right,” The Washington Post, 04/29/10

“The herd gallops toward the precipice for a simple reason: It’s lonely and unpopular to go the other way.  Take the question of tax policies that could avert the next big U.S. financial disaster, which is our ballooning federal deficit.   The sensible real-world answer, many economists argue, is a value-added tax that would encourage saving at the same time it pays down the deficit to manageable levels.   But politicians are terrified of being right too soon on this one.  The Senate this month voted 85 to 13 for a resolution that called the VAT “a massive tax increase that will cripple families on fixed income” — and vaporized its political prospects.  By ruling out a VAT when it could keep the federal deficit in check, politicians have all but guaranteed that the debt crisis, when it comes, will be more damaging. But by then, everyone will be clamoring for a VAT, so it will be safe to endorse it.”

Gerald F. Seib, “Hi. My Name is America and I’m a Deficit Addict,” Capital Journal, WSJ.com, 04/27/10

“The tax system has to be changed.  The U.S. doesn’t have a system that can fund the government the country wants.  The Tax Foundation says the levies paid by the top 1% of taxpayers now exceed those paid by all of those in the bottom 95%. And the Tax Policy Institute says almost half of all filers will pay no 2009 income taxes at all, because of various exclusions and credits—up, by some estimates, from a quarter in 1990.  This may be great for those who like soak-the-rich rhetoric, but it’s no way to finance a country.  More than that, it’s a bit of a hoax on middle- and lower-middle-class Americans.  They certainly pay payroll taxes, and the more they are excused from the income tax-system, the more likely it is that they will be hit with sneakier and less-progressive taxes.  Tax reform—a flatter tax system, a value-added tax, something—is needed.”

Derek Thompson, “Value-Added Tax: What You Need to Know,” TheAtlantic.com, 04/27/10

“A VAT could reduce the deficit and its announcement would signal to foreign investors that we’re serious about deficit reduction, reducing our long-term interest rates and making it easier to borrow. What’s more, if a tax on consumption discourages some consumption, it might encourage Americans to save more, which might not be such a bad thing considering an avalanche of consumer debt added to the last recession.”

Clive Crook, “Make a VAT Part of the Solution: A Value-Added Tax, Though Imperfect, Would Do Less Economic Harm Than an Equivalent Rise in Income Taxes,” The National Journal Magazine, 04/24/10

“The right solution is to do a lot of things, not just one. First and foremost, as Samuelson advises, look for spending cuts. Raise the retirement age. Pare back wasteful subsidies. Follow through on the cost-control mechanisms that the health care law introduced too tentatively. Look hard for savings in defense.

Then, however, combine these savings with higher revenues, again from different sources. A simpler income tax would help. Capping the deduction for employer-provided health insurance would raise revenue and strengthen the incentive for cost control in health care at the same time. Bring in a moderate carbon tax. And introduce a VAT — which, though imperfect, would do less economic harm than an equivalent rise in income taxes. To combine what is necessary with what is politically feasible can best be done by using all of the above.”


Dustin Ensinger, “Washington Too Quick to Dismiss Value Added Tax,” Economy in Crisis, 04/21/10

“Without its own VAT, the U.S. is placed in a comparatively uncompetitive situation.    In 2006, foreign VAT nations collected rebates totaling $218.2 billion while the U.S. was forced to pay $122.4 billion in foreign taxes. Each year the foreign VAT imposes a $290 billion burden on exported U.S. goods and another $85 billion on services. This encourages outsourcing as American companies move offshore in order to circumvent the VAT and reap the same benefits as the companies producing in those nations.

In 2005, this foreign tax was applied to 94 percent of U.S. imports and exports. In EU countries alone in 2001, the average foreign VAT rate applied was 19.4 percent, coupled with an average tariff of 4.4 percent, this levies a total tax of 23.8 percent on American goods and services.  Despite the obvious flaws of not having a national consumption tax, those making laws on Capitol Hill, with very few exceptions, do not have the political fortitude to pass such a tax.”