Bartlett, Bruce, “Tax Reform That Works; Building a Solid Fiscal Foundation with a VAT,” New America Foundation, 11/30/12

In advocating a Value Added Tax, this concise paper by Bruce Bartlett takes on the myths about VAT and the mistaken political resistance to it.  It is highly recommended in the context of the realities of the “fiscal cliff.”  The link to the article is repeated at the bottom of this entry.

“…In my opinion, the greatest potential to break the tax reform gridlock is to get away from the model of cutting popular tax preferences in order to pay for rate reductions. That is the political equivalent of World War I-style trench warfare. I think it makes more sense to adopt a different approach, one more akin to Douglas MacArthur’s strategy of leapfrogging Japanese strongholds in the Pacific during World War II, leaving them impotent.

The tax equivalent of MacArthur’s strategy would be to leave in place all the existing deductions and credits, but make them irrelevant for most people. Prof. Michael Graetz of Columbia University has devised exactly such a plan.  He would institute an exemption of $100,000 for married couples ($50,000 for singles, $75,000 for heads of households).  All the existing deductions and credits would remain in place and could still be used by those with incomes above $100,000, but for the vast bulk of taxpayers they would become irrelevant because they would have no taxable income against which to take them. About 100 million of the 140 million people now required to file federal income tax returns would no longer have to do so.

Graetz would replace the lost revenue with a value-added tax (more below) combined with a rebate mechanism to relieve the regressivity on those with low incomes and also replace refundable tax credits for the poor. A recent analysis of the Graetz plan by the Tax Policy Center concluded that it could be done in a deficit-neutral manner with a VAT rate of 12.4 percent – well below the rates that prevail in Europe…”

“…For many years, official Republican Party platforms have opposed a VAT for the United States. The 1992 platform said such a tax in Europe “has resulted in higher prices, fewer jobs and higher levels of government spending.”  The 2008 platform said, ‘In any fundamental restructuring of federal taxation, to guard against the possibility of hypertaxation of the American people, any value added tax or national sales tax must be tied to simultaneous repeal of the Sixteenth Amendment, which established the federal income tax.’  The 2012 platform repeats the same language.

Fear that a VAT might come on top of the income tax and hence constitute some sort of double taxation is only one of many conservative objections to a VAT.  (No country imposing a VAT has ever abolished its corporate or individual income taxes, although excise and other taxes were often replaced.)

The irony is that the VAT is probably the best tax ever conceived from a conservative point of view. As a broad-based tax on consumption, it creates less economic distortion per dollar of revenue than any other tax – certainly much less than the income tax…”

“…A VAT would address a common conservative concern about the growing percentage of the population that pays no federal income taxes. In 2011, 46 percent of all returns had no federal income tax liability according to the Tax Policy Center.  It’s unrealistic to think that income taxes will be imposed on such people once they have become exempt. A VAT would be a way of getting all Americans to pay for the federal government’s general operations…”

“…Perhaps the strongest evidence that the VAT was considered the conservative tax reform is that it is the foundation of the flat tax, which is still supported by practically every conservative tax reformer. The flat tax, originally devised by Hoover Institution scholars Robert Hall and Alvin Rabushka, is a subtraction-method VAT with one twist; businesses are permitted to deduct cash wages paid from the base on which they calculate the VAT. Workers pay the same rate on their wages less only a personal exemption. The purpose of this adjustment is to create transparency so that everyone sees the tax they are paying, and to redress its regressivity.

This is not the only case of conservatives supporting a VAT when it suited them to do so. When former California Gov. Jerry Brown, a Democrat, proposed a VAT plus a flat rate income tax in 1992, this was widely hailed by supply-side economists such as Arthur Laffer and Gary Robbins. Similarly, conservatives have recently embraced a proposal that would have replaced California’s state income tax with a VAT.

In Congress, Rep. Paul Ryan, Republican of Wisconsin, chairman of the House Budget Committee and the Republican Party’s nominee for vice president in 2012, received high praise from conservatives for his “Fiscal Roadmap” plan that would eliminate the national debt by slashing spending. But its first version would also have replaced the corporate income tax with what he called a Business Consumption Tax that is, again, a type of VAT. Sen. Jim DeMint, Republican of South Carolina, generally considered to be the most conservative member of the Senate, cosponsored this legislation.

Nevertheless, whenever a VAT for the U.S. is suggested, conservatives are the first to denounce the idea. It is an article of faith among them that the VAT is a money-machine that must be fought to the death…”

Bartlett, Bruce, Statement Before the Committee on Ways and Means U.S. House of Representatives, July 26, 2011

…“There are, however, a number of problems with the FairTax that its supporters tend to dismiss or downplay. Here are a few.

The true rate is not really 23 percent. Thought of the way people think of state retail sales taxes, the rate is actually 30 percent. The 23 percent figure is derived this way. On a $1 purchase, the tax would be 30 cents for a total price of $1.30. Since the 30 cent tax is 23 percent of $1.30, FairTax supporters argue that the true tax rate is 23 percent. Nonsupporters are more inclined to think that this is just a trick to make the tax rate appear lower than it really is in order to increase support for the FairTax.

Another oddity is that the FairTax would apply to all government spending, including federal spending, as well as private spending. This will undoubtedly force state and local governments to raise their taxes. And it serves no logical purpose for the federal government to tax itself.

The FairTax would apply to new home sales as well as rent. And of course, mortgage interest and local property taxes would not be deductible because there would be nothing to deduct them from.” …

…”FairTax supporters argue that the prices of all goods and services will fall by about as much as the 23 percent tax that would be imposed because of the elimination of existing federal taxes. It is all a wash, they say. As prominent FairTax advocates talk show host Neal Boortz and former Rep. John Linder explain:

 Once the FairTax takes effect, you’ll be receiving 100 percent of every paycheck, with no withholding of federal income, Social Security taxes, or Medicare taxes – and you’ll be paying just about the same price for Tshirts and other consumer goods and services that you were paying before the FairTax.

 The principal documentation for this assertion appears to be a paper commissioned by Americans for Fair Taxation by Harvard economist Dale Jorgenson that is unavailable on its web site or anywhere else as far as I can tell. Although it is often implied by FairTax supporters that Prof. Jorgenson supports their proposal, this is not the case. He has his own tax reform plan that bears no resemblance to the FairTax.

Jorgenson has also been publicly critical of the FairTax. In 2007, he called it ‘reform by focus group.’  In 2008, Jorgenson said, ‘The main weakness of the FairTax is its comprehensiveness. It tries to roll everything into one tax, which simply can’t carry all that weight.’  He has also testified before this committee that a national retail sales tax would need a rate of 40 percent to equal all federal revenues.

And in a 2005 academic article, Jorgenson said, ‘The very high tax rate of the national retail sales tax provides powerful incentives for tax evasion and renders effective tax administration difficult.’”…

…”FairTax supporters have always glossed over the huge incentive for evasion once the existing machinery of tax compliance is abolished and all federal revenues are collected at exactly one point: retail sales. This is a key reason why the Reagan administration rejected the idea. In its 1984 tax reform report it said, ‘A federal retail sales tax, when combined with the retail sales taxes levied by most states, would provide irresistible inducement to tax evasion at the retail level.’”…