When House Speaker Nancy Pelosi told Charlie Rose last October that a value-added tax was “on the table” as a possible way to solve the nation’s fiscal woes, the remark didn’t generate much interest. But as recent budget figures have put the depth of America’s problem into black and white, and with former Federal Reserve Chairman and White House adviser Paul Volcker nearly seconding Pelosi’s view recently, the idea of a VAT — already in use in nearly 160 countries — is gaining traction. And some progressives are sounding an alarm.
[Economy1] The prospect of a VAT is likely to be discussed by the fiscal commission established by President Obama. The Wall Street Journal’s opinion page has already sarcastically labeled the consortium the “VAT Commission.” At a recent event organized by the Scholars Strategy Network, a left-leaning think tank, an MIT political scientist floated the prospect of VAT as a solution to the federal revenue crunch. Volcker just last week fueled the fire even more, noting that a VAT tax was not as toxic an idea as it once had been. (Sen. Charles Grassley, R-Iowa, responded this week by coming out against the tax.) All the attention has not been welcomed by progressive groups, who worry that a VAT would unfairly burden the already-struggling working poor. “It crushes the low-income and the elderly,” said Robert McIntyre, director of Citizens for Tax Justice.
Since VAT is a tax on consumption rather than income or investments, it’s considered a regressive tax. Poor people, who tend to spend a higher percentage of their income than wealthier ones, are disproportionately affected by consumption-based taxes. In the U.S., regressive sales taxes are balanced out by a progressive income tax structure.
Proponents of a VAT, though, contend that it wouldn’t hurt lower-income Americans if implemented properly, and that the additional revenue it generates would prevent cuts to social-service and welfare programs.
Left-leaning think tanks such as the Center for American Progress express concern that adding a VAT to the country’s existing tax code or using it to replace the majority of the income tax, as Michael Graetz, Columbia University School of Law professor and author of “100 Million Unnecessary Returns: A Simple Fair and Competitive Tax Plan for the United States,” proposed to the Senate Finance Committee in 2008, would tip the balance in favor of the rich and drop a staggering weight on an already-struggling demographic.
While value-added taxes are common throughout the rest of the world (including Europe, Canada and Australia), many Americans are still fuzzy about what exactly this tax is and how it works. A VAT is essentially a tax on all or nearly all goods and services. Many European countries exempt certain items such as groceries from VAT collection — a mistake, according to economists who counter that a laundry list of exemptions only serves to make the rate higher. What makes a VAT different from a sales tax is the way it’s collected.
The tax is levied on every company that participates in the development of a product, but each participant gets credit for the VAT that has already been paid. If a retailer in a country with a 10 percent VAT buys goods from a vendor, they pay an extra 10 percent on those goods. That retailer is then responsible for collecting 10 percent VAT on sales to customers. When each company in the supply chain pays taxes, though, they get to deduct the VAT they paid from what their customers paid. These somewhat complicated mechanics create a lengthy paper trail that thwarts would-be evaders. Since each company in a supply chain has to collect the tax, there’s also a certain degree of self-policing.
Although right-leaning lawmakers tend to favor regressive tax policies, some conservatives dislike the concept of a VAT because they worry it would inflate the size of the government. “Conservatives think VAT is a hidden tax and therefore a money machine,” said Gilbert Metcalf, professor of economics at Tufts University. In reality, analysts say that concern is overblown. The U.S. debt load has mushroomed so substantially that even adding a new revenue stream in the form of a VAT wouldn’t generate huge surpluses.
The cost of Social Security, Medicare and other entitlement programs is predicted to skyrocket in the coming decades. “The largest programs in the budget support older people,” said Eric Toder, a fellow at the Urban Institute and the Tax Policy Center.
For the nation’s working poor, that’s bad news, says Will Marshall, president of the Progressive Policy Institute. “What’s happening now is the automatic growth of entitlement spending is squeezing out space in the budget for everything else, which includes programs for low-income families.”
Toder and others dismiss the notion that ratcheting up existing taxes will be enough to fill the revenue gap. “You’re running against how high you can squeeze income tax. You don’t want to push it too much further. If you tax investment income too high, we’ll start seeing capital fleeing the U.S.”
If the administration and Congress do consider a value-added tax, some experts do hold out hope that it can be levied in such a way that doesn’t disproportionately impact the disadvantaged. While a VAT itself will never be progressive, there are ways to offset its burden on the poor. “There’s no reason low-income people should bear the burden of getting our nation’s finances in order,” said Columbia’s Michael Graetz. “There’s no inherent reason a VAT has to disproportionately burden low-income people,” he said.
Offering refundable tax credits for Americans living below a certain income threshold, for instance, would help equalize the burden. Graetz also proposed distributing debit cards similar to those on which food stamps are issued to lower-income consumers that would exempt a certain dollar amount of purchases from value-added taxation.
While many of the European VAT structures exclude necessities like food and clothing in the name of making the tax more progressive, many analysts say this just makes administration harder. Exempting certain categories of purchases also means that the rate on everything else is pushed higher. For instance, some European countries have VATs of up to 20 percent, a rate that can be attributed to numerous exemptions.
One of the most sweeping proposals is that put forth by Graetz, who suggests implementing a VAT of 10 to 14 percent and eliminating income taxes for households making less than $100,000 annually. Graetz, who also co-authored a book lambasting the 2001 repeal of the estate tax, maintains that his plan would simplify the tax process for 150 million Americans, and a combination of credits and offsets for lower-income people would keep them from bearing the brunt of the new tax.
While Graetz’s plan is revenue-neutral, he says it offers a better way to tackle the revenue crunch because a VAT is easier to increase than the current income tax. It would also relieve many current taxpayers of the annual burden of preparing and filing their returns. “Americans feel better about taxes that they feel they can pay without undue burden,” Andrea Louise Campbell, a political science professor at the Massachusetts Institute of Technology, wrote in a recent paper. “Easing payment not only helps public acceptance but also encourages compliance.” There’s also no way for the wealthy to avoid paying their share via tax shelters or accounting tricks, since the tax is collected at the point of purchase. This still isn’t convincing for some progressives. Yes, credits could offset the burden on America’s poor. But, they argue, those credits could be rescinded at the whim of a right-leaning Congress. “One concern has to be, will there be political pressure to eliminate those kinds of credits?” said Michael Linden, associate director of tax and budget policy at the Center for American Progress. “Having a VAT replace income tax entirely is a terrible idea,” he said. “If VAT becomes a solution it will have to be part of a larger tax system, ideally part of a larger tax reform effort.”
Graetz argues that draconian spending cuts in social and support programs would hurt low-income people more than an incremental tax increase. “You’ve got to look not just at the way revenues are collected but at the way those benefits are distributed,” he said. Credits or exemptions for the poorest Americans would protect them from paying a higher percentage of their income towards a VAT, and the revenues raised could keep social-service programs off the chopping block.