Here it comes: the VAT

The direction the fiscal winds are currently blowing is not good for the Obama Administration’s massive spending plans:

So what is the Obama Administration seriously considering in order to offset income tax shortfalls, in the face of a wobbly bond market? You guessed it — more taxes, specifically a national sales tax in the form of a “value added tax” or VAT.

Sales taxes have always been problematic for liberals because they are considered “regressive.” Poor people spend a higher percentage of their income on staples like food, clothing, and fuel, which translates into a bigger tax impact for the poor. The regressive nature of the VAT would have to be balanced by additional income tax levied on “big money” earners, perhaps starting with families that earn more than $100,000 a year. But VAT advocates believe that a VAT would raise enough revenue to completely eliminate the need for families who earn less than $100,000 a year to pay any sort of income tax. The Washington Post explains:

What would it cost? [Ezekiel Emanuel, brother of White House chief of staff Rahm] Emanuel argues in his book that a 10 percent VAT would pay for every American not entitled to Medicare or Medicaid to enroll in a health plan with no deductibles and minimal copayments. In his 2008 book, “100 Million Unnecessary Returns,” Yale law professor Michael J. Graetz estimates that a VAT of 10 to 14 percent would raise enough money to exempt families earning less than $100,000 — about 90 percent of households — from the income tax and would lower rates for everyone else.

And in a paper published last month in the Virginia Tax Review, [Leonard Burman, co-director of the Tax Policy Center] suggests that a 25 percent VAT could do it all: Pay for health-care reform, balance the federal budget and exempt millions of families from the income tax while slashing the top rate to 25 percent. A gallon of milk would jump from $3.69 to $4.61, and a $5,000 bathroom renovation would suddenly cost $6,250, but the nation’s debt would stabilize and everybody could see a doctor.

So that’s the sales pitch — if you are “poor” or “middle class”, you’ll pay the VAT instead of income tax, and (presumably) you’ll be free from Federal withholdings so you’ll get more take-home pay, or if you live at or below the poverty level, your VAT payments made on staples like food and clothing will be refunded. Even though you’ll (presumably) lose a lot of specific tax credits and deductions, in the end you will pay less tax and get more free stuff from the government. If you are “rich,” your income tax will be substantially less, the VAT will be manageable, and you’ll get more free stuff from the government. How state and local income and sales taxes would be affected by this plan still remains to be seen.

The biggest disadvantage of value added taxes is the way they are calculated. VAT for a particular item are based on the “value added” (an amount generally equivalent to the profit margin) to each individual component of that item, as each component is manufactured, distributed, and then finally assembled into the resulting item. Tracking the value basis for consumer goods is a complicated process, and depends a great deal on voluntary compliance from manufacturers and distributors. Businesses are allowed to recover some of the VAT portion of raw goods costs, but this also requires a lot of expensive inventory and cost tracking. The other problem with VAT is that the consumer has no way of knowing exactly how much of an item’s price is tax, since “value added” is a complex calculation based on the particular supply and distribution chain for any given item.

The politics involved in passing a national VAT could be very interesting. People in general usually balk at more taxes, but if the “you’ll pay less taxes overall” sales pitch proves to be a big enough carrot on the end of the government’s big stick, then public support may reach a high enough level to give lawmakers the confidence to vote “yes.” Also, national sales tax plans have periodically enjoyed bipartisan support, most notably Republican Mike Huckabee’s recent proposal to abolish income taxes and replace them with a 23% national sales tax. Still, the opportunity for government to continually tack additional taxes on top of a VAT, combined with the fact that consumers will never really know how much tax they are actually paying, should make us think long and hard before we embrace a new national sales tax.

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