Is a VAT the Answer? — The Commission, Part III
All over the developed world, countries are facing an extremely unpleasant budgetary reality: Per capita health care spending is growing at twice the rate of growth of per capita income.
Couple the fact that government promises of health care for the elderly are almost everywhere unfunded with the fact that pension promises are mostly unfunded and that aging populations mean an ever-increasing number of retirees per worker, and just about every first world country is projecting a fiscal nightmare.
So what’s the answer? The Obama administration has made it about as clear as it is going to get that after the fall election its solution to trillion dollar deficits is going to be a value-added tax (VAT). But is that a good idea?
Are you reelin’ in the years, stowin’ away the timeExpected Tax Rates. In a previous Alert, I presented estimates from Larry Kotlikoff and his colleagues of what the tax rates will have to be if we stay on the present course and try to fund excess government spending with a VAT, a payroll tax or some other form of a consumption tax. As the graphs below show:
- In the United States, the average tax on wage income will rise from 40.6% today (that’s a 15.3% payroll tax plus a 15% income tax plus state and local taxes) to 55% by 2030 and 62.1% by midcentury.
- If Europe follows the same path, the average tax on wage income will rise from 60.1% today to 72.5% in 2030 and 79.3% by 2050.
And note that these are average tax rates. Marginal rates will have to be even higher.
Theory vs. Reality. But given that revenue has to be raised some way, isn’t a VAT the best way to do it? Economists tend to like the VAT because it ultimately taxes consumption rather than production and by collecting the tax at every stage of production, it’s harder to evade than a sales tax, which puts the full burden on the final transaction. But, as it turns out, no country really has a pure VAT. All kinds of goods and services are exempted or taxed at lower rates. Randall Holcombe reports that Belgium, with a standard rate of 21%, also has rates of 12%, 6%, and 0%. France, with a standard rate of 19.6%, has 5.5% and 2% rates. Overall, if the United States followed the European model, in order to collect 5% of value added we would need a tax rate of almost 10%.
The Static Cost of a VAT. It turns out that a VAT also has high compliance and administrative costs, and these costs are largely independent of the rate. Holcombe has calculated that the cost to society (welfare loss) from a VAT rate of 2% is 56 cents for every dollar raised. For a 7% VAT rate, the cost is 33 cents for each dollar raised. This implies that it makes no sense to have a small VAT rate, but even a large one has heavy costs.
The Dynamic Cost of a VAT. Every tax discourages economic activity and the VAT is no exception. Based on a review of the literature, Holcombe calculates that a 10% VAT lowers the rate of economic growth by 10%. Based on this relationship, he finds that:
- After a 20-year period (by 2030), the loss of annual GDP for the United States from a VAT would be more than twice as much as the revenue collected.
- Moreover, at a lower than otherwise GDP, all revenue from all taxes would be lower, including state and local taxes.
- Considering all these effects, the net revenue to the government from a 3% VAT would be about 1/10th the loss of output for the economy as a whole in 2030.
- A 7% VAT, designed to bring in $915 billion in 2030, would in fact net less than one-third of that amount.
Holcombe concludes that higher taxes don’t really bring in that much additional revenue. Instead of growing the government, they shrink the private sector. As the following table shows:
- The French government doesn’t really spend much more per person than government in the United States does. But because of its higher tax burden, France’s per capita income is about $13,000 lower.
- Government spending per person in Sweden is only 12.6% higher than in the United States. But Sweden’s income is almost $10,000 lower.
Here are some dire warnings from President Obama’s debt commission:
http://www.washingtonpost.com/wp-dyn/content/article/2010/07/11/AR2010071101956_pf.html
Of course you aren’t going to get any details until after the election.
The answer to your question is: No. Never. Not on your life. Over my dead body.
I like Steey Dan. But they looked over the hill way back when they were singing this song.
This is going to become a very serious issue. In addition to Medicare and Medicaid unfunded liabilities, Congress just created health entitlements for the the rest of the country and those aren’t really paid for either.
Tax and spend. Tax and spend. It feels like we have resurrected Franklin Roosevelt. We’re going back in time and pretending that what we are doing is “progressive.”
So…. does anyone know a travel agent that specializes in tax- and freedom-friendly countries? I hear Jim Rogers lives in Singapore now. Maybe he needs an assistant?
VAT must replace the federal income tax in order to work properly. We first need to determine the “best” percent of Govt. Expenditure to GDP and then find the optimal VAT sans income taxes that will finance that level of Govt. expenditures.
But can you trust government at all any more. The legislative bills are obtuse, and who knows what the bureaus and commissions will do.
Progressive taxation is the same as Socialism or communism. Take the middle class assets away as soon as possible and make the remaining citizens,[ let’s call them peasants]as beholden to government as possible.
Government will rule. Controlled access to hospitals by government is a dangerous issue.
I’ve long thought that the only national consumption tax that would be feasible in the U.S. is the “income net of savings” approach. Of course income minus savings equals consumption.
Essentially all this requires is eliminating the penalties from traditional IRA and 401-K accounts, and eliminating or adjusting the annual contribution limits. You’d probably have to increase tax rates slightly to compensate for a one-time loss of revenue as people charge up their pre-tax savings.
Although it seems to me that the ideal consumption tax would target resource consumption and exempt labor costs as much as possible. But a large part of the price of any natural resource is the cost of labor to extract it (or to build the extraction equipment, or to earn the capital necessary to purchase the equipment), so I don’t know how you separate the two. And then you have to figure out how to tax imports and make sure exports aren’t double-taxed…
It is amazing to me that no one puts these discussions/needs relative to entitlement programs, deficits etc in the context of priorities for our counrty and what we can afford to do. Regardless of the reasons (most are not realistic or the truth)for fighting two wars, providing Healthcare to non citizens we can’t afford it regardless of the tax strategy one wishes to implement. The situation would be much less dire if we got our act together and quit spending trillions on initiatives that collectively will destroy our country. Don’t hold your breath.
Proponents of government programs prefer the VAT because it “efficiently” extracts funds from the economy without distorting markets like other types of taxes. The problem is: being too efficient and (seemingly) painless only adds to the incentive to spend. No amount of tax money will ever be too much for these people. Better to allow people to make their own way in life rather than trying to convince the populous that everyone can have free housing, free daycare, free health care, government pensions, etc. The economy slows down under the load of taxes. Cradle-to-grave safety net might give people the feeling of protection. But it also reduces consumption since people have little control over or preference to what they consume (people who have no children don’t benefit from free daycare).
The only way I’d ever agree to a VAT is if it replaced the federal income tax. Unfortunately, the Obama regime plans on adding a VAT on top of the federal income tax. In the meantime, the regime never mentions cutting spending or jettisoning useless federal programs that cost the taxpayers billions of dollars. In any event, the regime’s discussion of a VAT reminds me of Mark Twain’s famous quote: Sometimes I wonder whether the world is being run by smart people who are putting us on, or by imbeciles who really mean it.
Yes Virginia, Jim Rogers lives in Singapore. You should know, however, that Singapore has universal health care that includes mandatory savings, government price controls and government subsidies.
artk, I did not know that. I’ll have to revise my travel plans.
Ezra Klein asks what could a VAT tax substitute for? Answer: Not much. He writes:
Eric Toder and Joseph Rosenberg at the Tax Policy Center estimate (pdf) that a 5 percent value-added tax (VAT) would bring in $258.6 billion a year in tax revenue if applied to a broad base of goods and $160.9 billion if applied to a narrower base (excluding housing and food costs, for example) or applied to a broad base with a rebate to pay for necessities… a far cry from the more than $1.7 trillion (pdf) that personal income, Social Security and Medicare taxes brought in during fiscal year 2009.
See full article here: http://voices.washingtonpost.com/ezra-klein/
Artk, you left out Singapore’s medisave accounts. They were the first country to have medical savings accounts (est. in 1984); and they are mandatory. There are several NCPA studies on the Singapore system, which most people see as an alternative to a European-style welfare state.
artk: Don’t they also have caning?
Take a quick peek at the Roth IRAs. You pay your tax and then remove that money tax free at a later date … except if you plan to buy anything with it. Of course that’s pretty much what will happen when you get your salary. Pay tax when you get it – pay tax when you spend it or, if you’re really a dope, you save it, invest it and then pay tax even if you don’t spend it. Lots of fiscal magical thinking in Congress. Reminds me of that movie “Spend it and they will come” or something like that. What are they thinking? I vote for imbeciles.
Bart, they spend 3% of GDP on health care, have longer lifespans and better infant mortality rates then the US, and has the best street food in the known universe. I’m ok with the caning if I’m on the inflicting end.
This is all wrong. If there is a vat tax on everything I buy, I just won’t buy. I really don’t care what happens in austria or singapore, I’m struggling here not there. Everyone has ideas when its so simple, leave us alone, we had what we needed, if the Medicare was so overdrawn then instead of baling out Obama Buddies in the Banks he shoud have baled out medicare. We would all have been willing to pay more towards it as well, it would have been cheaper than what he is going to force us to buy. They take half of our social security money and put it in a general fund, which is supposedly the Fed Reserve, where it goes after that is anyones guess, I’d say the IMF. So how can they call that an entitlement, we’ve paid into that for 40 and 50 years and now its an entitlement? for who , them? certainly not us, they make it sound like welfare and its far from it. A Mexican can come here and work for 3 years and go back to Mexico and collect SS, not as much as American workers but enough for them to live in comfort in Mexico. What is this but another smack in the face for Americans? No one knows what’s going to happen to us or how to head it off, except to change Presidents or get rid of the CFR. either way we’re a winner. End of story .
I want shock therapy. Minus 4% of GDP in government spending- take everything back to 2006 expenditures except Social Security, Medicare and Debt Service. Give states all the waivers they need to make due with that amount. 25% top personal and corporate rates. Watch the boom.
Yes, but another revenue stream means more for the kleptocrats to steal! Vat’s All, Folks.
Dan, why exempt Social Security and Medicare?
Any consumption tax could only be even considered if in conjunction with repeal of the 16th Amendment. But of all considerations, and unfortunately the one most likely to be pushed, the VAT is totally unacceptable. If I am successful in my bid to become a member (TX CD 27) I will fight against the VAT to my dying breath.
Here is Bruce Barlett’s summary of what just about everybody has had to say about the VAT tax in the past few days:
http://www.thefiscaltimes.com/Blogs/2010/07/13/Focus-on-Value-Added-Tax.aspx
I feel somewhat like Vince Lombardi saying “Gentlemen, this is a football”. Let me explain.
To the basics – – –
What are “jobs” and who can or cannot create them? What are the types of jobs our society should strive for? What is the required environment to best support their development? What are the dangers of ignoring the proper emphasis of jobs? What are solutions? To wit:
1) All existing or potential jobs can be categorized into just two groups – – – those which add wealth (i.e., new money) to the societal, business, or personal entity we are examining and those which do not. On the scale of importance, nothing else impacts as much as this division. The ratio of the two categories (i.e., new-money-producing jobs to overhead jobs) plotted over time defines a waveform. This curve must remain in positive territory. All other traits are merely minor perturbations on that waveform. In so far as the national economy is concerned, maneuvering statistics, manipulating the interest rates, printing more money, creating “pseudo-jobs” funded by government, and a whole host of other combinations of epicyclical solutions will, in the long run, do little to assure its health. Over time this two-group division of jobs influences the economy to a far greater degree than any or all of these approaches; it will now and for all future generations. Disregard it, fail to emphasize the creation of new-money-producing (NMP) jobs, continue to rage over issues lower on the priority scale, and Americans, somewhere down the line, will face an onerous cost.
2) If the sector of jobs producing new money is so important, what does it encompass? It certainly includes most of manufacturing, large amounts of resource conversion, and some of the service sector; to a fractional extent; new money creation arises from other manufacturing and service sector jobs. Still other service sector occupations add minute amounts or do not generate new money at all. Granted, there are shades of gray as to how much new money a manufacturing, resource conversion, or service sector job creates. How much would be arguable ad infinitum but is not really important. For in the main, it is the increasingly overwhelming service sector that does not create new money but rather redistributes what has been generated elsewhere. Examples of the service sector include educators and infrastructure builders. Their contribution does, in some fractional way, contribute to the generation of new money. Other examples of the service sector include fast food workers, attorneys, much of the government sector, and most of the entertainment business, including sports. These latter examples contribute little to national new money creation. While it is undeniable that some of the government sector such as police and fire departments along with the military are necessary, they nonetheless do not add new money. In the end, regardless of what government, business, or personal sector we examine the key to any evaluation of jobs is that whatever the portion is that does not add new money is overhead. Only the NMP sector can provide funding for this overhead.
3) Any economic entity is impacted positively if activity within it produces a net inflow of new money to the entity. Of course the reverse to this is also largely true. Further, what may be beneficial for any financial entity may or may not apply at levels larger or smaller. For example, in Washington State, production of airplanes by Boeing or software by Microsoft brings in new money across several entities; it adds new money to the coffers of the respective city or town, to the county, to the state, and to the nation. Thus for these manufacturers, NMP jobs are a vital by-product. Looking at infrastructure builders, their effect is positive but only to the extent that what they construct brings in a net revenue increase for their funding entity (i.e., town, city, state, or nation). For educators, their impact is felt at primarily the national level to the extent that their students are trained to ultimately contribute to new money creation. In India the education of students is being geared very successfully toward recognizing and taking advantage of the world economy. In contrast, on the opposite side (i.e., sectors producing no new money), a national fast food chain with no overseas sales merely redistributes existing wealth within the nation although it may yield some fractional benefit to local entities. This analogy works equally well for all entities whether we are considering governmental departments, the legal system with all its judges, attorneys and attendant personnel, the medical sector with its doctors and dentists, professional athletes, the entertainment industry, etc., etc. The latter examples prosper only to the extent that the NMP sector provides enough gain for them to redistribute. For any entity, expenditures over time must overwhelmingly be in support of producing new money by that entity. This applies equally for all entities from the nation on down to the individual family. The creation and expansion of sectors that do not add new money continually add overhead costs to the sectors that do. Uncorrected and left to blossom indefinitely, this ultimately can only lead to financial misery.
4) If new money creation so necessary, why is it super-important now? To answer this, we need only review what has taken place in our most important entity, our nation. A look back shows that for much of our existence, we’ve been blessed with significant natural resources, among them coal, oil, natural gas, minerals, forests, fisheries, and abundant agricultural land resources. We also blazed through eras where we excelled over the rest of the world in manufacturing. Together, from our nation’s infancy, these two fueled the economic engine that very successfully drove our economy, also managed to help win a major war or two along the way, and made us into one of the most powerful nations on earth. But, over time, we’ve managed to deplete our natural resources and thereby what constituted massive financial reserves. Again, reviewing the past fifty years shows that we’ve managed to kill off much of our giant manufacturing capability and are continuing to do so at an accelerated pace. In the arena of NMP, only agriculture and a limited number of manufacturers truly prosper in our country today. To further negatively impact our financial future, along the way we launched into the two-fold path of redistribution of existing wealth with no consideration of contribution of the recipients or how that would grow, and borrowing against our future. These have now reached epidemic proportions. Originally, these were meant to be short-term solutions to short-term problems. But like an unchecked cancer, these have grown to where the life of the economy is being threatened. In fact, what are needed are long-term solutions to long range problems. But what are they and where are they? About the only answer to that has been, that through the use of our mental resources, we’ve developed services, some of which are marketable outside of our national economic envelope and thereby bring in new money.
This leads us back to the basic question again – why are resources and manufacturing so important? Simply answered! The resources provided a “start-up bank account” from which to draw. The manufacturing used these resources. It’s constituted an easy existence, made even easier because we recklessly pillaged the ground, water and sky in achieving the highest level of economic success per individual seen in history. Sort of like an inheritance, easy come, easy go. But now the “worm has turned” and we must live by our wits (i.e., our mental resources). To do so we must first of all, learn to prolong our remaining resources by minimizing consumption. To date efforts in this respect, have been laughable. Next, through the use of our mental resources we must plan to maximize the creation of new money per individual on average (perhaps a new and this time meaningful statistic to track) to supplant those resources we no longer have. This means directing ourselves toward marketing goods and services outside our national envelope. Disregarding the importance of this is leading to an endless progression of negative balance-of-trade figures. It’s building huge national deficits. Tracking the GNP and gloating over the fact that it is increasing without recognition of the NMP elements in it is rather like celebrating the “emperor’s new suit of clothes”. True, some people are amassing huge sums of personal wealth in the meantime. This creates and feeds an illusion that all is well and that all any of us have to do is “get in on the action” but – – – at some point our children’s children will have to pick up the tab.
So what does all this have to do with job creation? As any solvent company recognizes, overhead must be kept to a bare minimum in order to survive in a competitive environment. The remaining expenditures must be devoted to producing the goods or services that the company has to offer to provide new money for that company. Companies that could not follow that precept are no longer in business. Nations, states, cities, towns, and even individuals or families also must abide by this concept. If not, they ultimately face dire consequences because too much overhead will do you in! And government is overhead! Witness California and many small towns who have insurmountable problems. Also witness the growing number of individual bankruptcies. To their credit, some of these small towns and cities have begun to recognize the importance of attracting industry to bring in new money to their economic entity. Raising taxes did not and doesn’t solve the problem and it seems lowering them does not do so either – – – no surprise here. And by the way, Tax Independence Day advances even though taxes have been “reduced” in recent years.
If any entity must experience an inflow of wealth, any “jobs” created by the government must of necessity provide or assist in a net positive financial inflow to the governmental entity being evaluated. This works at every level. If they do not satisfy this ground rule, they are overhead at best. At worst they are merely a “redistribution of wealth ponzi scheme” and a financial burden on that entity, even if that entity is the nation. Unfortunately most governmental actions do not target new money creation as a goal. Instead the populace is made to endure endless tax increases always under the guise of providing an idyllic society, balancing the budget, providing full employment, solving social problems, or other seemingly noble intents. Cheap money is provided in order to “stimulate the economy”. Monetary increases are geared to the GNP and not to the production of new money. Of course, over time these approaches never balance the budget, do not solve the financial problems of the national economy, and certainly are not providing full employment, particularly when measured in terms of meaningful employment. Without resources, an inward-focused economic entity that does not seek to maintain a positive inflow of new money will not prosper in the long term. Witness the Russians and others who have tried to socialize without capitalizing. Worse yet, witness the Germans before WWII. They and others lost the battle. And make no mistake about it, along with our other conflicts, we are also in a “silent war of international economic survival”.
But what are possible solutions? They’re likely fairly drastic! For instance, I believe it is up to the leadership to steer the economy toward a condition wherein new money creation is recognized as the bottom line. This means training and promoting the sorts of employment that accomplishes this and does not merely redistribute wealth in a way that despite the best intentions ultimately promotes the creation of two distinct social classes, the haves and the have-nots. It means directing ourselves toward the kind of research that will restore this nation’s manufacturing sector and will also better utilize our remaining natural resources. It means developing and using our mental resources to support this mission. It may mean enacting a “non-value added” tax to promote the development of NMP jobs. Yes, I said non-value added as opposed to the conventionally mentioned value-added tax. It quite possibly means establishing a valid “priority control process”. Any of us that have been employed by major corporations have gone through the tedium of suggestion systems, followed by cost improvement, cost control, quality control and finally, process control. But all of these are really subservient to priority control which yet has not “hit the streets”. Worse of all, we are sadly lacking any priority concept at any governmental level. Instead, it’s a case of “we will provide for all of the people all of the time”. I have a good idea of how Lincoln might have used this in some famous phrasing of his.
Interesting Al, to say the least. And it makes sense IMO with the exception of your suggestion that we “prolong our resources by minimizing our consumption”. I don’t agree with that conclusion, and I can’t really understand how that connects with 98% of your stated philosophy. Perhaps you can explain.
I could not resist commenting. Exceptionally well written!
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