James Pethokoukis

Politics and policy from inside Washington

VAT Attack! Another reason it is a bad idea

Oct 28, 2009 18:36 UTC

One reason many free-marketeers want to take a pass on a value-added tax is that it would only fuel bigger government via higher tax revenues. Indeed, the good folks at TaxVox find new research that helps make that case (bold is mine)”

In the most recent edition of the American Economic Review, Raj Chetty, Adam Looney, and Kory Kroft, examine the effect of tax transparency – what economists call salience – on economic efficiency.

Traditionally, economists view the structure and application of a tax as unimportant. All that matters is the change in relative prices. But Chetty, Looney, and Kroft find that structure and application do matter. For example, they find that consumers are less likely to buy an item if a sales tax is explicitly listed on the product than if the same tax is instead added at check-out.

Chetty, Looney, and Kroft’s theoretical model indeed shows that efficiency increases as a tax becomes less salient. However, their model also shows that reducing the salience of a tax will necessarily harm consumers (albeit not by as much as it helps the government). In other words, tricking consumers into thinking a tax does not exist has two effects: 1) it leads them to poor consumption choices; and 2) it increases tax revenue because more transactions are taxed. In dollar terms, the harm to consumers is less than the increase in revenues. But whether or not you view an opaque tax as a useful policy instrument depends on whether you think the gains to government coffers are worth the reductions in consumer welfare.

As Milton Friedman feared, government can go a step further. If complicated and opaque taxes can dull consumer response, they can also dull the political penalty associated with higher tax rates. An optimizing government could then increase tax rates by more than fully-informed voters would like.  Amy Finkelstein, in the most recent edition of the Quarterly Journal of Economics, finds that drivers are less aware of tolls paid electronically and that switching from toll booths to electronic tolls led to a 20 to 40 percent rate increase. In other words, as salience goes down, tax rates go up.

Me: But for Team Obama, the hidden nature of a VAT would be a feature not a bug. The same approach is being tried with a) healthcare taxes via an excise tax on health insurance companies that will be passed onto consumers, and b) cap-and-trade which is a hidden energy tax that will also be passed along. There is nothing wrong with the idea of a consumption tax as long as it a) replaces other taxes and b) is transparent, such as would be the case with the Hall-Rabusha flat consumption tax.

COMMENT

Not hard to understand, but not obvious, either.

Very enlightening.

VAT Attack! The mysterious Christina Romer and higher taxes

Oct 28, 2009 18:21 UTC

Christina Romer’s speech on Monday had this overlooked bit, which I put into bold:

Our calculations showed that slowing the growth rate of health care costs by one and a half percentage points starting in 2014 would result in a budget deficit in 2020 that was 1 percent of GDP smaller than it otherwise would have been. By 2030, the impact is a reduction in the budget deficit of 3 percent of GDP; by 2040, it is a reduction of 6 percent of GDP.23 These estimates make vivid the notion that the number-one thing we can do to help get the long-run budget deficit under control is to slow the growth rate of health care costs.

Now, slowing the growth rate of costs will not solve all of our long-run budget problems. Our population is aging and even lowering the growth rate of health care costs quite substantially leaves them growing faster than GDP. As a result, other actions will also need to be taken. While health care reform may not be the “silver bullet,” it clearly must be a significant part of the solution to our deficit woes. It is the key step that we can take right now to bring the long-run budget problem down to manageable proportions.

Me:  What “other actions” might she be referring to? Obviously higher taxes. Indeed, earlier in the speech she references the work of economists William Gale and Alan Auberach in this Brookings report:

Even if rising health care costs are an important component of the long-term problem, they are not necessarily “the” cause of the fiscal gap. The estimated gap is increased by more than 5 percentage points of GDP just by continuation of the policies that were enacted during the Bush Administration. … It will prove difficult to close the gap entirely via modifications to existing taxes and spending programs. A new revenue source, such as a value added tax (VAT), may be needed. A VAT imposed at a rate between 15 and 20 percent would essentially close the fiscal gap under the Administration’s budget.

Good tax policy vs. bad policy

Oct 14, 2009 18:10 UTC

Don Marron explains thusly:

Taxes on income, for example, are usually worse for the economy than taxes on consumption. That’s why there’s a rising chorus of economists recommending the introduction of a value-added tax, rather than higher income taxes, if our nation decides it wants to support substantially higher government spending. High tax rates similarly tend to be worse for the economy than low rates. That’s why economists usually favor broad tax bases and low rates, rather than narrow tax bases and high rates. Finally, it’s preferable to levy taxes on bads rather than goods. Where appropriate, taxes on pollution (e.g., emissions of greenhouse gases) should thus be preferred over taxes on working, saving, or investing.

VAT Attack! The perfect tax … or maybe perfectly awful

Oct 14, 2009 13:25 UTC

Greg Mankiw does a good explaining the value-added tax. But this is ominous:

From a strictly economic standpoint, a VAT is great. It is essentially a flat consumption tax, like the so-called FairTax, but implemented in a way to reduce compliance problems. Because it is collected in stages along the chain of production, rather than all at the retail level, tax evasion is more difficult. … My bottom line: If I could replace our current tax system (including the personal income tax, corporate income tax, payroll tax, and estate tax) with a VAT, I would gladly do it.

Why do some conservatives hate the VAT? For political reasons. They fear it would be a new tax, hidden from many voters, used to expand government. They fear that rather than replacing our existing tax system, a VAT would add to it.  … Which brings us to Europe. Many European countries have both a VAT and a large government. But here is the hard question: which is cause and which is effect? Did the VAT cause government to become large, as VAT-opponents fear? Or did Europeans adopt large governments and then, needing to finance it, look for a relatively efficient way to raise a lot of revenue? I am inclined toward the latter hypothesis, but I will be the first to admit that it is entirely clear which way causation runs here.

Me: Want a VAT? First, put into place hard spending limits and spending reduction pathways, such a limiting spending growth to population growth + inflation or some such. And also get rid of the income tax.

COMMENT

I think the US should just get on with it. Who else is left without VAT/GST?? Prepare yourself for lots of hikes. If you look at this site http://www.tmf-vat.com is shows how Europe is increasing VAT by the month to cope with the spiralling deficits.
Richard

Posted by Richard | Report as abusive

VAT Attack! The value-added tax, Bruce Bartlett, the GOP and deficits

Oct 8, 2009 17:16 UTC

I have been exchanging emails with economic analyst Bruce Bartlett, a supply-side economist who has come out for higher taxes.  (See the NYTimes article on him earlier this week.) Bartlett (who blogs at the wonderful Capital Gains and Games) thinks Uncle Sam will never cut spending, thus taxes must go up, preferably in the form of a VAT.  He also has book coming out next week, The New American Economy: The Failure of Reaganomics and a New Way Forward.

Here a bit of what he has been telling me:

Bartlett on how much revenue a VAT would raise:

If we only need to raise taxes by a percentage point or two, to say 20% of GDP, then we don’t need a VAT unless we want to use it as a pure tax reform. We could use the revenue to abolish the AMT, abolish the estate tax, maybe abolish the corporate tax, whatever. That would be fine with me because we don’t need the revenue today. But I think we will need it in the future because I don’t see any natural limit to spending or any appetite in either party for significant spending cuts. Therefore, unless we want deficits of 10% of GDP forever we have to raise revenue. When the day comes that the political class finally agrees to raise net new revenue it will be better to raise it through a VAT a percent or even fraction of a percent at a time. If the VAT is already in place that will be easy—too easy, you probably think. But the only other alternative is to raise tax rates, which is worse.

Bartlett on a tax system he likes better than the VAT:

My ideal tax system is a Hall-Rabushka flat tax, always has been. One reason I like it is because it is essentially a subtraction-method VAT. But I think the time for it has passed. At this point I think it is inevitable that if we adopt a VAT it will basically be as an add-on to all the other taxes—that’s the way it is in every other country. If we can get rid of some worse taxes as part of the deal, that’s great. But to make that deal, conservatives have to play the game. If Democrats have to raise taxes on their own, they will do it in the worst possible way, economically. But if the Republican alternative is to do nothing, then Democrats will do what they have to do as they did in 1993. If they decide to do a VAT they would undoubtedly be very amenable to using some of the revenue for tax cuts that would enhance growth. But, again, if Republicans refuse to play the game and won’t commit themselves to support the final package, then Democrats will do it on their own and we will end up with something worse—multiple rates, exemptions that create inefficiency, and higher income tax rates to boot.

Bartlett on Republicans and budget deficits:

At some point, conservatives have to realize that they have to make a choice. Refusing to make one by living in a dream world where truly massive spending cuts are enacted to keep spending and taxes as a share of GDP in their historical range is not an option, in my opinion. If conservatives think I am wrong about the need for significantly higher taxes, then I think they have a responsibility to put plans on the table to seriously cut Social Security, Medicare and Medicaid and put real effort into getting them enacted.  But I don’t see it.  All I see are pie-in-the-sky plans to privatize these programs and somehow magically cut spending without reducing anyone’s benefits. Those aren’t going to happen, ever. So if we are going to live in the real world, how will spending be cut enough to prevent the need for higher taxes. If you find out, let me know.

Me: I would rather push hard for Hall-Rabushka, a flat consumption tax, and massive entitlement reform which would eliminate the need for taxes to rise as a percentage of GDP. But Bruce thinks both are politically impossible, and thus the GOP needs to push for a VAT while also dropping marginal rates.

COMMENT

Giving the politicians an unlimited amount of cash is insane!

No VAT tax forever!

Posted by Steve Freedman | Report as abusive

A VAT danger for Democrats

Oct 7, 2009 19:44 UTC

A good point on the political dangers of a VAT from David Henderson of EconLog:

But here’s what’s not a quibble: what happened to the political fortunes of the Canadian government that imposed that tax, something that Leonhardt doesn’t mention. Brian Mulroney, the Canadian prime minister at the time, imposed the tax at an initial whopping 7%. It’s true that it replaced a narrower hidden 13.5% tax on manufacturing and that it was designed to be revenue-neutral. But precisely because the GST was visible, it generated enormous opposition. The Liberal Party made repeal of the GST one of its main issues in the 1993 election. By then, Mulroney’s party, the Progressive Conservatives, had kicked him out and replaced him with Kim Campbell. Granted that Campbell ran one of the most incompetent campaigns in Canadian history and granted that there was a recession on at the time. But do you care to guess what happened to the number of seats in Parliament that the Progressive Conservatives won in that election? Let me give you a hint. They started with 169 out of 295 seats. And they ended with a number that can be counted on the fingers of one hand. To be precise, they ended with 2 seats, a 99% drop, and, a few years later, the Progressive Conservative Party disappeared via merger.

COMMENT

The party that significantly raises taxes digs itself an electoral grave. This is despite necessity and or fiscal soundness.

A good example in NJ was Governor Florio. He had no choice but to raise taxes due to significant budget shortfalls during the late eighties-early nineties recession. His successors, certainly benefited, but he was voted out after one term.

Taxes are very tricky politically, and the more you can obscure their effects, and make them less visible overall the better.

Posted by Greg | Report as abusive

Why the GOP shouldn’t embrace calls for a VAT

Oct 7, 2009 18:00 UTC

You can add New York Times economics columnist David Leonhardt to the parade of liberals, Democrats, Obama allies and fellow travelers — such as John Podesta, Nancy Pelosi, Paul Volcker, and Robert Rubin — calling for higher taxes, preferably a value-added tax.

But Leonhardt goes those folks one better in his new column. He extensively quotes conservative (and controversial) economic analyst Bruce Bartlett, a VAT proponent, who says Republicans are no longer credible on economic policy. That is, of course, another way of saying Leonhardt no longer thinks the GOP or conservative economics (hardly the same thing) are credible, assuming he ever did. And that seems unlikely given the tone and substance of his column.

Yes, let’s talk about credibility and start with a few howlers by Leonhardt:

1) “Most Democrats now acknowledge the central idea of supply-side economics: tax rates matter.” Have Democrats really conceded this point? Have they accepted the necessity of the Reagan supply-side tax cuts back in the 1980s? Doubtful. President Obama, for instance, has stated that he doesn’t think the high, unindexed-for-inflation tax rates of the 1970s were a disincentive to work, savings and investment. He concedes only that they may have “distorted” investment decisions by encouraging people to seek out tax-shelters. Not surprisingly, the Obama tax cuts were typically Keynesian, short-term and consumer demand focused.  The job tax credit that the White House is considering would be more of the same.

(And I’ve lost count of the number of times I’ve heard Democrats and liberal economists get wistful about the 1950s and its 90 percent top marginal tax rate. These also tend to be the same folks who credit the 1980s economic boom to falling oil prices, Paul Volcker’s inflation fighting, Jimmy Carter’s deregulation and typical cyclical rebound after a deep recession. In short, every possible explanation other than Reagan’s tax cuts.)

2) “Taxes are supposed to rise as a country grows richer.” Ah yes, Wagner’s Law, named after 19th century economist Adolf Wagner. Smart guy. Except that Americans decided to break Wagner’s Law starting in 1978 with the property tax revolt in California and deep cuts in the national capital gains tax rate, followed by the Reagan tax cuts. You might say that Laffer’s Law (as in Arthur Laffer) and the experience of the 1970s superseded Wagner’s Law by demonstrating how high taxes rates can choke economic growth and productivity.

Wagner is probably correct that richer societies demand more services, but who says that government has to provide them? They can be privatized, such as Indiana did with its toll road. And there is scant evidence that American desire higher taxes, as evidenced by recent election results in California (voters rejected higher taxes) and little support for higher energy taxes.

3) “But some basic arithmetic — the Medicare budget, projected to soar in coming decades — suggests taxes need to rise further, and history suggests that’s O.K.” Or the government could cut spending. Pushing back the retirement age on Social Security and tweaking its benefits formula turns a $5 trillion present-value deficit into a $5 trillion surplus, for instance. That’s just one idea. It is not an unalterable, incontestable reality that government spending cannot be reduced.

Give voters a choice between a) more government programs and a 33-50 percent increase in their tax burden and b) low taxes and free-market approaches to problems like healthcare. Let’s see which they choose.

And as far as the impact of tax increases on economic growth, let me quote a paper co-written by Christina Romer, chair of Obama’s Council of Economic Advisers: “Tax increases appear to have a very large, sustained, and highly significant negative impact on output … [and] tax cuts have very large and persistent positive output effects.” There you go.

4) “One of the country’s two political parties has no answer to an enormous economic issue — the fact that the federal government cannot pay for its obligations.” Must have missed the memo on how Democratic healthcare reform solves America’s deficit problems since, at best, the various plans are only roughly deficit neutral over the next decade. Also, Democrats have recoiled at the idea of taxing healthcare plans to pay for expanded coverage, an idea that many economists say also is necessary to reduce overuse of pricey, premium medicine.

And recall how Democrats harpooned Republican attempts to reform Social Security during the Bush administration, with many also refusing even to acknowledge that the system was in crisis.

Not that Republicans have much to crow about when it comes to spending. The GOP defense of out-of-control Medicare spending is completely political, as was the Bush administration’s decision to expand Medicare without paying for it.

Bottom line: Ultimately what tax-hike proponents fail to persuasively argue is why they believe that once government had access to greater revenue, especially via a VAT, it wouldn’t just spend the additional dough?

Americans know how that game works.

Moderate Democrats like Sen. Mark Warner have made the case that unless spending is cut and government reformed, big tax increases are fantasy policy. That’s right. First cut spending, then raise taxes if absolutely necessary.

COMMENT

Thank you for providing your perspective.

Here is a recent action alert, from Americans for Tax Reform, regarding this issue:

http://www.atr.org/tell-congress-dont-wa nt-vat-tax-a3991

VAT attack! More on Obama, Pelosi and the value-added tax

Oct 7, 2009 11:14 UTC

When you start looking for signs of the VAT virus, you start seeing them everywhere. Here are some excerpts from Howard Gleckman over at TaxVox, the blog of the Tax Policy Center:

I’ve just spent 90 minutes listening to five Washington hands discuss “the financial and economic consequences of an exploding debt.. … Urban’s Bob Reischauer and Rudy Penner (both former CBO directors), American Enterprise Institute Congress-watcher Norm Ornstein, TPC co-founder Len Burman, and international economist Mike Mussa agreed that the depths of the medium and long-term problem can’t be overestimated. …

Mussa, who spent a decade at the International Monetary Fund and is currently a senior fellow at the Peterson Institute for International Economics, figures it could be years before overseas investors turn bearish on the U.S. In part, he says, that’s because net foreign lending has actually fallen in the past two years—their huge increases in investments in Treasury paper have been more than offset by shrinking portfolios of private debt.

But that won’t last. Once the economy begins to get back on track, private capital and government will again compete for the same foreign money—bad news for everyone seeking funds.

Is there any way out? Ornstein sees little chance that a hyper-partisan Congress will confront the budget crisis in the absence of a financial market crisis, or even in the face of one. Interestingly, Burman, Mussa, and Penner think that when the fix finally comes, it will include a Value-Added Tax. Penner calls it “almost inevitable.”

Then there is this analysis by Heritage of the costs:

Just a 1 percent VAT on all goods and services in the economy would raise $63 billion for Congress to spend each year. Some suggest the VAT rate should be set as high as 20 percent. At that rate, a VAT that covers all goods and services in the economy – including food, clothing, housing, and health care – would collect an additional $1,260 billion a year and cost every U.S. household $10,680 annually.

Even if Congress passes a VAT that has a rate of just a few percentage points, it would likely lead to higher rates in the future. Evidence from other countries that already have VATs show once it is on the books the rate tends to rise over time.

COMMENT

Question. How does the VAT affect the states Sales Taxes? Is it part of the states sales tax or a different tax all toghether?

Posted by Jamie | Report as abusive

Obama and the VAT: Now it’s Pelosi’s turn

Oct 6, 2009 17:12 UTC

You can add House Speaker Nancy Pelosi to the group of Democrats or Obama allies (John Podesta, Paul Volcker, Roget Altman) calling for a value-added tax. (I predicted all of this days ago.) Here is Pelosi (via The Hill):

Pelosi, appearing on PBS’s “The Charlie Rose Show” asserted that “it’s fair to look at” the VAT as part of an overhaul of the nation’s tax code.

“I would say, Put everything on the table and subject it to the scrutiny that it deserves,” Pelosi told Rose when asked if the VAT has any appeal to her.

The VAT is a tax on manufacturers at each stage of production on the amount of value an additional producer adds to a product.

Pelosi argued that the VAT would level the playing field between U.S. and foreign manufacturers, the latter of which do not have pension and healthcare costs included in the price of their goods because their governments provide those services, financed by similar taxes.

“They get a tax off of that and they use that money to pay the healthcare for their own workers,” Pelosi said, using the example of auto manufacturers. “So their cars coming into our country don’t have a healthcare component cost.

“Somewhere along the way, a value-added tax plays into this. Of course, we want to take down the healthcare cost, that’s one part of it,” the Speaker added. “But in the scheme of things, I think it’s fair look at a value- added tax as well.”

COMMENT

Actually a combination of Soylent Green, Logan’s Run(the old are expendable), Brave New World (social conditioning and population control and 1984 (doublespeak and History if Bunk). I feel like I’m trapped in Room 101.

Posted by R McGrew | Report as abusive

VAT Attack! Greenspan: Raise taxes with a value-added tax

Oct 2, 2009 15:13 UTC

At the Atlantic magazine symposium I am attending, former Federal Reserve chairman again said he thinks taxes are going up and that a value-added tax would be the “least worst” way of doing it.  This dovetails nicely with what I wrote yesterday:

Does President Obama have a secret plan to raise taxes on middle-class Americans — and,well, pretty much everybody else — with a European-style, value-added tax? Actually, it’s not such a big secret. Connect the dots:

1) The joint statement from the just-concluded G20 Summit in Pittsburgh called for balanced global growth — which means Americans must spend less and save more and reduce its budget deficit.

2) That same weekend, John Podesta, co-chairman of Obama’s presidential transition team and an outside White House adviser, tells a Bloomberg reporter that a value-added tax is “more plausible today” than ever, adding that “there’s going to have to be revenue in this budget.” A VAT is a kind of consumption tax.

3) Yesterday, the Center for American Progress, the liberal think tank with close White House ties, holds a conference on the rising national debt. While speaker after speaker — Paul Krugman, Roger Altman, CAP President Podesta (again), Laura Tyson — admits entitlement spending must be reduced, they also agree that taxes must be raised. Altman suggests $400 billion in new tax revenue is needed almost immediately to calm financial market fears, and a VAT would be a great way of doing it. That’s $400 billion a year, by the way, not over ten years.

4) Also, yesterday was the first meeting of President Obama’s tax reform panel led by former Federal Reserve Chairman Paul Volcker. In a two-part interview with Charlie Rose airing yesterday and today, Volcker says that if Washington can’t get spending under control, either a VAT or a carbon tax would be effective revenue raisers. “Those are two big ones,” he says.

5) As they used to say in the Soviet Union, “It’s no coincidence.” This is also the conclusion of one Washington insider with ties to the White House economic team: “Does this all add up to a trial balloon? Of course, it’s a trial balloon. And I expect the administration will propose major tax reform, including a VAT.”

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