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Will a VAT turn America into a Greek-style welfare state?

Daniel J. Mitchell is an expert on tax reform and supply-side tax policy. He is a senior fellow at the CATO Institute. The opinions expressed here are his own.

This post is part of an ongoing series on tax reform ideas. Where do you stand? Come back regularly to be a part of the national debate.

Many Washington insiders are claiming that America needs a value-added tax (VAT) to get rid of red ink. Proponents even claim that this European-style national sales tax is good for growth. Some of them say the imposition of a VAT would modernize our tax system, whatever that means. Others argue a VAT could be used to finance pro-growth tax reforms. And President Obama says that a VAT is “something that has worked for other countries.”

Every single one of these assertions is demonstrably false.

But one thing that everyone acknowledges is that the VAT is capable of raising enormous amounts of tax revenue. The tax is imposed on consumption, which accounts for about two-thirds of America’s nearly $15-trillion gross domestic product. So even a low tax rate of five percent theoretically would generate as much as $500 billion for the politicians to spend. In practice, though, politicians usually insert loopholes in exchange for campaign cash, so the actual amount of revenue would be lower.

It does not matter, however, how much revenue a VAT generates with a five-percent rate. One of the many problems with a VAT is that it is a hidden levy. Unlike a regular sales tax, which is imposed at the cash register, VATs are imposed at each stage of the production process and thus get embedded in the price of goods. And because the VAT is hidden from consumers, politicians find they are an easy source of new revenue – which is one reason why the average VAT rate in Europe is now more than 20 percent!

You probably won’t be surprised to learn, though, that all the additional tax revenue from a VAT has not resulted in deficit reduction. Western European nations first began imposing VATs about 40 years ago, and the result has been bigger government, permanent deficits and more debt. According to the Economist Intelligence Unit, public debt is equal to 74 percent of GDP in Western Europe, compared to 64 percent of GDP in the United States (and the gap was much bigger before the Bush-Obama spending spree doubled America’s debt burden).