With $1 trillion annual federal budget deficits looming for each of the next 10 years, and with public debt reaching unsustainable levels, public debate has focused on the central question: How the heck do we get out of this hole?
Faced with unattractive taxing and spending options, elected officials and mainstream media recently have floated the idea of a value-added tax. What is the tax and why have people including liberal House Speaker Nancy Pelosi, moderate-conservative New York Times columnist David Brooks, and CNN international commentator Fareed Zakaria all suggested it? Even Washington state's 2002 Gates Commission, in its generally commendable report, recommended consideration of a VAT as part of general state tax reform. Is it a good or bad idea?
It is a dreadful idea, a national sales tax that could raise huge amounts of revenue but which would be the mother of all regressive taxes, falling mainly on the backs of middle- and low-income taxpayers.
Now, the details.
A VAT was first proposed in Europe after World War I but was first implemented on a national scale in France in 1954. It now provides about half of that country's public revenues. It also has been called "a cascade tax," because it is levied on products and services at each stage of the economic chain of supply. It is a particularly handy tax where high sales taxes and tariffs encourage tax evasion.
A VAT is assessed on goods and services each time there is a transaction. The seller charges the tax to the buyer, who, in turn, pays the tax to the government. There are all kinds of exceptions and special circumstances which apply, depending on the country utilizing the VAT. But, overall, the general principle applies.
A VAT, as any other sales tax, tends to dampen demand and consumption — and, thus, overall economic growth, even though the government gets its revenues. Small businesses, where cash is used, often evade the tax. Travelers to Europe are familiar with one aspect of the VAT: goods sold for export are not taxed. This often leads to fraud as goods (as in the European Union) are shipped in massive amount from one country to another.
The best known VAT is the European Union's, flowing from the original French VAT. It is compulsory in EU member states. But variants are applied in a host of other countries, including Canada, New Zealand, Australia, India, the Nordic countries, Mexico, and many other Latin American countries. It is under study in many other places. Rates vary but can reach as high as 25 percent. In most countries, the VAT is only one tax among many.
Here in the United States, most states have sales taxes but only one has over time adopted some form of a VAT. Michigan used a single business tax, replacing seven business taxes, including a corporate income tax, from 1975 until it was repealed some 16 months ago.
Given Washington state's recent taxing/spending history — that is, spending perpetually rising, taxes rising to pay for the spending, neither spending nor taxing ever reduced — one can only recoil at the prospect of a state VAT here. At the national level, a VAT indeed would raise big globs of tax money and help reduce prospective deficits and debt. But only if the new revenues were not seen by elected officials as an excuse for not dealing with long-term entitlement spending (i.e., on Social Security, Medicare, Medicaid, and the new health-care program) on an urgent basis or for spending more on other purposes.
Worldwide, governments always have tended to spend what they receive in public revenues and, then, to expand government services requiring more public revenues. That certainly has been the case in the VAT-dependent European Union, now facing both near- and long-term financial/debt crises.
Imposing a VAT could raise big new money. But it would, of course, have no effect whatever on the mentality of those who spend the money. It represents no free lunch or end-of-rainbow pot of tax gold. Back to basics: pay as you go; don't spend more than you have; foster economic growth; levy taxes fairly and progressively.