Is the VAT Really Simple?

Few people disagree that the U.S. tax code needs to change.  Currently there are tens of thousands of pages of laws and procedures and regulations, growing by several thousand pages a year.  The more complex, the more open to interpretation, breeding new code band-aid after code band-aid, just adding to the complexity.  Attempts at social engineering create conflicts with basic economics.  Armies of CPA's and tax attorneys are supported by this system to keep the other army of IRS tax enforcers at bay.

Billions of dollars wasted, sucked out of the economy, every year, just to control the sucking of billions of dollars out of the wallets of taxpayers.  Imagine what could be done with those funds, the mouths that could be fed, the bailout dollars that could be thrown around.

Several people have recommended a "flat tax" where a set percentage is levied on all taxpayers, eliminating the enormous complexity of deductions and marginal rates.  Others have suggested a consumption or "value added" tax, which would impact only those that consume.  Those that consume more, pay more.  Those that save, pay less.

It's highly possible, if not inevitable, that Americans will soon live under a radically different tax system - one that the pundits and politicians aren't talking about.

It's called a value-added tax, or VAT, and it's been used for decades to pay the bills and sustain the immense growth of governments around the world, from France to Mexico to Australia. Created in 1954 by a French economist, the VAT is the most potent, efficient machine for revenue generation yet invented.

As my friend Jim Huntzinger pointed out, the concept of "sustain the immense growth of governments around the world" is a problem in itself. 

Presumably a VAT is simple.  It may be simpler than our current morass, but truly "simple"?  Not really.

The VAT is essentially a sales tax, except that it's charged at each stage in the development of a product instead of at the moment when the product is sold.

Take, for instance, a car with a sticker price of $30,000 and a value-added rate of 10%. Ford might buy its steel and other materials for $8,000 plus $800 in a VAT tax. A dealer then pays $25,000 plus a $2,500 tax for the finished vehicle. Ford takes an $800 credit for the tax it already paid and sends $1,700 to the government. A buyer then pays $30,000 for the SUV and $3,000 in taxes. The dealer collects the $3,000, takes a credit for the $2,500 worth of taxes already paid, and sends $500 to tax authorities. Ultimately, the government pockets $3,000, or 10% of the retail price of the car, in taxes.

Ugh.  Yes, I guess it could be fairly simple, definitely more streamlined than the current mess.  But collecting at each stage, then issuing credits at each stage, in the end collecting the same net amount as if the total VAT had been collected at the end?  But some analysts call this "genius."

The genius of the VAT is that, while the consumer pays it, the actual cash is mostly collected from producers before it reaches the retailer. Since the VAT is essentially a hidden charge embedded in the price of goods and services, raising the VAT doesn't arouse nearly the uproar caused by increasing income taxes.

The ease with which a VAT can be increased points to one of its big drawbacks: Governments see it as an easy way to pay for increased spending, which is a potential drag on economic growth.

Aha!  There we have it!  Trying to make the tax less visible so it can be easily increased.  That's a good thing?  To the contrary, we should always be very aware of the tax we pay, debate the merits of tax increases, and scrutinize how our hard-earned tax dollars are used.

This is also why I've long been an advocate of eliminating the automatic tax withholding out of pay checks, stopping the inclusion of the tax amount in gasoline prices, and the like.  When I owned my own manufacturing business, I used to have to cut a check for the biweekly payroll tax... both the employee and employer side.  I now pay quarterly taxes by cutting a real check. 

When you actually have to write a check it really hits home that you're paying taxes, and how much of your compensation is involved. Of course the logistics of enforcing a system where all taxes must be paid by check is far more complex than regular, almost hidden, withholding.

This is also why it is very dangerous how we're approaching the "tax tipping point"... where more people don't pay taxes than pay taxes.  The presumed policies of the next administration may very well push us past that point.  More people will be riding free than will have skin in the game.  

Perhaps a VAT or especially flat tax is the way to go to avoid this danger.  Let's just try to keep it simple.

Comments

[patriotic tax payer]

I think the income tax should be flat rate with a standard deduction set at half or 2/3 of the average income.

[martinb]

South Africa used to have a sales tax, then changed to VAT many years ago. The reason was, there is a large informal economy of street hawkers and it's impossible to get them to pay tax. With VAT you collect a bit of tax all the way up the line, so a bigger percentage of the total gets paid, thus sharing the burden more evenly.

I used to do VAT payments and the paperwork is quite cumbersome. As a concession, small organisations which don't have enough turnover to justify employing a VAT-competent employee are exempt. As are basic foodstuffs like fresh fruit and vegetables, bread, maize meal, rice, and cooking oil.

It's a consumption tax, which is good, because even people with undeclared incomes or good tax lawyers have to pay it.

It was first introduced at about 4% and rapidly went up to 14% where it has been for years. If they tried to put it up even more there'd be big complaints. There seems to be a natural ceiling to what rate the public will accept.

Don't be afraid of VAT. It's a good tax. Come and learn from South Africa how to do it. We've got the best finance minister in the world, Trevor Manuel.

[martinb]

PS: Barack Obama visited South Africa in 2006 on his way to Kenya. The only cabinet minister he saw? Finance Minister Trevor Manuel. Perhaps that's a straw in the wind.

[Hank]

Have you seen the FairTax proposal? www.fairtax.org

[Jeff Arnold]

Hank-
I've been a Fair Tax fan for years. One major difference to Europe's VAT is the transparency. Instead of an embedded tax collected from the producers at each manufacturing stage, it is collected from the consumer in the form of a National Retail Sales Tax (in place of Income Tax). This makes it impossible to hide tax increases, and as an added bonus, it forces criminals and "visitors" to pony up. It also eliminates the IRS, the benefits of which should be apparent to all Lean Thinkers.

[Tommaso Palmitesta]

Is there a way to subscribe Mr. Obama to this blog?? He could save taxpayers a lot of money by reducing his "inventory" of "advisors" and "experts".