Daniel J. Mitchell
Having a vision of a free society doesn’t mean libertarians are incapable of common-sense political calculations.
For example, the long-run goal is to dramatically shrink the size and scope of the federal government, both because that’s how the Founding Fathers wanted our system to operate and because our economy will grow much faster if labor and capital are allocated by economic forces rather than political calculations. But in the short run, I’m advocating for incremental progress in the form of modest spending restraint.
Why? Because that’s the best that we can hope for at the moment.
Another example of common-sense libertarianism is my approach to tax reform. One of the reasons I prefer the flat tax over the national sales tax is that I don’t trust that politicians will get rid of the income tax if they decide to adopt the Fair Tax. And if the politicians suddenly have two big sources of tax revenue, you better believe they’ll want to increase the burden of government spending.
Which is what happened (and is still happening) in Europe when value-added taxes were adopted.
And that’s a good segue to today’s topic, which deals with a common-sense analysis of the value-added tax.
Here’s the issue: I’m getting increasingly antsy because some very sound people are expressing support for the VAT.
I don’t object to their theoretical analysis. They say they don’t want the VAT in order to finance bigger government. Instead, they argue the VAT should be used only to replace the corporate income tax, which is a far more destructive way of generating revenue.
And if that was the final–and permanent–outcome of the legislative process, I would accept that deal in a heartbeat. But notice I added the requirement about a “permanent” outcome. That’s because I have two requirements for such a deal:
1. The corporate income tax could never be reinstated.
2. The VAT could never be increased.
And this shows why theoretical analysis can be dangerous without real-world considerations. Simply stated, there is no way to guarantee those two requirements without amending the Constitution, and that obviously isn’t part of the discussion.
So my fear is that some good people will help implement a VAT, based on the theory that it will replace a worse form of taxation. But in the near future, when the dust settles, the bad people will somehow control the outcome and the VAT will be used to finance bigger government.
Here are examples to show why I am concerned.
Here’s some of what Tom Donlan wrote for Barron’s.
…the U.S. imposes the highest corporate tax rate in the developed world. Make no mistake, corporations pay no tax. That is a tax on American consumers, American workers, and American shareholders. Don’t think that the corporate income tax eases your personal tax burden. Add your share of the corporate income tax to the other taxes you pay. Better yet, create a business tax we can all understand. A value-added tax is a tax on consumption. We would pay it according to the amount of the economic resources we choose to enjoy, and we would not pay it when we choose to save and invest in making the economy bigger and more productive. We would pay it on imported goods as much as on those domestically produced. The makers of goods for export would receive a rebate on their value-added tax. Trading the corporate income tax for the value-added tax is one of the best fiscal deals the U.S. could make.
I agree in theory.
America’s corporate tax system is a nightmare.
But I think giving Washington a new source of tax revenue is an even bigger nightmare.
Professor Greg Mankiw at Harvard, writing for the New York Times, also thinks a VAT is better than the corporate income tax.
…here’s a proposal: Let’s repeal the corporate income tax entirely, and scale back the personal income tax as well. We can replace them with a broad-based tax on consumption. The consumption tax could take the form of a value-added tax, which in other countries has proved to be a remarkably efficient way to raise government revenue.
Once again, I can’t argue with the theory.
But in reality, I simply don’t trust that politicians won’t reinstate the corporate tax. And I don’t trust that they’ll keep the VAT rate reasonable.
At this point, some of you may be thinking I’m needlessly worried. After all, journalists and academic economists aren’t the ones who enact laws.
I think that’s a mistaken attitude. You don’t have to be on Capitol Hill to have an impact on the debate.
Besides, there are elected officials who already are pushing for a value-added tax! Congressman Paul Ryan, the Chairman of the House Budget Committee, actually has a “Roadmap” plan that would replace the corporate income tax with a VAT, which is exactly what Donlan and Mankiw are proposing.
…this plan does away with the corporate income tax, which discourages investment and job creation, distorts business activity, and puts American businesses at a competitive disadvantage against foreign competitors. In its place, the proposal establishes a simple and efficient business consumption tax [BCT].
At the risk of being repetitive, Paul Ryan’s plan to replace the corporate income tax with a VAT is theoretically very good. Moreover, the Roadmap not only has good tax reform, but it also includes genuine entitlement reform.
But I’m nonetheless very uneasy about the overall plan because of very practical concerns about the actions of future politicians.
In the absence of (impossible to achieve) changes to the Constitution, how do you ensure that the corporate income tax doesn’t get re-imposed and that the VAT doesn’t become a revenue machine for big government?
By the way, this susceptibility to the VAT is not limited to Tom Dolan, Greg Mankiw, and Paul Ryan. I’ve previously expressed discomfort about the pro-VAT sympathies of Kevin Williamson, Josh Barro, and Andrew Stuttaford.
And I’ve written that Mitch Daniels, Herman Cain, and Mitt Romney were not overly attractive presidential candidates because they’ve expressed openness to the VAT.
This video sums up why a value-added tax is wrong for America.
The Value Added Tax: A Hidden New Tax to Finance Much Bigger Government
Last but not least, let me preemptively address those who will say that corporate tax reform is so important that we have to roll the dice and take a chance with the VAT.
I fully agree that the corporate income tax is a self-inflicted wound to American prosperity, but allow me to point out that incremental reform is a far simpler–and far safer–way of dealing with the biggest warts plaguing the current system.
Lower the corporate tax rate.
Replace depreciation with expensing.
Replace worldwide taxation with territorial taxation.
So here’s the bottom line: If there’s enough support in Congress to get rid of the corporate income tax and impose a VAT, that means there’s also enough support to implement these incremental reforms.
There’s a risk, to be sure, that future politicians will undo these reforms. But the adverse consequences of that outcome are far lower than the catastrophic consequences of future politicians using a VAT to turn America into France.
P.S. You can enjoy some good VAT cartoons by clicking here, here, and here.
P.P.S. I also very much recommend what George Will wrote about the value-added tax.
P.P.P.S. I’m also quite amused that the IMF accidentally provided key evidence against the VAT.