Wednesday, January 4, 2012

Why America Shouldn't Adopt the Value-Added Tax

The value-added tax, better known as the VAT, is a consumption-based tax that assesses a tax during each stage of production of a given good. This was brought to my attention because I was reading a Wall Street Journal op-ed piece by Daniel Mitchell pointing out that in a recent interview with the Wall Street Journal, presidential candidate Mitt Romney said he would be open to the idea of implementing the VAT in the United States.

There are some things that I like about the VAT. There would be an equal tax burden on each stage of production, rather than having the burden solely on the distributor of the final product. The VAT is a much simpler form of taxation than, let's say, the progressive income tax we currently have, which means less bureaucracy. The end result of both equally distributed burden and simplified flat rate is increased revenue with less inefficiencies. Also, the VAT is more in lines with a free society. Under the current system, you don't have any say as to how much you pay in taxes. However, with the VAT, you can pay as much or little as you want in taxes because it's directly linked with consumption. If it's high enough, it might even incentivize you to save up some money instead of go into over-consumption mode.

If every other country in the OECD has implemented the VAT, why shouldn't America? To answer that question, here are some issues I have with implementing it here:

  1. Although the VAT can incentivize savings, it could just as easily backfire and have a detrimental effect on consumption if the rate of taxation is too high.
  2. The richer members of society will consume more goods, and thus put more into tax revenue. In theory, this should equalize tax burden amongst socio-economic classes. However, there is an issue where you have more inelastic goods, such as food, clothing, or even gasoline. When discussing such inelastic goods, the tax becomes more regressive, thereby further hammering the poor with tax burdens.
  3. There are still issues with enforcement of the VAT. Unlike the flat tax, the VAT involves many stages of production, which means that there would have to be greater enforcement mechanisms in place to make sure the tax is being paid.  Tax evasion with the VAT has been an ongoing problem both in Europe and in China.  As such, any reduction in costs of the simplification of the tax code would most likely be negated by enforcement costs. 
  4. As Mitchell brings up in his op-ed, Congress would realize that the tax is more efficient, and thus cause a tax hike because they would not think that they have reached the top of the Laffer curve yet. 
  5. Even if Mitchell is wrong about the VAT being a carte blanche to increase taxes, many people are forgetting something. This tax would most probably not be in lieu of the current tax system. If it were, I, along with other economists, would feel differently. Knowing the politicians in Washington, if this were ever to pass, my educated guess would be that the VAT would be in addition to the current tax system, thereby creating a greater tax burden for the American people. 
Much like they did back in 2010 (see Section 11 of H.R. 4851), I hope that Congress has the minimal common sense to maintain the stance that implementing the VAT, especially in this economy, is not only bad policy, but against their self-interest, especially if they're up for re-election this year.


  1. Any businessman who has gone through a sales tax audit knows how horrible a VAT would be. HORRIBLE! Substantial % VAT, like substantial % sales tax, also creates a tremendous temptation to cheat.

    1. It's not only the increased temptation to cheat, but because the tax is implemented at every stage of production, it gives more opportunities to cheat, which is why VAT-based tax fraud is a problem in other countries.