The VAT is BAD

There have been many facts, fiction, analyses and opinions circulating on the possibility of a European-style value-added tax (VAT) becoming a reality in the United States.  Several online articles describe the VAT, how it works and the pros and cons.  (See Wilkipedia, European Taxation and Customs Union, and of course,  NCPA’s commentary and an additional editorial from the Wall Street Journal, to name a few). 

The VAT is collected at every stage of the production of a good and also paid by the consumer who purchases the final good.  Proponents of a VAT argue that it since it is a tax on consumption (akin to a national sales tax), it does not discourage work, as do the marginal income tax rates on labor.  Furthermore, they claim it requires less compliance paperwork than the income tax or a traditional sales tax.  Even though the tax is collected and paid to the government at every stage of production, those who purchase products for resale to consumers will receive credit  for most VAT paid.

But the devil is in the details.  On top of the already convoluted paperwork involving the current income tax system, a VAT system will require manufacturers, wholesalers and retailers to calculate and keep track of taxes paid in order to receive credit, which involves – you guessed it - paperwork, time and administrative costs.  Small businesses will be hit especially hard, as evidenced by various website articles from the United Kingdom instructing small businesses on how the VAT works.  (Read one such article from the U.K.’s Small Business Entrepreneurs website).

So who else will get the short end of the stick besides small business?  Consumers, of course.  They will still pay the full VAT on retail goods purchased, regardless of the length of the production chain.  Since nothing happens in a vacuum, a VAT would have distortionary effects on both the supply of and demand for goods.   At the risk of sounding like a simpleton, a 15 percent VAT on  goods will add at least 15 percent to the cost of  goods, possibly more if businesses pass additional administrative costs on to the consumer.

Unless the law of supply and demand has drastically changed since I was in college,  when the price of a good increases, the demand for that good falls.  Our economy is heavily reliant on consumer spending - consumption of goods comprises more than two-thirds of gross domestic product – so what will happen to the economy?

And don’t be misled by the notion that  ”a simple VAT could eventually replace the income tax system.”  There is too much revenue in both for government to give up one for the other.  Europe has not abandoned their high marginal income tax rates in favor of  the VAT…why would we?

The bottom line is the VAT, especially implemented in the current tax system, will kill economic growth.

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