The Senate just said “No” to a VAT. Disagreeing, Paul Volcker sort of said “Yes” when he observed that a VAT is “not as toxic an idea” as we once believed. Suddenly everyone seems to be talking about a VAT.
Here are some basic VAT facts:
1. What is it?
Most fundamentally, the VAT is a consumption tax, sort of a distant relative of the sales tax. Please think about a pretzel. A sales tax on a pretzel would be paid at the cash register. (Federal sales taxes now provide only 3% of federal tax revenue.)
The VAT, a value added tax, is also a consumption tax. If we levied a VAT, as with the sales tax, our pretzel would have a higher price. However, the consumer does not pay the entire tax at the cash register. Instead, at each production stage, the value that is added to the product is taxed.
With a 10% VAT, when $100 of wheat for pretzels leaves the farm, the flour maker who buys the wheat pays $100 for the wheat and a $10 tax. Then, when the pretzel factory buys the flour, it pays (very hypothetically) $1000 for the flour plus $100 VAT minus a credit for the taxes that were already paid. At each stage, the VAT is levied on buyers of the unfinished product; the consumer covers the final VAT payment. Piecemeal, through a sequence of tax forms, the federal government identifies and charges for “value added”.
2. Who uses the VAT?
Close to 100 countries generate revenue through a VAT. In France, for example, more revenue is raised through their VAT than through income taxes. I checked the OECD website and saw that VAT rates vary. Denmark: 25%; Spain: 16%; Thailand 7%.
But then I discovered that reality can be a lot more complex. In the U.K., for example, where food is tax free, they decided to exclude frozen yogurt that needs to be thawed. They faced similar dilemmas about children’s clothing, having to decide the whether small adult sizes are for children and even if flotation devices are clothing.
3. Why is a VAT desirable?
Many economists believe that a VAT can generate “a ton of revenue“. Also, as a consumption tax that elevates prices, a VAT can encourage saving.
4. What is wrong with a VAT?
It is regressive. That is why the UK VAT, for example, excludes food. Also, a VAT can be complex.
5. When was the VAT created?
The VAT was invented in 1954 by Maurice Laure, a French tax official.
You can see where all of this is heading. It’s complicated. The basic issue, though, is if we spend more, we need more revenue.
The Economic Life
In the U.S., the personal income tax generates 44% of all tax revenue while social insurance taxes account for 42%. Corporate income taxes are a distant third at 7%.