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What's New

2010-03-01 08:47:00

The VAT (value added tax)

Question: So, what’s new?

Answer: Again, always glad to be asked. This month I want to write about what is now...and what will be, in my opinion, for months to come, one of the most hotly-debated, domestic topics...the value-added tax, or VAT. Just the other day, Paul Volcker, respected head of the Fed prior to Alan Greenspan, and prior to our current head, Ben Bernanke, issued a statement. He said, "If at the end of the day we need to raise taxes, we should raise taxes." His proposal would be for a value-added tax (VAT) that would be based upon everyone’s consumption of goods and services, from the originator of the product and/or service, all the way through the production chain, with each producer paying a tax only on the value that they added to the product or service, thus eliminating double taxation. He estimated that for every 1% tax imposed by a VAT, it would raise $1 Trillion in revenue, every 10 years. Under the budget President Obama submitted for 2011, we have a $1.5 Trillion budget deficit. If we had a 15% VAT in effect now, on the purchase of every good and service provided, we would eliminate this deficit. Here is an article written by Diane Furchtgott-Roth of the Manhattan Institute in June of 2009, with her opinion of a VAT. While I don’t agree with all of what she had to say, she does have good points that are worth noting.With Congress and the White House mindful—and troubled— that health-care reform could cost over $1 trillion in the next decade, the House Ways and Means Committee this week compiled a list of ways to raise money based on options from the nonpartisan Congressional Budget Office. One is that ‘hoary old chestnut’...the national value-added tax (VAT), similar to a national sales tax. It is more popular with some conservatives, who see it as an alternative to taxing income, than with liberals, but a few liberals like it because they see it as a tax on consumption that will encourage saving, or as a way to pay for subsidies to low-income families. Perhaps he was only practicing legislative diplomacy, but chairman Charles Rangel (D-NY) of the Ways & Means Committee, where tax bills originate, refused to rule out a VAT in recent conversations, saying "it’s been put on the table." To be sure, Rangel went on to acknowledge obliquely that many Democrats might not support such a tax. Nor has there been any hint from the Obama White House that the 44th president would go for a VAT. But a 1% VAT could raise $100 billion a year, and a 5% VAT could bring in $500 billion. That may have a seductive ring in the ears of some in the White House and on Capitol Hill—a small tax yields a lot of money. Nevertheless, it is a bad idea. The tax, on goods and services, is levied only on the value added at each stage of production. Take a hand-made guitar: When the maker buys the strings and the wood, he receives invoices that show how much value-added tax their producers have paid. By assembling the guitar into an instrument a musician can use, the maker adds value, and can sell the guitar for more than the cost of the materials. He will pay tax on his sales price, but may first subtract the taxes that suppliers have paid, avoiding double taxation. Net, he pays tax only on the value he adds. The problem with the VAT is that it is biased upward over time, because it is so tempting for legislatures to produce more revenue by making small rate increases. When imposed in 1967, Denmark’s VAT was 10%; it is now 25%, in addition to a top income tax rate of around 59%. A year later, in 1968, Germany levied a 10% VAT. Germans are more fortunate; their VAT has risen "only" to 19%, and their highest income tax rate is "only" 45%. Twenty-nine OECD countries have VATs, and only three— Canada , Japan , and Switzerland —apply rates under 10%. The others impose rates of 10% or more, and 12 have rates of 20% or higher. In sum, the notion that a VAT will be a small, single-digit tax is not born out by other countries’ experience. In fact, in many countries the VAT is the largest source of government revenue. It’s politically unrealistic to expect that a VAT would be a substitute for the income tax, so it would end up being an additional levy, one that enlarges the government’s claim on the rest of the economy. Putting a VAT in the hands of Congress is like giving an alcoholic the keys to the wine cellar and saying he’s welcome to drink just one bottle. Of course, the following morning several bottles will have been consumed. Len Burman, a liberal economist with the Tax Policy Center, suggests imposing a VAT and then rebating the revenue back to families through lower income taxes and vouchers to buy health insurance. If this complicated plan seems too good to be true, that’s because it is. The notion that Congress will reduce other taxes when it imposes a VAT strains credulity at a time when it is considering expensive "investments" in energy, health, and education. Countries do not use their VATs solely for one program, such as health care. They use them to pay for a wide variety of expenditures. There’s no reason to expect it to be different in America. Should Congress wish to move towards a consumption tax in order to encourage savings, there are better and simpler ways to do so. The best is to take the myriad of tax-free savings accounts we have now—529 college savings plans, 401(k) retirement plans, traditional Individual Retirement Accounts, Roth Individual Retirement Accounts, Health Savings Accounts, Simplified Employee Pensions, etc.— and meld them into one large tax-free savings account and place no limit on annual contributions. Income going into this omnibus savings account would not be taxed, so de facto we would have a consumption tax, since the only money subject to income tax would be money spent. A VAT has the potential to fund all of Congress’s pet projects, such as cap-and-trade, renewable energy, electric cars, high speed rail, and, of course, health care. It’s the taxpayers who would be the losers. The Obama administration immediately distanced itself from Volcker’s comment. I would think this had to be a political move to appease some element of the electorate, as nowadays, few things are done by this administration without considering the political ramifications. And…there are other factions of the electorate that say they don’t support it, but they never say how they’re going to solve the problems we are facing. If not this…what solution do they have to reconcile the terrible "hit" to our country, our children and our children’s children from this runaway spending and fiscal irresponsibility? The only thing that keeps popping up is to tax even more those singles making $200,000 and up, and those couples making $250,000 and up. On April 10th, the headlines read, "47% of all Americans will not pay taxes for calendar year 2009." "The top 10% of all household incomes are paying 73% of all the Federal income tax." I wonder what will happen when all of these folks making all this money say, "I think I will retire. I’m through." Who is going to get taxed then? Maybe this is what ultimately happens when all of the wealth is finally redistributed. On my "first blush" consideration of Volcker’s comment, I thought about the county-wide 1% sales tax we had here for the Arena. I have to say, I don’t think it was that big of a deal…for anyone…and whether or not you agreed with the need for the Arena…look how quickly the Arena came to be as the result of this. Now I know a 15% VAT would be a bigger deal (probably somewhere around 15 times as big of a deal as Volcker’s example of 1% (smile)), but the thought of what he had to say didn’t alienate me. Maybe it should have. Maybe I’m too "thick headed." Don’t get me wrong…I am not a proponent for higher taxes…but I am a proponent for survival. Somehow, we have to have a massive, dual-effort of cutting spending and raising revenue before our national debt moves into the "junk bond" classification, if it hasn’t already. If it has…this is even more important. And as far as the administration of this tax is concerned, it is only a problem if you got a failing grade in 5th Grade Math. It is not rocket science. If I sell pizzas, I add the 15% VAT onto the selling price of my pizzas, less the 15% that was added onto the products I purchased to make the pizza (i.e. pepperoni, mushrooms, green peppers, olives, flour, etc.). How difficult is that? Enforcement would be equally as easy. How many pizza shop owners are there who can’t tell you how many pizzas they sell each day? Those that can’t are a moot point because they won’t be in business long enough to matter. Some of you are going to say, "A 15% tax? Are you kidding me? How will we ever afford it?" My answer is, "Unless we do something to reduce our Federal deficit and payoff our national debt, no other country will want to loan us money and pick up our debt. When we have finally taxed individuals and businesses to the "tipping point," which we will be at shortly, the only other option is to print more money. Printing more money makes it worth less, meaning it takes more money to buy the same goods and services. When this is the only option left, it quickly spirals out of control into hyperinflation. Whether we "stem this tide" with a 15% national sales tax, or a 15% VAT, it will look like a "green light special" when compared to the price you will pay for goods and services in the state of hyperinflation (i.e. $8 per gallon gas, $5 per loaf of bread, $6 per gallon of milk, etc.). While I am still in this "first blush" phase, I could be for a 15% VAT, or a 15% national sales tax, going into effect today, for the next 10 years, if the following conditions were met: 1) the tax is imposed on every purchase of every good and service, without any type of tax credits going back to any group of people. In other words…there would be no exemptions of any kind; 2) the tax can be decreased but never increased over 15%; 3) the Federal budget would not be increased one dime over the current 2011 budget, and for the next 10 years; 4) PAYGO would be strictly enforced (nothing is spent unless there is money in the budget from somewhere to pay for it); 5) taxes would stay the same as they are right now, as of this date, for every business and individual; 6) the proceeds go into the general fund and can never be earmarked for a special cause; and 7) for every dollar’s worth of revenue the tax brings in, the current year’s Federal budget must be cut 25 cents. The first six conditions should be easily understood. Let me explain the seventh in more detail. The Federal budget for 2011 is $3.6 Trillion, with estimated receipts of only $2.1 Trillion, creating a $1.5 Trillion deficit. It should be agreed upon by all that this cannot be sustained…over the short or long haul. The budget has a lot of "fat" in it…lots of "fat." But, so that we get everyone on board, let’s start with a "fat" budget (seldom do you get to do that in a bankruptcy because the bankruptcy trustee usually trims down the budget pretty tight (smile again)). Then, let’s change our lawmakers’ role in Congress from a "looters’-mentality-non-caring-about-the-future-spending-machine," to one that is based on prudence and fiscal responsibility. They will now spend their time as it relates to the financial affairs of our country, trying to reduce planned expenditures, instead of figuring out ways to steal, waste and support hidden agendas. Let’s hear re-election campaigns that say, "Vote for me…I introduced legislation and was successful in getting it passed, that reduced the Federal budget by $32 Billion, by forcing all lawmakers to give up two aides and one staff member each;" or, "Vote for me, I introduced legislation and was successful in getting it passed, that reduced the Federal budget by $46 Billion, by having expense accounts for all lawmakers reviewed and approved by the General Accounting Office (GAO), just like they are approved in businesses throughout our great country;" or, "Vote for me, I introduced legislation and was successful in getting it passed, that reduced the Federal budget by $128 Billion, by instituting a ‘National Earmark Review Committee,’ and having its findings approved by an oversight committee made up of Governors of the 6 poorest states." You see, whether we save by reducing the current year Federal budget’s planned expenditures, thereby not contributing that amount to the national debt; or we use the proceeds of the tax to directly pay down the national debt, it’s a "sleeve off a vest" kind of thing. When you give a sleeve off a vest, you’re not giving up anything…because there is no sleeve (just in case you didn’t catch it). All of this revenue goes to improve the financial condition of our country…one way or another. The only reason why the tax would be used to reduce our Federal budget deficit instead of it all going to reduce our national debt, is for the purpose of evaluating the job our lawmakers are doing…including the President. If they can’t figure out ways to trim a "fat" budget, get them out of there and get someone in who can. Because the Federal budget cannot be increased one dime for the next 10 years, our country’s financial picture, presently and for future generations, would get more "rosy" with each passing year. In one fell swoop, we would either balance (or come close to balancing) the current year’s Federal budget, and/or use the amount saved from the same to pay down the national debt. That’s it. There would be no "yabuts." It would just happen. Businesses would begin to thrive because there is actually a plan in place to make us more "healthy," and all that "healthy" entails. They would begin to invest in equipment and creating more jobs. The private sector will begin to spend and buy things. We would have the "roaring teens" in no time. Just having this plan on the books and implemented would do this. We wouldn’t have to wait for the results, but once they started to roll in…it would be a frenzy. No matter whether we do a VAT or national sales tax, if the mission is survival…and I have to assume it is…America is going to have to "suck it up" for the foreseeable future to get this country back in financial shape. No one likes to do this…but the "bill collectors" are not going to stop coming to our door. There has to be a price we pay for what a few of us have done. Once we begin this tax and get it working…we will lead the world again. Ask anyone familiar with federal budgets…if the theft, waste and hidden agendas are gone…we could run this country each year, for the next 30 years, on half of what the Federal budget is for 2011. What did I miss here? Write to me and let me know your thoughts. God willing, I will be back next month.