Tuesday, November 17, 2015

A case for a Value Added Tax

The very fact that I post this in response to Catherine Rampell's editorial in this morning's Daily Star might identify my total lack of credentials in the area of tax policy. But charging ahead ...

A value-added tax, or VAT, is a tax on consumption. It’s sort of like a sales tax. But rather than being collected only when a product is sold to a consumer, the tax is paid at each stage of the production process based on how much "value" has been added to that product — for example, by spinning cotton into cloth, or sewing that cloth into a T-shirt.

Even though the tax is collected at various stages of production, economists believe it is generally borne more by consumers than businesses. Companies pass on the cost of the tax in higher prices down the production chain, keeping their profit margins roughly unchanged.

More than 160 countries, including every developed country except the United States, has some form of VAT. The VAT is also one of the first proposals out of the International Monetary Fund’s bag of tricks for countries that need to raise money.

That’s because it’s a really, really useful tool.

Because it is born by consumers, the knee-jerk reaction is to label it as regressive. But Rampell reacts with a point about income tax.

The main downside of a VAT is that it hurts the poor more than the rich, because the poor spend a larger share of their incomes on basic necessities.

There’s an easy way to counteract that problem, though: Just make the income tax system more progressive. What matters is the progressivity of the entire system, rather than any one component. Unfortunately, both [GOP presidential candidates] Paul and Cruz [who advocate some form of a VAT] want to make the personal income tax less progressive, too.

Relative to the occasional GOP push for a "flat tax" (as in Arizona), the VAT seems to be a more reasonable tax system. It does seem at least less regressive than the flat tax.

Now if we could just get our political leaders to get over their Europhobia we might be able to take a serious look at a comprehensive tax reform. Rampell concludes:

There’s only so much revenue a country can wring out of an income tax system. A well-designed VAT could help get our fiscal house in order.

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