Adding a VAT

Josh Barro has a piece in favor of a Value Added Tax in Bloomberg. A VAT is a tax levied on business sales minus their inputs or costs, so all companies ‘adding value’ along the production chain pay the tax, but it is collected at the sale of the final consumer good. If you buy a sweater for $50 and the VAT is 10%, $5 of the $50 is the VAT.

In my book Balancing the Budget is a Progressive Priority, I didn’t suggest that we add a VAT, but I do think that it will take a substantial increase in tax revenue as a percent of GDP to ever have a balanced budget again. I suggest 21% of GDP, which is about 3 percentage points higher than the 40 year average, a level that is doable, but won’t be easy. Would a VAT be useful to consider? A key question, and a few thoughts.

  • Is the VAT viewed as a supplement to our current system of taxation (payroll taxes, personal and corporate income, excise taxes) or a replacement of some portion? I asked Josh Barro via twitter for his views, and he said he viewed the VAT as supplementing our current federal taxation regime, shown below. Individual income taxes and payroll taxes are the largest source of federal revenue, with corporate and excise taxes being much smaller (in percent of GDP terms).

Barro notes how difficult tax reform that increases revenue will be, whether it is in the individual or corporate income tax, because as much as people claim to support it in theory, most deductions and exemptions benefit those who are powerful. So, one strong positive of the VAT is that it could raise a substantial amount of revenue, and would not be as noticeable and its burden would be spread across all consumers. A negative is that it is a regressive tax (lower income have larger percentage of their income subjected to the tax).

I have suggested ending the corporate income tax, and treating dividends and capital gains as normal income, while raising the top personal income tax rate and thereby making it more progressive. I stand by the notion that the most important tax reform decision is determining what proportion of GDP will be collected in taxes. Within that overall level of taxation, distributional impacts are important. Currently, we have a regressive payroll tax and a progressive income tax as the two largest revenue raisers, so it could raise concerns to add another large regressive revenue raiser. Josh Barro has a follow up post in which he argues distributional/fairness concerns about the VAT are not as big a worry so long as you are not adding a VAT and doing nothing else. This argument makes sense at some level, but I haven’t read all the underlying work he cites, and Michael Linden is lots more skeptical on twitter about this and points to this document (that I need to read).

Whatever we concluded, this strikes me as the type of discussion we should be having; what level of tax will be collected to finance a plausible level of spending? Within that, what mix of taxes will be used? The hardest part of all this is imagining that our dysfunctional political system could ever have a reasoned discussion of these issues. That is demoralizing.

About Don Taylor
Professor of Public Policy at Duke University (with appointments in Business, Nursing, Community and Family Medicine, and the Duke Clinical Research Institute). I am one of the founding faculty of the Margolis Center for Health Policy, and currently serve as Chair of Duke's University Priorities Committee (UPC). My research focuses on improving care for persons who are dying, and I am co-PI of a CMMI award in Community Based Palliative Care. I teach both undergrads and grad students at Duke. On twitter @donaldhtaylorjr

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