Nearly every major economy around the world except the U.S. has a tax on consumption, also known as a value-added tax or national sales tax. With a structural deficit that will likely surpass the size of the gross domestic product this year, is it time for the U.S. to start taxing consumption instead of income? In an interview with News Bureau Business and Law editor Phil Ciciora, U. of I. law professor Richard L. Kaplan, an expert on taxation and retirement issues, examines the likelihood of the U.S. adopting a value-added tax.
How much viability would a value-added tax have in Washington right now?
The value-added tax is a proposal that has found a lot of favor among academics but virtually none among politicians. It's been written about for well over three decades but there is still tremendous resistance to this idea in Washington.
President Reagan's Treasury department did an exhaustive study of the VAT in the run-up to what became the Tax Reform Act of 1986, but concluded that it was not worth proposing. Nearly 20 years later, President Bush's tax reform panel looked at a national retail sales tax as well as a value-added tax. In both cases, the panel concluded that these alternatives were not worth pursuing.
What's the appeal of a value-added tax?
As a general matter, most people prefer a tax that they expect not to owe. Thus, taxing consumption appeals to folks with a strong savings propensity. More broadly, some policymakers believe that society benefits when personal savings are increased, so they prefer a tax system that rewards this behavior instead of an income tax, which tends to penalize savers.
Furthermore, countries that have a VAT have found that it has been a very effective way of raising revenue without upsetting the populace so much because it is less obvious. The VAT is not like a sales tax, which hits you in the face each time you buy something. Instead, a VAT is embedded in the price of a good or service.
At the same time, we already tax consumption at the state level through sales and use taxes. There are also federal taxes on cable service, telephone, tobacco, alcohol and gasoline, among others. A value-added tax would be an additional tax imposed on all goods and services.
How difficult would it be to implement such a tax?
Although the concept of a value-added tax seems fairly straightforward, it becomes more complex when the rubber meets the road of implementation. For example, a VAT would have a huge impact on older Americans who typically spend a lot of money on medical services. Should such purchases be exempt? If so, what about college tuition that younger families typically pay? Or for that matter, what about home purchases?
Experience with a VAT in other countries has shown that politicians are still likely to indulge their inclination to hand out legislative favors. So, if your district includes a major manufacturer of sailboats, a VAT exemption for sailboats will be important to adopt. Other legislators will see the VAT as an opportunity to distinguish, say, between beer and wine and put a higher tax rate on beer to discourage youthful drinking.
The point here is that a VAT is not a path out of the tax complexity maze; it is just a different maze. And as long as it is Congress that is writing the VAT, which the Constitution requires, then there will be special exemptions and rate reductions, and that is really what complicates the tax law.