A National VAT: A Socialist Republican Solution?

The United States certainly isn’t the only nation to struggle with sluggish economic growth and a daunting government deficit. Most of its fellow G-8 countries, including Japan, Britain, and the nations of the Euro currency zone, are doing so as well.

Among these countries, though, the federal governments of the United States and France might have the most in common. Both President Obama and President Sarkozy are preparing to fight grueling re-election campaigns, appealing to voters who have grown weary of years of grinding austerity. And Sarkozy is struggling to save his nation’s sterling AAA credit rating, a battle that Obama fought and lost during the American federal budget battles last summer.

Last week, the French President pushed through a sizable increase in his government’s Value Added Tax (VAT) burden, in an effort to finance his country’s social “safety net” programs without increasing the federal deficit. Considering how often Republican presidential candidate Mitt Romney labels Obama a “European socialist,” one might have assumed that the American President would support a similar policy.

Interestingly, though, only one American presidential candidate espoused the establishment of a new tax resembling a VAT. President Obama, ironically, was not that candidate.

Nine, Nine, Nine!

Republican Herman Cain was actually the candidate who called for the imposition of a 9% sales tax, accompanied by drastic reductions in the individual and corporate income tax rates to 9% as well. Although he was originally considered a minor candidate, the astonishing popularity of his tax plan briefly sent him skyrocketing to the very top of the polls before other considerations compelled him to quit the race.

Nevertheless, he was briefly perceived as the champion of conservative Republican politics, even though he espoused the adoption of a taxation policy that was far more similar to contemporary European taxation systems than to the traditional American system. By dropping out of the race well before the first contest in Iowa, though, his policy escaped the harsh scrutiny that it likely would have received eventually.

Because Mr. Cain modified his explanation of the “nine, nine, nine” policy from time to time, it is unclear whether his sales tax would have only been levied on consumer retail purchases, or whether it also would have been levied on business-to-business wholesale transactions. A retail levy would resemble a traditional American local sales tax, while a wholesale one would more closely reflect the style of a European social VAT.

Economic Theory

Placing politics aside, one may wonder how the choice of taxation methodology would impact economic health. To put it simply, would most economists prefer to see the American government rely overwhelmingly on a national income tax (as it does now) to finance its activities? Or would they prefer to see it shift towards a sales, VAT, or other consumption based tax?

Most economists are generally in favor of higher taxes on undesirable activities and lower taxes on desirable activities. Before the global markets crashed in 2008, Americans appeared to be spending far too much, and saving (and earning) far too little. Thus, the concept of a national consumption tax appealed to many economists at the time.

Now that recessionary declines in American consumption patterns have threatened the economic recovery, though, many of these same economists now believe that a national consumption tax would crimp consumer spending and thus deter economic growth. And many conservative politicians are loathe to approve any new taxes at all, fearing that the imposition of even minor new taxes will inevitably evolve into major new levies over time.

Simplicity and Fairness

Perhaps the most baffling aspect of Cain’s popularity, though, involves the reason(s) why conservative Republican voters embraced the “nine, nine, nine” policy at all. Considering that longstanding Republican policy advocates the rejection of any increase in taxation levels, why did those voters embrace the establishment of a new system of VAT taxation along with the maintenance of the existing system of income taxation (albeit at a lower 9% level)?

One reason might have been the attractiveness of simplicity itself. In an era when a majority of Americans are compelled to use terribly complex computer programs to compute and file income taxes, the sheer simplicity of a flat 9% tax rate must have been highly desirable to many voters.

Another reason might have been the ostensible fairness of a single rate that could be applied to all Americans. After all, Warren Buffet himself famously noted that he pays lower rates of income taxation than do his secretaries. Because the contemporary American system of income taxation is actually regressive in certain respects, a flat rate tax must have been highly desirable as well.

Regardless of the reason for its attractiveness, the sight of a conservative Republican candidate embracing a European styled VAT tax with the enthusiastic support of his “base” undoubtedly represented one of the stranger moments of a highly unusual political campaign season. At times of such high levels of voter discontent, we may well experience more such unusual moments in the days ahead.

Time for a VAT, America?

How did Americans celebrate April 15th, the national annual filing deadline for income taxation?

Some undoubtedly spent hours meeting with their accountants, and then stood on long lines at local branches of the United States Postal Service, waiting to mail their returns to Uncle Sam. Others joined the Tea Party protestors at various locations throughout the United States, and called for the abolishment of the Internal Revenue Service.

Many Americans indeed grumble about paying their taxes, but a system of taxation represents a price that must be paid to provide for a functioning federal government. Recently, though, some economists and financial advisors have begun calling for the imposition of an entirely new type of taxation.

Is it a federal property tax? Or a national poll tax? No, American economists have begun to suggest the implementation of a Value Added Tax. Although VATs are common in other western industrialized nations, they would represent an entirely new brand of taxation system in the United States.

What’s a VAT?

A Value Added Tax is similar to a sales tax, except that firms only collect and pay taxes that are based on the net values that they add to all items sold. Alternatively, in a system of sales taxation, firms collect and pay taxes on the gross values of their retail prices.

Is this a confusing distinction? Understandably so; VAT is indeed a bit more complicated than a sales tax; nevertheless, a simple example should clarify matters. Let’s assume, for instance, that a newspaper delivery boy purchases 100 newspapers for $100 and then resells them to his customers for $120. If the VAT tax rate is 10%, the newspaper publisher would charge the delivery boy an extra $10 and remit those funds to the government as a VAT tax. Then the delivery boy would charge his customers an extra $2 and, likewise, remit the funds to the government as a supplemental VAT tax.

Because the total amount of this tax would equal 10% of the gross sales revenue, it would be economically equivalent to a 10% sales tax. But the retail customers would not observe most (or, in some situations, any) of the VAT taxes detailed separately on their sales invoices, and thus would tend to consider them less intrusive (or, at a minimum, less irritatingly observable) than general sales taxes.

Economics Pros and Cons

So is a VAT a good idea or a bad idea? As with many such issues, economists have trouble agreeing on an answer to this question!

Many American economists dislike income taxes in general because, by taxing income generation activities, the federal government effectively prevents its citizens from enjoying the full fruits of their labors. Instead, such economists prefer consumption taxes such as sales and VAT taxes because consumption taxes tend to discourage spending activities instead of earning activities.

Of course, these recommendations apply specifically to American consumers, who are generally known for spending much of their earned compensation and saving little of it. Conversely, economists often prefer that Asian nations rely more on income taxes than consumption taxes because Asian citizens are generally known for spending little of their earned compensation and saving much of it.

In a broader context, American economists also disagree about whether consumption taxes should replace income taxes or (alternatively) supplement them as additional sources of government revenues. Conservative economists who believe that the federal government should be downsized only tend to support VAT proposals that replace the current income taxation system. Liberal economists, though, believe that the federal government should maintain or expand its current size; they tend to support the maintenance of the existing income tax system alongside a newly implemented VAT system.

Will They or Won’t They?

So what will Washington DC do? Will American politicians implement a new VAT system throughout the United States? The answer to that question may actually be more dependent on the future of the social safety net than on theoretical economic and taxation policy.

This is because most economists and other commentators agree that the bulk of the federal government’s projected budget deficits are attributable to the expanding social programs. If Washington DC fails to rein in its future spending obligations on these programs, it may have no choice but to institute a VAT system alongside the current income taxation system in order to increase its revenue base and finance these growing expenditures.

On the other hand, if Washington DC actually manages to reduce the future cost burdens of these social programs, then it may be able to afford to consider the complete abolishment of the entire system of income taxation and its replacement by a streamlined VAT system. Because conservative and liberal American economists theoretically agree on the preferability of the VAT methodology over an income taxation methodology, this dramatic step may prove to be a relatively popular one.

In the meantime, though, Americans will continue to mark their calendars every April 15th as Income Tax Filing Day … as well as April 16th as a national day of relief!