Value Added Tax Will Mean More Government

With the growing mega-sized debt load in the US, and the passage of the health care bill, lawmakers are scrambling for ways to generate new revenue. And, from the look of it, Washington seems to have rested its eye on a solution from Europe, the value-added tax (VAT).

The VAT is a tax on consumption which, from an economic perspective, should be better for the economy than income taxes. However, that’s only the case if the VAT replaces other taxes… which is unlikely.

According to The Wall Street Journal:

“In the U.S., VAT proponents aren’t calling for a repeal of the 16th Amendment that allowed the income tax—and, in fact, they want income tax rates to rise. The White House has promised to let the top individual rate increase in January to 39.6% from 35% as the Bush tax cuts expire, while the dividend rate will go to 39.6% from 15% and the capital gains rate to 20% next year and 23.8% in 2013 under the health bill, from 15% today. Even with these higher rates, or because of them, revenues won’t come close to paying for the Obama Administration’s new spending—which is why it is also eyeing a VAT.

“One trait of European VATs is that while their rates often start low, they rarely stay that way. Of the 10 major OECD nations with VATs or national sales taxes, only Canada has lowered its rate. Denmark has gone to 25% from 9%, Germany to 19% from 10%, and Italy to 20% from 12%. The nonpartisan Tax Foundation recently calculated that to balance the U.S. federal budget with a VAT would require a rate of at least 18%…

“…The very efficiency of the VAT means that it throws off huge amounts of revenue that politicians eagerly spend. The VAT thus becomes an engine of even greater public spending. In Europe, average government spending was about 30.2% of GDP when VATs began to spread in the late 1960s. Today, those governments are more than 50% larger, with spending of 47.1% of GDP on average. By contrast, U.S. government spending (federal and state) rose to 35.3% from 28.3% as a share of GDP in the same period.”

The VAT has the potential to be an enormous cash cow for the government. Although the revenue generated could be put to good use, like a stepped up effort to reduce debt and deficit, it’s more likely to just make a big government even bigger.

You can read more about the likely sequence of events in The Wall Street Journal’s coverage of Europe’s VAT lessons.


Rocky Vega,
The Daily Reckoning