Debate: Spending, Not Taxes, Is the Problem

(April 14) -- Widely used in Europe, the value-added tax (VAT) has always seemed a nonstarter in the United States. That may be changing given apparently insurmountable structural deficits and fear that the financial collapse of Greece could happen here if revenue isn't increased.

These days, the VAT is being taken seriously even by pro-market conservatives and libertarians.I do not agree with their arguments, but they present an interesting challenge.

The VAT, started in France in 1956, is a tax on the transfer of goods and services that ultimately is borne by the consumer. As such, it increases the cost of just about everything, from your bread and cheese to a visit to the hair salon.

As I have explained in a previous article for Reason, liberals and big-government enthusiasts like the VAT precisely because it's so ubiquitous (and because it's typically layered on top of existing taxes, rather than being substituted for them). For pro-market folks, the VAT is appealing only if its funds are mostly used for deficit reduction and, hence, avoiding a Greek-style collapse brought on by unsustainably large public-sector debt.

The VAT does have some appeal.

Because it taxes consumption rather than income, it is a better tax than an income tax, which penalizes savings and investment. It is also a fantastic revenue-raising machine.

And, as an article published in the National Tax Journal by Michael Keen and Ben Lockwood shows, the VAT in itself doesn't appear to be causing the growth of government in countries that have it.

My opposition to the VAT comes mainly from the disbelief that a new tax is the way out of debt.

First, it is tempting to note that Greece collapsed in spite of having a 19 percent VAT since 2005. This is quite different from arguing that Greece wouldn't have failed if it didn't implement a VAT. There are many examples of countries that implemented a VAT and didn't collapse. However, it gives some evidence that the added revenue from the VAT wasn't used to reduce the country's debt and ultimately change its course.

Second, there's little to no chance that the government could credibly commit to assign even a share of any new VAT revenue to deficit reduction.

Take President Barack Obama's first budget, released last year. In it, he assumed that most of the $600 billion coming from proposed cap-and-trade fees would be allocated to deficit reduction. A year later, his budget still assumes the revenue (even though the law is not yet passed), but all of it has been allocated to spending programs, not to reducing the deficit. A government that cannot commit fictional revenue to deficit reduction is unlikely to do so with actual money either.

Besides, even if the government could credibly pledge VAT revenue to deficit reduction, a VAT would not even start to address our problems.

Projections by the Tax Policy Center show that a 5 percent VAT in the United States would raise more than $3 trillion in the next 10 years. However, the Office of Management and Budget shows that we would need an additional $5 trillion in revenue to fill the gap. Even a 10 percent VAT wouldn't be enough to cover our short-term deficits.

Also, our real financial troubles only kick in when baby boomers start retiring and Medicare costs skyrocket (see the chart here). The revenue raised by a VAT wouldn't even start to cover this spending explosion.

In other words, if advocates of the VAT are serious about fixing our current fiscal crisis, they shouldn't be asking for a VAT alone but for a VAT and a credible commitment (one that no one can renege on once the VAT is in place) to dramatically cut spending. Short of such commitment they can't be taken seriously.

More importantly, focusing on revenue mechanisms such as a VAT in deficit-reduction discussions misses the fundamental point that spending, not revenue, is the cause of our financial troubles. Looking for new sources of revenue moves our attention from what needs to happen now: slow or stop spending increases and reform entitlements, sooner rather than later. For all these reasons, I am against the VAT.

Veronique de Rugy is a senior research fellow at The Mercatus Center at George Mason University. She can be reached at vderugy@gmu.edu.


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