VAT Is a Tax With Appeal for Liberals, Conservatives

Although most presidential candidates are scrupulously avoiding the T-word, a tax increase of some kind is likely to be the first order of business for the next administration.

Economists of all stripes agree that the wobbly dollar and the huge trade imbalance are both the result of the continuing federal deficit. The Gramm-Rudman law requires the federal deficit to drop all the way to $90 billion in 1990, which will require either spending cuts or tax increases totaling an estimated $60 billion dollars. There is no way Congress can get that kind of money out of spending cuts.

On the contrary, a long list of deferred public needs is demanding attention. A good case can be made for a modest spending increase, to finance everything from day care, to better education, to welfare reform, to public infrastructure, to long-term nursing home care for the aged.

What sort of tax should Congress enact? An emerging coalition of unlikely bedfellows thinks the best idea would be a value-added tax, or VAT, which is a kind of national sales tax.

Conservative business groups like a VAT on two counts. First, it diverts the pressure for new taxes away from business. In the absence of a VAT, Congress might continue the process begun in the 1986 tax reform, of eliminating business tax loopholes.

Second, they like the VAT because taxing consumption creates an incentive to save, and a higher rate of savings makes investment capital more plentiful.

Interestingly, many liberals, who in the past dismissed value-added taxes as regressive, now see a VAT as the best avenue for quickly restoring public spending. In fact, a VAT needn’t be regressive. It is possible to turn a VAT into a progressive tax, either by taxing different kinds of products at different rates or exempting necessities such as food. It is also possible to give every household a refund of value-added taxes paid on, say, the first $10,000 of all consumption. That would leave poor families with no value-added tax bills, and moderate-income families with a big exemption. And Congress could also use some of the revenue from a VAT to reduce the burden of the payroll tax, which is our most regressive tax.

A VAT could also turn out to be the lowest common denominator for the new bipartisan commission created under last December’s budget summit. The 12-member commission is charged with giving the incoming President a blueprint for reducing the deficit. Lately, business lobbyists have been talking of a grand VAT coalition--made up of liberals who want new spending, conservatives who want to preserve or enlarge business tax preferences, and budget balancers who want quick reduction of the deficit. A 5% VAT could raise on the order of $80 billion, and provide money for all three causes.

Liberals, who learned in elementary economics class that consumption taxes are to be avoided, would be wise to reconsider a VAT. Western Europe tolerates much more generous levels of public spending--and higher private savings rates as well--largely because European tax systems rely heavily on value added taxes.

At the same time, conservatives are wrong to view a VAT merely as a substitute for further tax reform. The 1986 reform closed a number of loopholes, but not all of them. We need to maximize the revenue base that now exists and insist that the well-to-do pay their share. For example, it makes good sense to tax the capital gains on inherited stocks (which now escape taxation). That would raise $10 billion annually. There is also a good case that the top rate on income tax, which drops to 28% in 1988, should be kept at a higher rate for very wealthy people.

As our lawmakers finally come to terms with the need for new taxes, they should avoid two traps. First, they should not assume that every nickel of new revenue must go for deficit reduction. We also need to restore domestic spending. And Congress should not view a VAT as an alternative to additional tax reform. Indeed, only if we combine a VAT with loophole closings will there be enough revenue both to resolve the deficit and to finance necessary and popular spending programs.