America needs a VAT


Does America need a VAT? The short answer is “yes.”

Influential figures, including Bruce Bartlett on the right, Paul Volcker in the center and House Speaker Nancy Pelosi on the center-left, have suggested that a value-added tax of the kind used by other modern governments be considered as a principal means to reduce the federal deficit. Although the White House has emphasized that there are no immediate plans for a VAT, President Obama told CNBC that a VAT is one of the major tax-reform alternatives being considered to close the budget gap.

But the case for adopting a federal VAT does not rest on deficit reduction alone. Even if overall tax receipts do not go up, a modest, sensitively framed VAT that reduces corporate income taxes and/or reduces payroll taxes has the potential to make the American tax system fairer and more efficient, as well as much friendlier to those enterprises that can most effectively resuscitate our broken economy right now.

A value-added tax is a consumption tax, like a sales tax. But because a VAT is collected at each stage of the production of a product, it avoids the problem of “cascading” sales taxes on top of sales taxes. If a sales tax were 5%, then a farmer who sells wheat to a baker for $100 would pay $5 and the baker who used the wheat to sell bread for $200 would pay $10. However, a VAT of 5% on the final sale of the bread for $200 would be collected in portions at each stage of production: $5 from the farmer and $5 from the baker, adding up to $10 in total. Even a narrow-based VAT that exempts necessities like food or children’s clothing can collect large amounts of revenue with relatively low rates, and it’s also a lot harder to “game” or evade than an income tax.

Our current corporate income tax system inspires large-scale tax evasion while generating surprisingly little revenue. Over the last generation, most of our foreign commercial rivals and trading partners have sought to attract overseas investment and retain domestic production by slashing their corporate income tax rates. The U.S. stands almost alone with one of the highest corporate income tax rates in the world. This provides an incentive for companies to move production out of the United States and play games with shell corporations. In the process, both the American economy and American workers lose.

While many of the jobs we’ve already lost to other nations are probably gone for good, if we used a VAT to replace part or all of the corporate income tax, it should at a minimum be easier to hold on to the jobs we still have and to create new ones. A study by Eric Toder and Joseph Rosenberg published in March by the Urban Institute-Brookings Institution Tax Policy Center and the New America Foundation shows how.

Even if, in enacting a VAT, Congress narrowed the base and exempted necessities, a modest VAT could still pay for substantially reducing the current 35% U.S. corporate income tax, with the very positive result that both the cost of doing business in the U.S. and the incentive for offshoring production would shrink.

A narrow-based VAT could in turn also serve to substantially reduce the employer portion of the payroll tax from its current level of 6.2%, which would stimulate businesses to start hiring again. Any Social Security revenue lost in the process could be raised in other ways, such as by lifting the cap of $106,800 on employee earnings subject to the payroll tax. Because most economists agree that employers pass on the cost of the employer half of the payroll tax to their employees, a payroll tax cut would reduce taxes for workers even as it lowers the cost of hiring by employers.

The best approach, however, seems to be a VAT that at the same time reduces both corporate-income and payroll taxes. For example, a narrow-based 5% VAT could be “apportioned” to significantly cut the corporate income tax from 35% to 25.6%, while at the same time slashing the employer portion of the payroll tax from 6.2% to 4.5%.

Replacing growth-choking taxes with a modest VAT could be the basis of a new grand bargain between progressives — who oppose slashing programs that millions of Americans depend on more than ever — and pro-business conservatives, who favor lower corporate and payroll taxes. Progressives need to concede that a good tax system is one that encourages investment, growth and jobs, not one that intrinsically soaks the rich and punishes corporations. Conservatives, in turn, need to concede that additional government revenues need to be raised, preferably by taxes like a VAT that least distort economic decision-making.

A modest VAT will not by itself solve the nation’s long-term deficit problem. That will require, first and foremost, controlling the escalating costs of the American healthcare sector, which make U.S. goods and services far more expensive than in other countries. Introduction of a federal VAT would also need to be coordinated with reductions in sales taxes by states that might share the new revenue, and increases in overall taxation should wait until the American economy is out of intensive care.

That said, however, a modest VAT on the order of 5% that reduces both corporate income and payroll taxes and includes thoughtful exemptions would, perhaps more than any other single systemic initiative, spur investments, help America grow its way back to good economic health and materially reduce the deficit. It warrants the active and energetic support of the Obama administration and Congress.

Leo Hindery Jr., chairman of the U.S. Economy/Smart Globalization Initiative at the New America Foundation and a member of the Council on Foreign Relations, is an investor in media companies. Michael Lind is policy director of the Economic Growth Program at New America.