Value Added Tax (VAT) on the table
By: Daniel Murdock
Libertarian Party Intern
Recent estimates have raised the federal deficit to unprecedented levels, however, the Obama administration continues to push costly government goals, like health care reform. The prospect of increasing debt has forced Federal Reserve Chairman Paul Bernanke to warn that, "unless we demonstrate a strong commitment to fiscal sustainability in the longer run, we will have neither financial stability nor healthy economic growth." Such warnings have led congressional members and the administration to consider all avenues to increase revenue. While the Senate Finance Committee recently declined to include value-added taxes (VAT) as a possible source of government revenue, many Washington policymakers, including Paul A. Volker, chairman of the Obama administration’s tax system task force, are carefully re-examining the potential of a value-added tax. Some individuals, like Senator Kent Conrad (D-N.D.), have gone so far as to say, “I think a VAT…has got to be on the table.” Currently, over a 130 countries use varying forms of value-added taxation; still, the detrimental effects a VAT has on income and investment have previously prevented the United States from seriously considering such a tax.
A VAT taxes all the value added to a product throughout its production, distribution, and sale. Many states also apply VAT to the provision of services, like restaurants or hotels. While VAT applies to businesses, industry automatically shifts the tax burden to consumers. As a result, economists often consider a VAT as a consumption tax. The implementation of a value-added tax would increase government revenue, but it would also have negative repercussions on investment, inflation, and real income.
Because a VAT places a levy on all goods and services, prices artificially increase, resulting in a decrease in real and disposable incomes. Price increases would also reduce the demand and consumption of goods. Businesses would have smaller revenues, and therefore, smaller profit levels. Consequently, businesses would be less willing to make significant investments in new technology or workers. If consumption falls too drastically businesses may not only create fewer jobs, but they may even reduce their workforce, contributing to the current job loss situation.
A value-added tax will decrease product consumption, but the implementation of a VAT would also cause one of the most feared forces of the market: inflation. Data from the Bureau of Labor Statistics currently places inflation at -0.7%; however, many consider the real inflation rate, which includes food, fuel, and other goods not included in the Consumer Price Index (CPI), to be several percentage points higher. If the federal government immediately implemented a 25% VAT, CPI inflation would instantly be 24.3%. Such a dramatic inflationary rise would create massive problems for both businesses and consumers as the value of the dollar drops. Future increases in the VAT rate would also contribute to excessive inflationary forces further reducing the buying power of Americans.
While a VAT has many obvious damaging effects, such tax systems are also open to government exploitation. Unlike sales tax, which can easily be seen on a receipt, value-added taxes are considered part of the production cost of a good or service. As such, it is impossible for regular consumers to determine how a value-added tax affects the price of the final product. Because the amount of taxation remains hidden, governments come to view a VAT as an easy and painless source of revenue, providing an incentive and opportunity for governments to expand by increasing the VAT. For example, in 1962 Denmark implemented a 9% value-added tax; however, that rate has gradually increased until its current level of 25%. Similarly, within the past decade, Fiji has increased its VAT rate by 25%. Eventually, government exploitation of a VAT may have disastrous results for the economy.
While the current deficit is a major concern, the Obama administration would be more prudent to implement massive government spending cuts instead of introducing harmful value-added taxation. Under the current circumstances, a VAT would exacerbate the current economic meltdown. Now is not the time for extreme and costly measures. Governments, at all levels, must reduce spending and become more fiscally responsible.