NCPA - National Center for Policy Analysis

IS A VALUE-ADDED TAX THE ANSWER?

July 13, 2010

The Obama administration has made it clear that after the fall election its solution to trillion dollar deficits is going to be a value-added tax (VAT).  But is that a good idea, asks John C. Goodman, President, CEO and the Kellye Wright Fellow for the National Center for Policy Analysis? 

What will the tax rates have to be if we stay on the present course and try to fund excess government spending with a VAT, a payroll tax or some other form of a consumption tax?  According to estimates from economist Larry Kotlikoff and his colleagues: 

  • In the United States, the average tax on wage income will rise from 40.6 percent today (that's a 15.3 percent payroll tax plus a 15 percent income tax plus state and local taxes) to 55 percent by 2030 and 62.1 percent by midcentury.
  • If Europe follows the same path, the average tax on wage income will rise from 60.1 percent today to 72.5 percent in 2030 and 79.3 percent by 2050. 

And note that these are average tax rates.  Marginal rates will have to be even higher, explains Goodman. 

Every tax discourages economic activity and the VAT is no exception.  Based on a review of the literature, Randall Holcombe, the DeVoe Moore Professor of Economics at Florida State University, calculates that a 10 percent VAT lowers the rate of economic growth by 10 percent.  Based on this relationship, he finds that: 

  • After a 20-year period (by 2030), the loss of annual gross domestic product (GDP) for the United States from a VAT would be more than twice as much as the revenue collected.
  • Moreover, at a lower than otherwise GDP, all revenue from all taxes would be lower, including state and local taxes.
  • Considering all these effects, the net revenue to the government from a 3 percent VAT would be about one-tenth the loss of output for the economy as a whole in 2030.
  • A 7 percent VAT, designed to bring in $915 billion in 2030, would in fact net less than one-third of that amount. 

Source: John C. Goodman, "Is a VAT the Answer?" Health Policy Blog, July 12, 2010. 

For Goodman text:

http://www.john-goodman-blog.com/is-a-vat-the-answer-the-commission-part-iii/?utm_source=newsletter&utm_medium=email&utm_campaign=HA#more-11710  

For NCPA text:

http://www.john-goodman-blog.com/how-bad-is-our-fiscal-crisis/  

For Holcombe report:

http://mercatus.org/sites/default/files/publication/VAT.Holcombe.pdf 

 

Browse more articles on Tax and Spending Issues