IS A VALUE-ADDED TAX THE ANSWER?
August 3, 2010
All over the developed world, countries are facing an extremely unpleasant budgetary reality: Per capita health care spending is growing at twice the rate of growth of per capita income. The Obama administration has made it about as clear as it is going to get 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 at the National Center for Policy Analysis.
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, measured in gross domestic product (GDP):
- After a 20-year period (by 2030), the loss of annual 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.
Holcombe concludes that higher taxes don't really bring in that much additional revenue. Instead of growing the government, they shrink the private sector.
Imposed on top of existing taxes, a VAT would lower the rate of economic growth and therefore reduce the standard of living below what it would be otherwise. But it would do nothing to change the health care spending path we are on. Unless we find a way to reduce the rate of increase in health care spending (something the Obama administration has been loath to do), imposing a VAT would be a case of "all pain, no gain," says Goodman.
Source: John C. Goodman, "Is a VAT the Answer?" National Center for Policy Analysis, Brief Analysis No. 715, August 3, 2010.
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