Andrew Mancini & Daniel Malo
1 October 2012
Value Added Tax
American Exceptionalism has been part of United States history since our victory over The British in The Revolutionary War. America has always aspired to set the global standard in everything it does. When it comes to the tax system however, America is behind the rest of the world. The United States heavily relies on taxing income to raise revenues and the only significant taxes on consumption are at the state level. Most countries have some form of a value added tax (VAT), generally accepted as the best form of consumption tax, which provides many benefits over the income tax. The VAT is better for businesses and could promote more production here in the United States while at the same time, level the playing field with foreign companies here and abroad. The VAT is also more efficient and better at capturing revenues from people that have an ability to pay when compared to the income tax in place now. This paper will focus on discussing the benefits of a value added tax when compared to the current income tax system but will also address some of the weakness with the tax and attempt to show that they are not that significant.
Better for Business
A VAT provides a significant advantage for countries in global trade. The VAT is most beneficial because of its border adjustability. The tax is subtracted from exports and added to imports (Haimowitz 4:30). “A VAT works like an export subsidy for foreign exporters and an import tariff at the same time,” (Economyincrisis.org). A good example of how the VAT affects trade is described in a video on Taxreform.org. A $50,000 dollar car is produced in Germany and about to be shipped to China. Upon leaving Germany, the 19% VAT in Germany is returned to the car manufacturer, making the price of the car $42,000. When the car reaches China, the 17% value added tax in China is assessed on the car making the price for sale in China $49,000 (Haimowitz 5:50). This example shows the advantages of the VAT. Without it, the German car would cost $58,500 in China.
Since the United States has a corporate income tax and its trading partners operate with a VAT, the United States is at a major competitive disadvantage in global trade. “The U.S. corporate income tax tends to decrease exports and increase imports (by definition, therefore, hurting U.S. trade competitiveness)” (Nicholson p26). As it currently stands, over 150 nations use the value added tax (Economyincrisis.org). The United States is the only OECD country that does not have some form of a VAT (Nicholson p2). For the most part, this covers every country that the United States trades with. As it stands, there are no tax deductions for products being exported from the United States but these same products will be hit with a foreign countries VAT when they arrive there (Haimowitz 6:50). “The VAT ranges from 5% in Canada and Japan to over 16% in China, Mexico, Spain, Italy, and the UK” (Haimowitz 7:05). This makes U.S. products more expensive. At the same time, imports coming into the United States from other countries receive a tax rebate equivalent to that country’s value added tax rate. Upon arrival in the United States, there is no value added tax placed on these imports by the United States, giving imports a price advantage over U.S. produced goods (Haimowitz 6:50).
This system provides a competitive advantage to foreign countries. United States companies have been paying while companies in countries with a VAT in place have been saving. “In 2006, foreign nations collected VAT rebates totaling $218.2 billion while American companies were forced to pay $122.4 billion in taxes due to the VAT. Each year the VAT imposes an average of $290 billion burden on our goods exported and another $85 billion on services,” (Economyincrisis.org). Under this system, United States companies are outsourcing in order to avoid the disadvantages of producing in the United States. At the same time, the United States is a less attractive place for foreign companies to produce goods. A VAT in the United States could help with keeping jobs here and increase the advantages to producing in the United States. With a national unemployment rate of 8.3% and the current national debt of over 16 trillion dollars, it is something to strongly consider.
More Money In Your Pocket
The VAT is foremost about paying a tax on goods consumed, rather than paying that tax through deductions from income. It can be favorable to the consumer in that they might notice more net income in their paycheck, possibly encouraging personal savings but also increasing one’s fluid spending ability. These two positives externalities of the VAT have the potential to assist contemporary (and timeless) concerns of retirement savings and economic vibrancy, by offering stronger personal savings stewardship and more spending ability in the local economy. The VAT can possibly be an economic engine, and necessary for a stable economy, hedged across the spectrum of taxable consumer purchases; foremost, it puts more money in people’s pocket, saved or spent, either is an investment.
Of course, these potentials come only in lieu of lowering or removing income and corporate taxes, in favor of a ‘light’ or total VAT system. A system as such would allow for more spending by companies, as well as making them more competitive with other VAT countries. The ‘lost’ taxes could then allow for the phase-in of consumption taxes, generating revenue on increased purchases. Even a slow adoption of the taxation model would reward handsomely and make our current tax structure closer to parity. For example, in 2009 the United States imported $1.9 trillion worth of consumer goods. A nominal VAT of just 10 percent could have raised $190 billion from those imports.
Uncle Sam Needs You!
The VAT captures a consumer’s ability to pay by levying a consumption tax on goods that might otherwise go untaxed. Under a VAT system everyone would pay into the ‘pool’ with every purchase. It can theoretically be applied across all types of purchases, such as homes, cars, computers, and exotic goods; there are ethical considerations to be made regarding items of human necessity. The VAT can simplify tax structure for all parties, easing the burden, cost and size of tax administration and enforcement. Rather than a system of deductions, subsidies, and rebates; corporate accounting and loopholes, the VAT proposes a more efficient revenue collection scheme.
Under our current income tax structure, many people make no tax contribution, such as students, tourists, or workers in the country illegally. This gives equity to the system by inducing their participation in reciprocity for receiving many of the benefits that others’ income taxes pay for. There is less ‘deadweight’ in the financing of public spending, HOWEVER when implementing policy, we should remain cognizant of the real economic burden on those groups, so that they aren’t ‘outpriced’ from purchases. If the rate of taxation is not ‘fair’ it will be unworkable by intrusion of underground economies and decreased purchasing, and only serve to the detriment of the policy.
The Value Added Tax is a form of consumption tax. The main problem with consumption taxes is that they are both horizontally and vertically unequal. The vertical equity problem is that it would be a regressive tax by nature. The lower a family’s income, a higher proportion of their income will have to be spent on consumption goods. This means that lower income families will pay a higher proportion of their income to taxes. In general this is not a good thing. There are measures that can be taken to reduce the regressive nature of the tax. No tax on food and water is a good start. Also, lower tax rates could be placed on items that are essential for households such as kitchen appliances. At the same time, higher tax rates can be enforced on luxury goods such as expensive clothing, fancy cars, or jet skis.
The horizontal equity problem is that tax rates amongst people with the same ability to pay can be different based on lifestyle. With a consumption tax, a person that saves more will pay fewer taxes than a person who likes to spend a lot of money. We can conclude from this that a consumption tax would encourage people to save and invest which is not necessarily a bad thing. For example, Social Security cannot provide enough income for people when they retire. If Americans save more money under the VAT, it will reduce some of the pressures on the Social Security system, a big problem for our country right now.
The Value Added Tax has the potential to be an economic catalyst for our country when properly implemented. It would better leverage American companies to compete against foreign VATS levied nearly everywhere else in the world. It would keep more cash for spending or savings for the individual and their local and state economies. The VAT keeps taxation equitable and collective. Acknowledging the regressive-ness inherent in the tax, attempts could be made at the taxation of the most expensive and most copious products, again, capturing an individual or company’s ability of means to pay. That the United States is not working with a highly effective VAT system, wherein the rest of the world does, can remind one of our stubbornness to accept the global measuring standard, the metric system–in favor of the Imperial approach. Folks familiar with that issue might recall a NASA blunder where our measuring errors were responsible for a multi-billion dollar Mars mission failure. Similar to our healthcare system, our global neighbors, and our stagnation towards a universal single-payer delivery and management program which would bring equitability and parity to our ‘American Exceptionalism Dream’. We should embrace all of these approaches, especially concepts like the VAT, and we must also make them our own, because they are practical and fair, and would make that vision closer to reality.
Economyincrisis.org. “Value Added Tax (VAT)”. Economy In Crisis. Web. 29 September 2012
Haimowitz, Sara. “Value Added Tax (VAT): Fair Trade, Jobs & Growth”. 17 August 2012. Online Video Clip. Trade Reform. 29 September 2012
Nicholson, Michael W. “Value-Added Taxes and U.S. Trade Competitiveness”. Forum for Research In Empirical International Trade. July 2010. Web. 29 September 2012