Value-added: the tax increase that may fly

[DEDixon 39]

Americans on Thursday may be filing the lowest taxes they will ever see again. Experts say big tax hikes are inevitable, likely a European-style value-added tax, which resembles a sales tax on steroids.

Paul Volcker, an economic adviser to President Obama, let the VAT cat out of the bag last week when he said a value-added tax is less "toxic" than it once was. Obama budget chief Peter Orszag quickly backtracked Friday, telling the Economic Club of Washington that the former Federal Reserve chief was not speaking for the administration.

Volcker's comment was a classic Washington gaffe, defined as a politician accidentally telling the truth. The budget arithmetic is ruthless. The federal government is adding an average of $1 trillion in debt each year. Neither party has a plan even to stabilize the deficit. Many experts describe a looming "calamity" that will force action.

Sens. Ron Wyden, D-Ore., and Judd Gregg, R-N.H., are pushing income tax reform to forestall a value-added tax.

"Be prepared for a tax increase in the range of $750 billion a year in today's dollars," said Bruce Bartlett, a supply-side advocate and former official in the Reagan and George H.W. Bush administrations. That assumes equally large spending cuts that would slash programs much as state and local governments are slashing services now.

"Anybody with the slightest familiarity with real-world politics knows we need some kind of deal to both raise taxes and cut spending in about a 50/50 ratio," Bartlett said.

A value-added tax remains plenty toxic politically. It is levied at each stage of production, unlike a sales tax, which is paid at the cash register. It can raise vast sums and is far less visible to consumers than a sales tax. Every 1 percentage point raises roughly $100 billion, so a 10 percent value-added tax could erase deficits for now.

Worldwide strategy

Rates in Europe range from 6.5 percent in Switzerland to 25 percent in Denmark and Sweden. Most countries, from China and India to Australia and New Zealand, use value-added taxes.

Imposing one in the United States would require Obama to renege on his pledge not to raise taxes on the middle class. Republicans pounced on Volcker's comment as evidence that Obama is seeking a locomotive for a European-style welfare state.

Budget experts say the sooner Democrats abandon their fantasy that the rich can finance social programs, and Republicans abandon theirs that slashing benefits for the elderly and poor is a politically viable alternative, the lower the tax increases are likely to be.

Need tax to pay bills

"There's no way we're going to be able to pay our bills without it," said Len Burman, an economist at Syracuse University and former director of the center-left Tax Policy Center. "It could come about in a really humiliating way, when our foreign lenders say they're not going to lend us any more money unless we get our finances in order very quickly, in which case we'd have to put a VAT in place."

Ironically, conservatives used to like value-added taxes because they tax consumption, reward saving and are broadly distributed.

Liberals hate value-added taxes for the same reason: they hit the poor and middle class harder than the wealthy.

"We need a money machine," said Charles McLure, who helped develop former President Ronald Reagan's proposals for the 1986 bipartisan tax reform, and is now at the Hoover Institution at Stanford University.

Can't keep borrowing

"We can't continue to live beyond our means, we can't continue to borrow from the Chinese and the Saudis, and even if we could, I don't think we want to give them that level of control over us," McLure said. "There are not that many expenditures you could cut that would make a big difference, unless you want to renege on the debt, Social Security or Medicare or cut defense a lot. Once you look at the numbers, I think you've got to do something on the tax side."

Many economists agree with McLure that a value-added tax is preferable to raising the overloaded income tax. Obama wants to raise the top income tax rate from 35 percent to 40 percent. That's in addition to an expanded 3.8 percent Medicare payroll tax on high earners to help pay for the new health care law.

Studies show that for Obama to stabilize the deficit and keep his pledge to raise taxes only on individuals earning more than $200,000 a year, those persons would get to keep just 9 cents of every dollar they earn, not counting state taxes.

Conservatives insist the budget problem is caused by high spending, not low taxes.

Liberals should start cutting farm subsidies or rolling back Medicare for the wealthy to protect the social programs they hold dear, said Chris Edwards, director of tax policy at the libertarian Cato Institute.

When 'chaos comes'

"When the chaos comes, all kinds of stuff will be cut," he said. "Enlightened liberals should see the coming budget crisis is not going to be to their benefit."

To forestall a value-added tax, both sides are eyeing income tax reform. Republicans, and now Democrats, have littered the tax code with special breaks that sound like a tax cut but really are new spending in drag.

Obama has embraced these with gusto. In his weekly radio and Internet address on Saturday, he bragged about tax credits for first-time home buyers, new cars, tuition, alternative energy, small businesses, children and others - even as he claimed to be closing loopholes.

Such programs now cost more than $1 trillion a year. They have made the tax system opaque and unfair, so that two people or businesses with similar incomes can pay no tax, or a large tax, depending on which breaks they get.

Wyden and Gregg's tax reform bill would eliminate some of these breaks but not the costliest ones such as the tax exclusion for health insurance and the mortgage interest deduction. Their plan does not raise revenue.

"We wanted a politically viable vehicle," Gregg said.

How a value-added tax works

A value-added tax is a sales tax on the difference between what a company pays for raw materials to create a product and the value of the finished product. In this example of the manufacturing of a table, a 5 percent value-added tax will be applied several times - and ultimately passed to the consumer in the form of higher retail prices:

Raw materials: A timber company sells harvested timber to a sawmill for $200 a truckload. A mining company sells ore to a nuts and bolts manufacturer for $4 a pound.

Lumber and hardware: The sawmill cuts the timber into lumber and sells it to a small table company for $400. The nuts and bolts manufacturer produces and then sells 5 pounds of nuts and bolts to the table company for $40 ($8 a pound). The manufacturer is taxed 5 percent on the added value of $20, for a tax of $1. The sawmill is taxed 5 percent on $200, the value added to the timber, for a tax of $10.

Making tables: Using raw materials worth $440 (lumber bought for $400 and 5 pounds of nuts and bolts bought for $40), the table company will make five tables that it sells for $1,500 ($300 each). The table company is taxed 5 percent of $1,060 (the value added), for a tax of $53.

Total value-added tax: $10 (lumber) + $1 (nuts, bolts) + $53 (for five tables) = $64

Total tax on each table: $12.80

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2010/04/11/MNSC1CQFCS.DTL&type=printable

[I AM NOT THAT GUY 5,715]

A National Sales Tax would not be that bad for businesses, as the tax is collected at the point of sale. Therefore, the retailer would have free use of the money, until he/she had to make the periodic payment on the sales tax collected (except for certain large retailers, who often have to prepay those taxes, based on estimated sales).

A Value Added Tax, on the other hand, becomes a cost of doing business, since it adds to the cost of the product. In effect, the retailer will be paying tax on his inventory, long before it becomes "sold as tangible property."

[I AM NOT THAT GUY 5,715]

Making tables: Using raw materials worth $440 (lumber bought for $400 and 5 pounds of nuts and bolts bought for $40), the table company will make five tables that it sells for $1,500 ($300 each). The table company is taxed 5 percent of $1,060 (the value added), for a tax of $53.

Total value-added tax: $10 (lumber) + $1 (nuts, bolts) + $53 (for five tables) = $64

Total tax on each table: $12.80

Did they mention that in a state like California with an average state and local sales tax rate of 9%, $27 is already being paid on the table, before the VAT? That puts the total tax around $40 for each table.

The VAT that is being discussed will range somewhere between 15% and 28%, not 5%, so even at 15%, that VAT is around $39. The total tax on that table now becomes $66.

Edited April 13, 2010 by ##########

[one...two...tree 2,762]

I love this little nugget of truth...

Ironically, conservatives used to like value-added taxes because they tax consumption, reward saving and are broadly distributed.

Liberals hate value-added taxes for the same reason: they hit the poor and middle class harder than the wealthy.

Mike Huckabee was touting a similar tax idea back when he was running for president.

[Dan J 277]

A National Sales Tax would not be that bad for businesses, as the tax is collected at the point of sale. Therefore, the retailer would have free use of the money, until he/she had to make the periodic payment on the sales tax collected (except for certain large retailers, who often have to prepay those taxes, based on estimated sales).

A Value Added Tax, on the other hand, becomes a cost of doing business, since it adds to the cost of the product. In effect, the retailer will be paying tax on his inventory, long before it becomes "sold as tangible property."

It would likely result in a decrease in sales. Especially for any products that are considered discretionary, at least for lower and middle income folks.

[DEDixon 39]

i don't mind VAT as long as they drop income taxes. they drop income taxes and all the deductions so no filling in april would be great.

[one...two...tree 2,762]

Lets repeal Bush's tax cuts on the wealthy. That would be a better solution, IMO.

[DEDixon 39]

Lets repeal Bush's tax cuts on the wealthy. That would be a better solution, IMO.

before bush, we had a spending problem so repealing his cuts isn't going to do much to the deficit or the debt.

problem is that pols, no matter how much money comes through the door, will always spend more. deficits are a "why not if we can" in washington.

i think we need a law that outlaws a deficit when growth is positive. this is the only way to control the pols (repubs and dems). one exception to the law would be to finance war - we have to be able to borrow to protect ourselves.

as it is, if we spend too much when the economy is good, when bad times hit, we have to triple deficits to keep everyone from suffering too much. we should balance the budget in good time so in bad times we are simply doing what is expected by borrowing.

[one...two...tree 2,762]

before bush, we had a spending problem so repealing his cuts isn't going to do much to the deficit or the debt.

problem is that pols, no matter how much money comes through the door, will always spend more. deficits are a "why not if we can" in washington.

i think we need a law that outlaws a deficit when growth is positive. this is the only way to control the pols (repubs and dems). one exception to the law would be to finance war - we have to be able to borrow to protect ourselves.

as it is, if we spend too much when the economy is good, when bad times hit, we have to triple deficits to keep everyone from suffering too much. we should balance the budget in good time so in bad times we are simply doing what is expected by borrowing.

Where do you us to cut spending on?

[JohnSmith2007 353]

Where do you us to cut spending on?

Let make it easy, 25% accross the board. Every single program, nothing excluded.

[Obama 2012 1,714]

I love this little nugget of truth...

Mike Huckabee was touting a similar tax idea back when he was running for president.

Well, not exactly. The "Fair Tax" actually calls for the elimination of income taxes and makes taxes strictly based upon consumption.

[one...two...tree 2,762]

Let make it easy, 25% accross the board. Every single program, nothing excluded.

Ok, but in real terms, what do you suppose that would mean? For example, how many veterans services would suffer because of the cuts?

[I AM NOT THAT GUY 5,715]

Well, not exactly. The "Fair Tax" actually calls for the elimination of income taxes and makes taxes strictly based upon consumption.

And he is a proponent of a NST, not a VAT. Not quite the same thing.

[one...two...tree 2,762]

Well, not exactly. The "Fair Tax" actually calls for the elimination of income taxes and makes taxes strictly based upon consumption.

Still very similar. The problem with Capitalism is that wealth tends to get concentrated into a small percentage of the population. Progressive tax policies are just like any other tax scheme in the sense that they encourage or discourage some types of behavior. One of main reasons why we had such a large Middle Class in the 50's was because of our progressive tax policies discouraged companies paying out lofty sums of money to their top executives. Now we have a huge disparity between the rich and poor in this country and the free market capitalists tell the working class its simply their fault for not working hard enough.

[I AM NOT THAT GUY 5,715]

Ok, but in real terms, what do you suppose that would mean? For example, how many veterans services would suffer because of the cuts?

You could start by setting Federal Government salaries to prevailing wage or lower. Things have changed quite a bit, from just 20 years ago, when a GS employee would give his left nut to be paid WG. I would put benefits commensurate with industry averages, and eliminate the right of public employees to organize. Then, I would double the amount of inter-agency audits, and pay the individual auditors bonuses for every government position, procurement, and program, that is shown to be redundant, or unnecessary, and could be eliminated.