Value-Added Taxes and the Tax Reform Debate: A Primer

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By Kaustuv Basu

President Donald Trump likes the concept of a value-added tax. “I like it, I like it a lot, in a lot of ways,” he said in a recent interview with The Economist magazine.

But Trump said in the same May 11 interview that a VAT can’t be sold in the U.S. because the country is used to an income tax. The topic has been considered politically toxic both by liberals and conservatives for years.

Still, the idea of a VAT seems to have some political backers, including Rep. James B. Renacci (R-Ohio) and Sen. Benjamin L. Cardin (D-Md.). While it’s a political long shot, if the more conventional idea of a broadening the base and lowering the rates doesn’t gather momentum, the VAT idea could get another look, some tax observers told Bloomberg BNA in recent weeks, pointing to the substantial amount of revenue a VAT could raise.

Here are four things to know about the VAT debate:

What about economic considerations?

While a VAT has economic merits, it would be politically difficult to pass, according to Kyle Pomerleau, director of federal projects at the Tax Foundation.

Pomerleau said a VAT system would make tax reform easier by allowing for larger cuts in corporate and individual income tax rates without leading to large budget deficits.

“In fact, it could be used to raise revenue and balance the budget,” he said in an email. “It is also a relatively efficient tax that can raise revenue without significantly harming the economy; a property that Republicans tend to like.”

Pomerleau said a consumption tax similar to the ones proposed by lawmakers such as Renacci and Cardin could gain momentum if other tax reform approaches fail.

One long-standing conservative criticism of a VAT is that it is a money machine. “Once a VAT is in place, Congress could easily increase the VAT any time it wants more taxpayer money to pay for new programs,” Curtis Dubay, then a research fellow at the Heritage Foundation, said in a 2010 report.

The Tax Policy Center said that empirical evidence shows otherwise. “In advanced countries, VATs were phased in during the 1960s and 1970s.” But later research “has shown VAT revenues remained remarkably constant for a long time, hovering around 7 percent of gross domestic product (GDP) in the 1990s and 2000s,” the center said.

Is it politically toxic?

Democrats and Republicans have found common ground in opposing a VAT. Typically, Democrats think that a value-added tax is regressive while Republicans think it will grow the size of the government, Pomerleau said.

Edward Kleinbard, a business and tax law professor at the University of Southern California, said in an email that many Republicans remain opposed to a VAT because they fear it will lead to a much larger role for the government, but some entertain the idea in exchange for higher income tax cuts. Democrats who call the tax regressive should keep in mind that “government spending that could be financed by a VAT is super-progressive in its application,” said Kleinbard, a former head of the Joint Committee on Taxation.

Ray Beeman, a former tax counsel to Ways and Means Committee Republicans, said if a VAT replaced the income tax-based system there could be less objection to the idea. “Although you’d still have the political issue of it being an invisible tax that would be easy to dial up,” he said. “And somewhere lurking in the background is the thought that it’s ‘too European.’ ”

What about exemptions?

The main problem with a VAT is that by the time it went through Congress, it would look nothing like the conceptual VATs described by economists, Beeman said. Lawmakers would attempt to add exemptions to protect specific industries and other interests, he said.

“It probably would look worse than our current system,” Beeman said.

Kleinbard said it wouldn’t be difficult to design a comprehensive VAT if Congress could police itself and control its impulse for special carve-outs.

But a VAT doesn’t have a good way of measuring value when it comes to financial services that are bundled into products, according to Kleinbard. A “free checking” account with zero interest and free services is an example, he said.

What could happen in Congress?

The Cardin idea is a “credit invoice” consumption tax, similar to those used in Australia, New Zealand and Canada. Cardin calls it a “progressive consumption tax.”

A Senate aide said that the tax plan described in Cardin’s bill, which was introduced in the last Congress, addresses some major policy concerns—the tax base would remain broad because the exemptions aren’t used for certain goods and services and there would be a built-in “circuit breaker” by which it returns money to taxpayers if the progressive tax portion of the bill raises more than intended. The Cardin bill would propose a tax rate of 10 percent.

Renacci’s tax plan, which was released in July 2016, would replace the corporate income tax with a 7 percent VAT. The Tax Foundation estimated that his plan would reduce federal revenue by $845 billion but would lead to a 5.6 percent higher gross domestic product in the long run. His plan also proposes a “circuit breaker.”

“I am a big believer that all plans need to be looked at. A consumption tax plan needs to be analyzed as well, and then let the people make a decision. But in the end, I believe a consumption tax, structured properly, is more pro-growth than an income tax,” Renacci told Bloomberg BNA.

“An income tax is regressive on wages and shareholder value, so let’s have hearings and discuss all the plans just like the White House appears to be doing. That way we look at the pluses and minuses of every plan,” he said.

House Ways and Means Committee Chairman Kevin Brady (R-Texas) has said that the idea of a VAT would face political resistance. Brady told Bloomberg BNA that the idea was rejected “for a number of key growth reasons.”

To contact the reporter on this story: Kaustuv Basu in Washington at kbasu@bna.com

To contact the editor responsible for this story: Meg Shreve at mshreve@bna.com

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