In an op-ed in today’s Wall Street Journal, Senator Rand Paul announced his tax plan. While Herman Cain had his 9-9-9 plan, you can think of Mr. Paul’s approach as the 14.5-14.5 plan: He would replace all of today’s federal taxes with a 14.5 percent flat personal income tax and a 14.5 percent value-added tax.
[Reposted from The New York Times | Josh Barro | June 18, 2015]
Yes, a VAT. A tax on goods and services that would generate twice as much revenue as his proposed income tax — $2 trillion a year, according to the Tax Foundation analysis that Mr. Paul cites in his op-ed. But please don’t call it a VAT. Mr. Paul calls it a “business-activity tax.”
Steve Moore of the Heritage Foundation, who is an economic adviser to Mr. Paul, was more blunt in an interview. “It’s a tax on consumption,” he said.
Americans tend to think of a VAT as Europe’s version of a sales tax: the thing hidden in the price of goods and services that makes everything expensive when you’re on vacation in Paris. In fact, every country in the Organization for Economic Cooperation and Development except the United States collects a VAT — even Canada, which has a lean 5-percent VAT called the Goods and Services Tax.
In his op-ed, Mr. Paul bragged that his tax would have a lower rate than today’s taxes on business income. He made this comparison:
I would also apply this uniform 14.5% business-activity tax on all companies — down from as high as nearly 40% for small businesses and 35% for corporations. This tax would be levied on revenues minus allowable expenses, such as the purchase of parts, computers and office equipment.
Yes, it’s true that 14.5 percent is less than 40 percent. But it’s an irrelevant comparison because these are taxes on two very different things.
You may notice an important item that is missing from Mr. Paul’s list of “allowable expenses” for businesses to deduct: wages and salaries. That omission — meaning businesses pay tax on their profits plus their employees’ wages — is why his tax has such a large base and collects so much revenue. It’s also what makes the tax a VAT: Once it’s imposed across all companies (and across governments and nonprofits, which would also pay the tax despite its name), the tax base adds up to the value of all the goods and services produced in the economy.
It may not be immediately obvious why a VAT is economically equivalent to a sales tax. Think of it this way: While a sales tax is charged at the point of final sale to the consumer, a VAT is charged in pieces all the way along the supply chain. A retailer pays VAT on his sales, minus what he paid to wholesalers; a wholesaler pays on what he collects from retailers, less what he paid to manufacturers; manufacturers pay on what they get from wholesalers, less the cost of parts. When you add it all up, the whole tax bill is the same as if a sales tax had been collected at retail.
And that’s a key thing to understand, because while Mr. Paul calls this tax a “business-activity tax,” the economic cost of the tax would principally be borne by consumers.
The person who makes a tax payment is not necessarily the person who bears the burden of the tax. Today’s payroll tax is paid half by employers and half by employees, but economists agree that in the long run, the cost of the payroll tax is borne by workers; the employer part of the payroll tax simply translates, over time, into lower wages.
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Today’s corporate tax is paid by companies, but as Mitt Romney said, “corporations are people, my friend,” and the corporate tax must ultimately fall on individuals. Some of those individuals are shareholders, but a portion of the corporate tax gets shifted to workers in the form of lower wages. Economists disagree on the exact proportion, but the Congressional Budget Office estimates a 75-25 split, with owners paying most of the cost of the corporate tax.
In the case of a VAT, well, as Mr. Moore says, a VAT is a tax on consumption. That means it is borne by the people who do the consuming, even if businesses are the ones submitting the forms and writing the checks.
And that makes Mr. Paul’s plan less appealing for individual taxpayers than it looks at first glance. The shift to a 14.5 percent flat income tax would mean a reduction in tax bills for many people, especially since he would repeal the payroll tax. But the 14.5 percent VAT would ultimately flow through to consumers in the form of higher prices.
Historically, American conservatives have resisted the VAT for its hidden nature, which allows governments to collect lots of revenue without taxpayers noticing too much. In Europe, VATs can be as high as around 25 percent; it is an economically efficient, easy-to-collect tax that helps make it possible to support Europe’s relatively large government sector. Mr. Paul’s choice to characterize his VAT as a “business” tax only goes to show how one can be disguised.
The former Treasury secretary Lawrence Summers once quipped that conservatives oppose a VAT because it is a money machine and liberals oppose it because it is regressive (that is, people with lower incomes pay a larger share of their income in tax, because they consume a higher fraction of their income). Mr. Summers said we would get a VAT when conservatives realize it’s regressive and liberals realize it’s a money machine. And indeed, while conservatives have historically been uneasy about VATs, Senator Paul would use his to replace revenue lost from two progressive taxes conservatives hate: corporate income tax and graduated taxes on high personal incomes.
Canada and Australia both got their VATs from conservative governments. If Mr. Paul is elected, perhaps the United States will follow in their footsteps.