Time for a VAT, America?

How did Americans celebrate April 15th, the national annual filing deadline for income taxation?

Some undoubtedly spent hours meeting with their accountants, and then stood on long lines at local branches of the United States Postal Service, waiting to mail their returns to Uncle Sam. Others joined the Tea Party protestors at various locations throughout the United States, and called for the abolishment of the Internal Revenue Service.

Many Americans indeed grumble about paying their taxes, but a system of taxation represents a price that must be paid to provide for a functioning federal government. Recently, though, some economists and financial advisors have begun calling for the imposition of an entirely new type of taxation.

Is it a federal property tax? Or a national poll tax? No, American economists have begun to suggest the implementation of a Value Added Tax. Although VATs are common in other western industrialized nations, they would represent an entirely new brand of taxation system in the United States.

What’s a VAT?

A Value Added Tax is similar to a sales tax, except that firms only collect and pay taxes that are based on the net values that they add to all items sold. Alternatively, in a system of sales taxation, firms collect and pay taxes on the gross values of their retail prices.

Is this a confusing distinction? Understandably so; VAT is indeed a bit more complicated than a sales tax; nevertheless, a simple example should clarify matters. Let’s assume, for instance, that a newspaper delivery boy purchases 100 newspapers for $100 and then resells them to his customers for $120. If the VAT tax rate is 10%, the newspaper publisher would charge the delivery boy an extra $10 and remit those funds to the government as a VAT tax. Then the delivery boy would charge his customers an extra $2 and, likewise, remit the funds to the government as a supplemental VAT tax.

Because the total amount of this tax would equal 10% of the gross sales revenue, it would be economically equivalent to a 10% sales tax. But the retail customers would not observe most (or, in some situations, any) of the VAT taxes detailed separately on their sales invoices, and thus would tend to consider them less intrusive (or, at a minimum, less irritatingly observable) than general sales taxes.

Economics Pros and Cons

So is a VAT a good idea or a bad idea? As with many such issues, economists have trouble agreeing on an answer to this question!

Many American economists dislike income taxes in general because, by taxing income generation activities, the federal government effectively prevents its citizens from enjoying the full fruits of their labors. Instead, such economists prefer consumption taxes such as sales and VAT taxes because consumption taxes tend to discourage spending activities instead of earning activities.

Of course, these recommendations apply specifically to American consumers, who are generally known for spending much of their earned compensation and saving little of it. Conversely, economists often prefer that Asian nations rely more on income taxes than consumption taxes because Asian citizens are generally known for spending little of their earned compensation and saving much of it.

In a broader context, American economists also disagree about whether consumption taxes should replace income taxes or (alternatively) supplement them as additional sources of government revenues. Conservative economists who believe that the federal government should be downsized only tend to support VAT proposals that replace the current income taxation system. Liberal economists, though, believe that the federal government should maintain or expand its current size; they tend to support the maintenance of the existing income tax system alongside a newly implemented VAT system.

Will They or Won’t They?

So what will Washington DC do? Will American politicians implement a new VAT system throughout the United States? The answer to that question may actually be more dependent on the future of the social safety net than on theoretical economic and taxation policy.

This is because most economists and other commentators agree that the bulk of the federal government’s projected budget deficits are attributable to the expanding social programs. If Washington DC fails to rein in its future spending obligations on these programs, it may have no choice but to institute a VAT system alongside the current income taxation system in order to increase its revenue base and finance these growing expenditures.

On the other hand, if Washington DC actually manages to reduce the future cost burdens of these social programs, then it may be able to afford to consider the complete abolishment of the entire system of income taxation and its replacement by a streamlined VAT system. Because conservative and liberal American economists theoretically agree on the preferability of the VAT methodology over an income taxation methodology, this dramatic step may prove to be a relatively popular one.

In the meantime, though, Americans will continue to mark their calendars every April 15th as Income Tax Filing Day … as well as April 16th as a national day of relief!