A Value Added Tax Will Not Reduce the Deficit!


Thursday November 18th, 2010   •   Posted by Randall Holcombe at 9:41pm PDT   •  

Politicians have been advocating a value added tax (VAT) for decades, and with the huge projected federal deficits interest in a VAT seems to be increasing lately. Last Spring Paul Volker was suggesting one, and David Theroux recently noted in his blog Paul Krugman’s support. Alice Rivlin and Pete Domenici suggest a 6.5% “debt reduction sales tax,” probably phrased that way to avoid saying “value added tax.”

I wrote a study on the VAT for the Mercatus Center this year, which can be found here, and have been to Washington twice in the past few months to give talks to congressional staffers in the VAT, based on my Mercatus paper. My Mercatus paper on the VAT was even referenced in Glenn Beck’s new book, Broke, so the VAT issue appears to be on the radar of lots of people these days.

Will a VAT help reduce the deficit? The evidence seems to lean the other way.

Greece, Portugal, Spain, Ireland, the UK, and France all have substantial VATs, and those countries also have serious deficit problems that have made the news in the past year. So, on the surface, it appears that adopting a tax structure like those countries is not the answer to solving the deficit problem. Look a little deeper, and the reason becomes more apparent.

There is no doubt that the initial effect of a VAT would be to inject major amounts of money into the Treasury. The VAT is known as a revenue machine. Over the longer run, the VAT does not add appreciably to revenues, however.

One reason is that the VAT is a very complex tax. In theory it has the same effects as a sales tax, but in practice the record-keeping required imposes huge compliance costs on taxpayers, and adds substantial administrative costs on government. These costs are a drag on the economy, and reduce income and economic growth. My Mercatus paper gives the details of my reasoning here. . . .

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