A Value Added Tax (VAT) is a tax on value added all throughout the supply chain as products are brought to market. In practice it is used as a tariff on imports.
The U.S. has pursued trade agreements that multilaterally reduce tariffs. However, as foreign nations removed their tariffs they have replaced them with VATs which is another form of a tax or tariff on imports. The U.S. hasn’t enacted a VAT and the results have been predictable: The U.S. loses jobs and production capability to foreign nations and we finance our government via debt.
The VAT acting as a tariff on imports is the result of WTO rules allowing nations to rebate consumption taxes, such as a VAT, making the product essentially tax free. So a nation can rebate taxes on products for export and still collect taxes on imports. Of the 150 trading partners in the Organization of Economic Cooperation and Development every nation has a VAT and uses this method to reduce the price of their exports and increase the price of imports. Everyone except the U.S.
Milton Freidman famously stated in his book “Free to Choose,” that, “if you tax something you will have less of it and if you subsidize something you will have more of it.” This rule has put the U.S at a distinct disadvantage for decades since we tax production and all our trading partners tax consumption. The net result is that the U.S. gets more consumption relative to production, and our trading partners get more production (jobs). This explains our decades of job losses and part of our intractable trade deficits as well as the U.S. sliding from the world’s largest creditor nation to the world’s largest debtor nation. Our accumulated national debt is only slightly larger than our accumulated trade deficit.
So the need to get in step with the rest of the world on taxation should be clear – we need to shift some of the tax burden for government from production to consumption. In other words, we need a VAT or similar taxation methodology.
Without getting into the weeds with details, here is a brief example of how the lack of a VAT-like tax (averaging 17% world—wide) puts America at a huge disadvantage:
- If a product (say a cell phone) costs (say $300) the same to produce in America and a foreign nation, currently the foreign nation would sell this product in America for $300 and the foreign producer would receive a $51 rebate. The American cell phone would sell for $351 in the foreign nation with $51 going to their treasury. This gives the foreign producer a $102 (34%) advantage over the American producer.
- Implementing a U.S. VAT would neutralize some or all of this disadvantage.
Democrats want to keep the existing code and increase taxes to pay for even more government. The good news is that each Republican candidate wants to lower taxes on production by shifting some taxes to consumption. Some have bold plans and others trim at the margins. The bold plans are coming from Ted Cruz, Rand Paul and Donald trump. Using the U.S. Tax Foundation as source for these three, I will summarize their plans:
Senator Cruz’s (R-TX) tax plan would enact a 10 percent flat tax on individual income and replace the corporate income tax and all payroll taxes with a 16 percent “Business Transfer Tax,” or subtraction method value-added tax. In addition, his plan would repeal a number of complex features of the current tax code. I like that Cruz shifts more towards consumption (16%).
|Table 1. Economic Impact of Senator Cruz’s Tax Reform Plan|
|Full-time Equivalent Jobs (in thousands)||4,861|
|Source: Tax Foundation Taxes and Growth Model, Oct. 2015.|
While Senator Paul’s (R-KY) plan shifts less to consumption (14.5) than Senator Cruz’ plan, it has an additional feature that I like a lot. It eliminates the payroll tax giving every working American a significant increase in take-home pay.
|The Rand Paul “Flat and Fair Tax” with a 14.5% Income Tax Rate and a 14.5% Business Transfer Tax|
|Economic and Revenue Change Estimates vs Current Law|
|After-Tax Wage Rate||11.4%|
|Full-time Equivalent Jobs (in thousands)||4,300|
|Source: Tax Foundation Taxes and Growth Model.|
Donald Trump’s tax reform plan would reduce individual income tax rates, lowering the top rate from 39.6 percent to 25 percent and creating a large zero bracket. The plan would also reform the business tax code by reducing the income tax on all businesses to 15 percent and eliminate business tax expenditures, including deferral and interest deductions. In addition, the plan would eliminate the Estate Tax and the Alternative Minimum Tax.
|Table 2. Economic Impact of Donald Trump’s Tax Reform Plan|
|Full-time Equivalent Jobs (in thousands)||5,329|
|Source: Tax Foundation Taxes and Growth Model, Sept. 2015.|
The best feature of the Trump plan is that it would increase domestic jobs the most of the three plans discussed. Additionally, since it is less transformative, it has a better chance of passing Congress. As for me I would prefer a bolder plan that includes a permanent value added tax so we could tax imports and exports equally rather than favor imports. Mr. Trump’s plan helps workers a little less than I would prefer.
Frank Shannon served in the U.S. Army, was an engineering/operations manager for AT&T for 27 years, was the owner of a small manufacturing business for 23 years, served as Colorado Chair of the Coalition for a Prosperous America and moved to Mesquite in 2013.