Blame the French for the VAT you pay

U.S. House Ways and Means Chairman Bill Thomas is floating the idea of mating President Bush's Social Security proposals with a tax reform featuring a European-style value-added tax – and this looks too close to Medicare redux for comfort, says the Wall Street Journal.

The VAT is essentially a hidden sales tax that originated in France and has become a favourite of legislators around the world because of its ability to stealthily raise large sums of revenue with a minimum of public outcry. Compared with other kinds of taxes, the VAT does have certain virtues. For one thing, it's a lot better way to get revenue than raising marginal income tax rates, since it creates relatively little disincentive to work.

But according to the Journal:

In most of the world where VAT’s exist, and certainly in Europe, VAT’s are levied in addition to, not in place of, other taxes.

VAT’s place a higher relative burden on lower-income earners who spend a higher percentage of their income on consumption, so VAT’s have often resulted in calls for income tax rate increases to preserve the overall progressivity of the tax code.

Moreover, the efficiency of the VAT is exaggerated:

Since it applies to virtually every transaction in the economy, it requires an army of inspectors to administer.

Evasion is easy, especially in service industries, so governments keep raising the rate, driving still more economic activity underground in another vicious circle.

U.S. VAT rates would have to be in the world-wide normal range of 10 -20 percent to make it worthwhile to administer, according to research by the International Monetary Fund.

One lesson of the Medicare fiasco is that bad Congressional ideas need to be stopped before they gather too much political momentum, says the Journal.

Source: Editorial, The Tax That France Built, Wall Street Journal, March 4, 2005.

For text (subscription required): http://online.wsj.com/article/0,,SB110989777176970233,00.html

For more on Value-Added Tax: http://www.ncpa.org/iss/tax/

FMF Policy Bulletin/ 29 March 2005