The Senate Won't Do VAT

The Senate overwhelmingly voted 85-to-13 on Thursday to reject the idea of a value-added tax in a resolution proposed by Sen. John McCain. All six of the senators on the president's bipartisan commission on the deficit -- three Democrats and three Republicans -- voted with the majority.

Sad. The resolution isn't even close to binding, and the VAT could live yet, but it's dispiriting that Sen. McCain would force the Senate to vote on this issue based on his emotional reaction to a Wall Street Journal editorial on the subject.

The thrust of the WSJ piece is that Democrats are plotting a VAT to pay for "the Obama Administration's new spending," and that consumption taxes will Europeanize the United States, destroy jobs and encourage the government to feed itself with higher VAT rates whenever we feel particularly hungry for more spending.

It's true of course that hidden taxes like consumption are more easily hiked and the VAT has proved a remarkable money-maker for some European countries. But the editorial's reasons for bashing the tax aren't fair to facts. "The Obama Administration's new spending" isn't the issue. The issue is something we'd have even with a President John McCain: growing entitlement spending paid for by historically squat total tax rates. The VAT would help pay for these programs and reduce foreign borrowing. A smart VAT could even be off-set with rate cuts in federal income, payroll or corporate tax cuts.

That's precisely what Eric Toder and Joe Rosenberg proposed in this excellent paper on how a VAT/tax-cut combo could effect after-tax incomes. Here's a key chart that examines what would happen if you reduced employer contributions to payroll taxes or corporate taxes by enough to offset the burden of VAT (in the far right column, employer contribution rate falls to 3.5% and maximum corporate tax rate drops to 19.7%):
Effect VAT tax cut swap aftertax income.png
The value-added tax is not a magical panacea for the deficit or tax simplicity. It could take years to set up. Layering a VAT on top of our tax regime without offsets would have a significantly regressive impact on effective rates. Over time, legislators will carve both wise and special interest-heavy exemptions into the tax. There are issues, but they are issues worth discussing rather than preempting with a politically motivated resolution born out of midterm jitters.