What’s wrong with a VAT?
Hayden has the following inquiry:
It seems that every country in the rest of the world utilizes some form of Value Added Tax. In a previous life, I owned a small bar/restaurant in Guatemala and had to pay a VAT on my purchases, which I, in turn, charged my customers. (If I didn’t charge my customers, I would have had to absorb the VAT I had already paid. Thus, unlike the FairTax, there was no incentive for me to cheat by underreporting my cash sales.)
Anyway, it seems that the VAT has been thoroughly researched, tried, and perfected over decades. It seems to work pretty well. In The FairTax: The Truth, even Boortz and Linder admit that it would be more efficient than the FairTax. Yet, the VAT is rarely, if ever, discussed in this country (though the idea is being floated around to pay for health care reform.)
So, my question is, why are FairTaxers so wedded to the idea of the FairTax? What’s wrong with a VAT?
As a fairtax supporter, I don’t think there is anything particularly wrong with a VAT. I’m sure some are fearful of it because it is usually presented as an additional tax to an already tax heavy regime (as Hayden rightly points out with our reference to socialized healthcare). I do think compliance is easier for a retail sales tax because there are fewer collection points. Of course, cheating on the VAT is less lucrative because each stage collects less tax than say the retail sales tax (which collects all the tax at once).
Overall, I prefer an NRST, but a VAT (as a replacement of course) would be second. I’d probably take the Flat Tax next (being it’s a consumption tax), followed by a flat income tax, then finally just keeping our current system, but getting rid of all the distortions (Employer Health Insurance write-off, Mortgage Interest Write-off, child tax credits, EITC, house buying credit, “making work pay” credit, all the crazy future stuff they (the politicians) are going to come up with to buy votes). One more thing, get rid of capital gains tax.
There are several problems with a VAT, and I’ve been meaning to blog about this for some time now and will probably use this question in my blog article.
First, the problem with the VAT that is being tossed around and considered by the U.S. Congress and White House is in addition to the current taxes, not as a replacement, like the FairTax. If it were a replacement, it might almost be tolerable. Almost.
Second, VAT’s are applied at every step of the process in assembling a good and delivering it for sale to an end customer. The FairTax is only applied once, at the end. It’s stricly for B2C transactions, while VAT’s are B2B, and (I believe–need to research this) also apply to things like shipping, storage, etc. This has two bad problems with it. It means that the VAT becomes a “hidden” tax, unlike the FairTax which is completely visible and aboveboard. It also means that it can be “gamed” like the income tax. Politicians will work to make their favorite companies/constituents/projects exempt from the VAT, and since it’s hidden, you’ll never know who is paying and who isn’t. Politicians and lobbyists love a VAT, which is really all you should need to know.
This is the problem in a nutshell. I’ll try to add more detail when I blog about this.
Here is a great writeup by Diana Furchtgott-Roth (Former head economist of Clinton Labor Dept) about issues with the VAT tax. Some of this criticism would likely apply to FairTax as well.
http://www.realclearmarkets.com/articles/2009/06/a_vat_tax_is_not_the_answer.html
Andrew,
This is an interesting thread. I, as a Fair-Taxer, acknowledge that the VAT is the mathematical equivalent of the FairTax. You make a good point that, as a retail merchant in Guatemala, it was slightly harder for you to cheat on a VAT because you already had paid most of the VAT on your supplies and inventory. Supposedly you could have cheated on the portion of the sales price representing the value you added, but the reward would have been less. Thus the advantage of a VAT over the FairTax is possibly greater control.
The principal advantage of the FairTax is fewer collection points. The registration requirement of the FairTax for all businesses, see definitions of Registered Seller, Taxable Property, Intemediate Sales Credit (Section 203), remains and gives the state sales tax authorities tools to audit books of raw materials and semi-finished goods producers. These tools reduce the advantage of the VAT.
We all agree that a consumption tax, be it the FairTax or a VAT, ON TOP OF income taxes would be a disaster.
~Jim Bennett
Summit, NJ
The problem with a VAT is that it assigns taxes during production phases of the sale of a finished good, which means that domestically-produced goods will be afflicted with greater taxes than foreign-produced goods. One big benefit of moving to a consumption tax is that it allows us to tax foreign goods at a higher rate than they are taxed now (due to corporate income taxes, payroll taxes, etc., which currently apply to domestic goods, being shifted to retail sales), putting them at parity with domestic goods without creating issues with the WTO.
I’d be ok with a VAT as a replacement system. I don’t really understand the argument that it hides the taxes, since it can be displayed on the receipt in the same way as the FairTax. The percentage would be identical. Barry’s argument does make sense though.. it could reduce the tax on imports.
One thought with the collection points is that it’s just not a matter of the number of collection points but the focus you apply for compliance. The distribution would likely change from a focused collection of big box retailers to the larger business community (increasing administration cost). Census figures for 2002 show that 48.5 percent of retail merchandise sales are made by just 688 businesses, 85.7 percent made by 92,334 businesses. In the service sector, approximately 80 percent of sales are made by 1.2 percent of U.S. businesses. This allows the FairTax to focus collection points in addition to any reduction in their number. However, the FairTax has more incentive for a business to cheat. Either way… I classify them as about the same thing if applied in the same way.
Back to this thread:
Here is an e-mail I received from an attorney friend of mine in Mannheim, Germany, explaining how the German VAT applies to his law practice. I translated it for this group and fellow FairTax-ers. His remarks also provide a valuable insight into how the VAT generally works. NOTE: for reasons that my friend explains, the terms VAT and turnover tax are used interchangeably.
—————————–
My friend writes:
Dear Jim,
…
To the subject:
1.
The VAT – officially – the turnover tax, is addressed in the Turnover Tax Law (“Umsatzsteuergesetz). You will find this at http://www.gesetze-im-internet.de, there under Gesetze/Verordnungen and there under Umsatzsteuergesetz = UStG. Have fun!
There each paragraph must be called up individually. It is simpler to search under http://www.google.de under Umsatzsteuergesetz 2009. There is a scrollable version. This version is more readable.
The statute, as with all tax statutes, is not simple. …
2.
Turnover tax is due when a business, domestically for compensation, furnishes goods or other value (including services, leasing, etc.). UStG Section 1, Para 1.
Special rules apply to foreign sales and EU sales, etc.
Sales and services between private persons are not covered by the Turnover Tax Law, and the compensation is not subject to the VAT. When a private person sells his car, there is no Turnover Tax due.
3.
VAT is due on attorneys’ fees also. The same applies for other services (IT-support, elevator maintenance, motor vehicle repair, commercial leases as distinguished from private leases, etc.).
4.
When I as an attorney spend five hours at a net rate of , E200.00 per hour, I bill E1,000.00 net plus 19% VAT = E1,190.00 gross. The client has to pay me this amount.
Theoretically I have to turn the entire VAT of E190.00 over to the government.
I may, however, deduct the VAT that I myself paid to other businesses, namely the VAT on my rent, on all my office supplies, on all services that I received from businesses.
If I earned fees for a month in the amount of E10,000.00 net, there is VAT due on them of E1,900.00.
If I used services and, for example, paid E1,100.00 VAT for them, I can deduct this VAT as so-called previously-paid tax, and only have to send the government the difference in the amount of E800.00 for the month in question. UStG Section 15.
When a manufacturer assembles a machine, he can deduct the VAT on the raw materials from his VAT return as previously-paid tax.
If a businessman does not sell his final product, or sells it under cost, he has a refund claim against the government for the month in question (more previously-paid tax than turnover tax due for his own value added).
5.
When we represent businesses, they can claim the turnover tax on our fees also as previously-paid taxes.
When we represent a private person, he must pay the turnover tax because he cannot claim it as previously-paid tax.
6.
As to disbursements, it depends. Some disbursements are not subject to turnover tax, some are subject to the tax.
Court costs: not subject to turnover tax.
Witness fees: not subject to turnover tax.
Residency registration fees, commercial register fees, business register fees: not subject to turnover tax.
Translation costs: subject to turnover tax.
Travel costs: subject to turnover tax.
Out of office costs: subject to turnover tax.
On our bills, we either charge telephone costs at a flat fee per matter of E20.00 or we itemize them.
There is a special rule for photocopying costs which I do not know. We do not charge our clients for photocopying. These are included in the fee.
Disbursements do not play a major role in practice. When we need, for example, a report from an outside expert, we are not the party ordering it, rather, our client is the party who retains the expert. The expert then sends the bill directly to the client.
If, as an exception to our practice, we retain or pay the expert, we bill the costs of the expert, with his VAT, directly to the client. We do not bill another VAT of our own on top of it.
7.
Things we buy for the law office are generally subject to VAT. There is an exception when the office, for example, buys a valuable antique cabinet from a private person. This however is a case that practically never happens.
Our customers (businesses or private persons) generally pay the entire VAT on our fees. The things we buy for our law office are included in the fee, however only as to the net amount without VAT, because we can deduct the VAT on those things as previously paid tax. We do not need to charge these through to the clients in order to cover our costs.
I hope I could help you with this discussion.
Many greetings,
Roland
I am also puzzled by why Americans prefer a Sales Tax over a VAT.
Briefly, a VAT is a tax over every transaction, either business to business or business to consumer. Let us get rid of some myths:
1. VAT is hidden.
A VAT is recorded on the purchase price of all goods. It is as clear as a sales tax.
2. VAT are paid by businesses
VAT are paid by consumers, like all taxes as they are pased on in prices.
3. VAT compounds as it moves down the chain so imported goods pay less VAT and local firms are disadvantaged.
VAT does not compound. Take a simple example – I buy wood at $5, carve it and sell it for a price of $10. Under a sales tax of 10% the wood still costs $5, price is $11 and I send $1 in as my taxes. Under VAT, my wood costs $5.50 as my supplier puts his VAT on the goods. I sell my goods for $11 as before and my VAT is $1 less the $0.50 I have already paid. The government gets the same tax. Imported goods pay the same 10% as local goods so a sales tax and VAT act the same.
So what is the advantage of VAT?
It is simpler – everyone pays VAT. There are more collection points but checking compliance is much easier. With 10% VAT on all your prices, a business sends 1/11 of turnover to the government less the VAT already paid. Even small business owners can handle that.
Bogus businesses could be a real problem under a sales tax. I can claim to be a web developer, register a company, and buy everything from an expensive laptop to a new office setup in my house and pay no sales tax. And I don’t have to make any money in my business.
Under VAT, as a business I pay VAT on every item. The only way I can get my money back is to sell services, charge VAT and then offset my VAT against VAT on purchased items. A bogus business just does not work.
Red Tape? Under VAT there are no business customers and exemptions from tax. How does a Walmart cashier decide who pays sales tax? And how is it recorded and verified?
New Zealand runs a single rate VAT system like this with very few exceptions – only financial services, international travel, rent on housing being exempt. The wide range – food, medical expenses, school fees – make gaming the system by providing exceptions very visible.
I had been under the impression that the VAT would tax domestically produced goods more than imported goods. Removing the tax advantage of imported goods is one benefit of the FairTax, but as forigner describes it, the VAT has the same effect. I would support either the FairTax or the VAT, then, as long as it was used as a replacement for the various other federal taxes which unfairly tax domestic goods but not imported ones.
Barry,
A VAT is applied to domestic goods and foreign goods alike. It’s just that domestic goods will have the VAT added at each stage of manufacturing (as it goes from one company to another…..steel into sheet metal…sheet metal into toaster box sheel….toaster box sheel into toaster) only on the value added during that stage. Whereas the imported goods will have the VAT added as it enters the country so it’s assessed value added will an estimated value I suspect since I don’t think our taxing authorities will have access to value added information. But who knows, maybe they will or do have an agreement with VAT countries to get such information as the VAT from the originating country is generally removed as it is exported.
Imported goods wouldn’t have to have the VAT applied on import – only when it was sold. #ven though the imported good hasn’t had the VAT applied through the supply chain, it also hasn’t been getting VAT credits either. So when the good is first sold in the U.S. (retail or wholesale), the full amount of the VAT must be remitted putting that imported good at an even level with any domestic good.
The VAT, whether foreign or domestic, and the FairTax are arithmetically the same. The FairTax, however, removes the corporate tax component and the employer tax component from the cost of American-made goods.
Foreign VATs, today and under the FairTax, are – and will be – abated for exports from their home countries. Today there is no border-adjusted tax in the United States to tax imported goods that are abated by their home countries. Under the FairTax, the abated VATS on goods coming to the United States will be picked up by the FairTax.
Today exported goods from the United States carry a high corporate, employer and state tax component in their prices. Moreover, US-exports are subject to VATs when they arrive VAT countries, making them less competitive. Under the FairTax, US-exported goods would leave the United States with no tax component whatsoever in their prices, making them more competitive.
Couldn’t a VAT do that also?
Sure it could.
I would have no problem if the FairTax, instead of being a retail sales tax, were a VAT, as long as the integrity of the rest of the bill were preserved.
~Jim
Jim,
Would you please elaborate on what you mean about preserving the “integrity of the bill”? For instance, do you still need some sort of prebate? Do you want to tax governments? Do you want to phase the thing in overnight? Etc. Etc.
Just curious.
Hank,
Sure. Thanks for the question. I would be fine with having the FairTax as a VAT instead of a sales tax, as long no other aspect of the bill is disburbed, i.e., the rest of the bill remains exactly as written – no mark-ups or amendments. That is: yes to the prebate (no to means-testing it), yes to taxing governments, and yes to immediate impelmentation (actually, I prefer six months), and yes to funding Social Security and Medicare through this tax.
As you can see, I’m really a FairTax hard-liner.
Regards,
~Jim
OK, hardliner,
Of course I would prefer to make certain changes to the legislation in the event it shifts from a sales tax to a VAT. I’d prefer to drop the unsupportable proposal to couch the tax in inclusive terms. The unconstitutional or inappropriate taxation of governments should be rethought. I’d certainly drop the implicit taxation of both investments and debt instruments as found in HR25, Sec. 801-806. Because there are 130 some odd countries that use the VAT, I agree that a shorter implementation period would be OK. I’d like one year, but your six months might work.
I do have one issue to offer that might be a more complex, (but not more expensive) problem. The 1/4 of 1% fee for collecting the sales tax was OK when the States only had to deal with the retail outlets. But, under a VAT, the States are going to have to keep track of and audit every single business in their State, large and small. I’m not clear just how the share of the 1/4 of 1% fee would be awarded to suppliers, but for sure, there would be five or ten times as many in the picture. The cost wouldn’t change, I guess, but the administrative problems would be huge, imho. Just a thought.
Hank,
Well, you may have caught me with the 1/4%. Maybe merchants don’t need that incentive under the VAT because they pay the VAT as they go.
My hard line is softening. That’s disconcerting!
Actually, there would be a substantial number of businesses under the FairTax bacause the registration certificate requirement of the FairTax applies to anyone who is in business. That business takes an intermediate sales credit under Chapter 2.
~Jim
Jim,
Disconcerting or not, you need to stay flexible on the bill language. Having worked on the Hill for ten years, I never saw a significant piece of legislation go through the system without any amendments. All legislation is a compromise, and no one gets all they might want, including Linder?
My guess is that the inclusive tax language won’t survive the Revenue subcommittee, nor will the $600 billion annual cash grant entitlement, nor the inappropriate taxation of State and Local government consumption. Want to go double or nothing on the bet we made about how many cosponsors there will be in the 111th Congress? (I’m winning?)
You are correct about registering all businesses, but there is a vast difference between a one time business registration, and requiring the State to track, audit and collect revenue from just the retailers.
By the way, I don’t suppose you would be willing to respond to some poor soul on FTN that wants to know where to locate the supporting data for the claim that there is $13 trillion in offshore wealth? I can assist if necessary, having found several references that might help? But, having been banned for telling the truth about taxation of federal employee salaries, I’m unable.
Best regards,
Hank
I like the VAT better than a retail sales tax. First, I don’t believe it is a “hidden” tax as many suggust. If a consumer pays say $50 in sales tax at the register. They would also pay $50 in a VAT system. The only real question would be if the VAT should be included in the price or on top of it. If it is included in the price then it would be more “hidden”, but it doesn’t have to be.
Second, a sales tax is easier to evade. I can tell you for a fact if I took my business’s tax exempt certificate down to wall mart and bought an ipod with it, it would be a long time before the government got around to auditing me (if ever).
Under a vat, there really isn’t any way to evade the tax. Business don’t get tax exempt certificates, they reinburse themselves for the tax paid with the tax they collect, then remit the rest. Under a sales tax, a small business may be tempted to avoid collecting the sales tax in order to boost sales. Under a VAT, if they don’t charge tax, they don’t have anything to reinburse themselves with. Of course, the government would reinburse business with negative tax balances, but they would be the first ones audited.
As for it being cumbersome, businesses would only have to list their sales and expenses on one simple form, and calculate what they owe. Businesses already have these numbers on file they don’t need to do any extra accounting. Is that really that much harder than going around requiring all your purchasers to provide you with a tax exempt form and keeping it on file? And for purchasers to have to petition the government for tax exempt forms? Certainly it would be significantly easier than filing a tax return every year. One could do it without an accountant.
This thread may heat up considerably in the weeks and months ahead. Based on Charlie Rose’s recent interview with Paul Voelker (SP?), the chairman of the Obama tax reform commission, it sounds like a VAT is coming! It seems clear that the federal government needs to raise huge amounts of additional revenue, and VAT could do that, perhaps in concert with reducing, but not replacing the income tax? After rereading all of the above comments, it doesn’t sound like any of you would have any great objection to a consumption tax such as a VAT?
The trial balloons are already in the air, and the train is about to leave the station without the Fairtax. I still don’t understand why AFFT didn’t take a run at the new Tax Reform Commission? Perhaps their failed effort in 2005 with the Bush Commission soured AFFT on ever making any headway with the Washington, DC bunch?
Stay tuned!
Help me out, someone. I recall that someone had an example of a VAT sales receipt, but I can’t locate it in the archives. Any assistance greatly appreciated
Unlike our current system, we need a tax system that is as transparent as possible. The more transparent the tax system, the better chance we have in controling government spending. There is no question; the FairTax is a very transparent system. Since there is only one tax rate, everyone will know if congress votes to raise the percentage. Those voting for this increase will be out of a job come next election.
The only way I would support a VAT is if it provided a prebate similar to the FairTax and eliminated all other federal taxes; if not, the poor will take a real beating with a VAT.
Like the FairTax, I prefer an inclusive tax. With an inclusive tax, if the price of an item is $133.00 that is what I pay plus any state sales tax. I don’t need to try to figure out how much extra money I will need to come up with to make the purchase. I know a VAT is an add-on tax, but I guess I could live with it as long as it appeared on every sales invoice.
As a small manufacture the VAT would be a nightmare of paperwork. It would also increase the governments costs of paperwork due to the large increase in the points of collection. If a product from raw material, to machining, to finishing, to assembly, to distributor, to retailer goes through 6 steps of production then 6 different companies would have to calculate and file the tax. I would much prefer a national sales tax just for the cost savings to US manufactures and service providers.
[...] properties to a sales tax. We’ve discussed it on this blog in the past – “What’s wrong with a VAT?” A VAT would have a higher administrative cost, and possibly open up more areas for loopholes [...]
The underground economy is huge and growing, estimated at $ 1 to 2 trillion with 150 to 300 billion or even more in lost tax revenue..
A consumption tax or VAT with a surtax for the more affluent, would largely eliminate the underground economy and may actually reduce taxes for the rest.
A fair tax would NOT.