A value-added tax would harm the economy

Nation's Business, July, 1989 by Warren T. Brookes

A Value-Added Tax Would Harm The Economy

A decade ago, I wrote a couple of columns urging Congress to replace the corporate income tax with a value-added tax (VAT).

My economic logic was impeccable: Exchange a massively random, economically distorting, inefficient tax on production and investment for a fairer, more uniform tax on consumption.

My political logic, however, was something less, as the late Al Ullman, the Oregon Democrat who was then chairman of the House Ways and Means Committee, was to discover a year later. After he endorsed a VAT, he was beaten by a Republican rookie.

An older and wiser political economist said to me at the time: "There's only one thing wrong with your idea, Warren: Show me a single country where the VAT has ever replaced another tax!"

I discovered he was right: Every country that has enacted the VAT also has a corporate income tax, and without exception all of those countries have much higher total tax burdens than the U.S. has. Britain's tax burden is 33 percent higher; West Germany's, 30 percent; France's, 55 percent.

In short, the VAT has been used again and again not to make the tax system more economically efficient but to generate vast increases in revenues, giving politicians, even conservative ones, spending temptations they find almost impossible to resist.

Few remember that British Prime Minister Margaret Thatcher "traded" some significant and needed reforms in that country's corporate and personal income-tax systems, cutting the top rate from over 90 percent down to about 65 percent from 1979 to 1984, in return for a large increase in the VAT to 15 percent.

In that period, the conservative Mrs. Thatcher watched her nation's total tax burden soar by 6 full percentage points, a whopping 17 percent relative increase. That increase was one of the key reasons why Britain was mired in 11-13 percent unemployment until much larger cuts in income-tax rates from 1986 to 1988 brought the needed final economic stimulus.

Britain discovered why Nobel economist James Buchanan, in his brilliant treatise "The Power to Tax," warns against any "base-broadening tax proposal" such as the VAT: "If such a proposal is adopted, it may be predicted that ultimately the value-added tax would be used to generate revenues greatly in excess of the revenue reductions under other taxes."

Sadly, this advice has not been heeded by some segments of the business community or by some Republicans.

Late in April, a small group of serious-minded Republicans calling themselves "The Congressional Consumption Tax Working Group," headed by Rep. Richard Schulze of Pennsylvania, took strong offense at an April 21 bulletin from the Republican Study Committee (RSC) titled "No Virtue in VAT."

That RSC bulletin had heavily condemned the VAT as "regressive," "hidden," and "economically stagnating." It announced the formation of the "Anti-Vat Coalition" of 40 members and growing.

On May 3, Schulze, a member of the House Ways and Means Committee, used the RSC letterhead to argue "a 5 percent consumption tax levied as a business transfer tax, or BTT (similar to the VAT), could raise $100 billion and totally replace the corporate income tax." It also chided Republicans for ignoring "the favorable aspects of taxing consumption." Aspects cited included savings enhancement, capital/labor equity, and reciprocity with trading partners that do not levy such a tax.

It suggested that "if one were to poll most businessmen or tax practitioners today, and ask them about replacement of the corporate income tax with a consumption tax, nearly all would agree with the concept."

Indeed they would, and with very solid economic reasons, but no one else would--and that is the rub. Democratic politicians think it would be politically suicidal to end taxes on big corporations in favor of socking ordinary consumers with a big new sales tax.

But proponents of the VAT who still favor this hopeful trade-off point to the fact that almost all other industrial nations now have a VAT. The latest to join the ranks of the proponents is Prime Minister Brian Mulroney of Canada, who in May proposed adding a 9 percent VAT in 1991. This followed an April decision by Japan's ruling party to adopt a 3 percent VAT.

Since the VAT is normally exempted for exports but applied to imports, it does act as a kind of protectionist tariff and yields a nominal bilateral trade advantage for the VAT user.

Those who make this argument, however, forget that a non-VAT Japan ran the largest trade surpluses in world history and that U.S. exports have been rising for the past two years.

Moreover, the two major industrial powers that are growing fastest and creating the most jobs are the two that are the lowest-taxed--the U.S. and Japan. Although a VAT might temporarily "equalize" some bilateral trade terms, the economic damage would far exceed such ephemeral gain.

Finally, as this column was being written, the U.S. budget deficit was declining sharply, perhaps as much as $20 billion this year, because of much faster revenue growth than forecast, over 9 percent through the first seven months of the fiscal year, suggesting a rise of some $75 billion to $80 billion in revenues in FY89, to be followed by an additional $85 billion in FY90.