Cato Scholar Urges US Tax Reformers To Resist VAT

A value-added tax system will not be the magic bullet that simplifies the US tax system while increasing revenues, as proponents of a federal consumption tax have suggested, according to a critique of the idea by Dan Mitchell of the Cato Institute.
Writing in the Wall Street Journal in response to renewed interest in consumption taxes in Washington as part of the wider debate on US tax reform, Mitchell argues that the evidence from Europe, where VAT systems have been in place for many decades, is not encouraging from the point of view of reducing both tax complexity and the overall tax burden.
“The classical argument in favor of a VAT says that it's desirable because it has a single rate and is based on consumption,” Mitchell writes. “It is true that single-rate systems (assuming a reasonable rate) are less harmful than discriminatory regimes with "progressive" rates. It's also true that a consumption-based tax would not inflict as much damage as our internal revenue code, with its multiple layers of tax on income that is saved and invested. But these arguments only apply if a VAT replaces the current tax system -- which is not the case here. And the evidence from Europe suggests it's not a good idea to add a somewhat-bad tax like the VAT on top of a really bad tax system.”
Mitchell notes that prior to the mid 1960s, before the advent of VAT in Europe, the average tax burden for the advanced European economies (commonly referred to as the ‘EU 15’) was just under 28% of gross domestic product (GDP) – a similar level to the US tax burden at the same time. By 2006, with VAT firmly entrenched across the European Union at rates of 15% or more (the legal minimum rate set down by the EU VAT Directive) the tax burden of the EU 15 had grown to a little under 40% of GDP. By contrast, the US tax burden had remained fairly static at 28%.
Mitchell also rejected the notion that VAT can increase the tax take without higher taxes on personal or corporate income, again pointing to Europe where taxes on income and profits consumed 8.8% of GDP in Europe in 1965 and 13.8% in 2006.
“The income tax system we have today is a nightmarish combination of class warfare and corrupt loopholes,” Mitchell writes. “Adding a VAT does not undo any of the damage it imposes. All that happens is that politicians get more money to spend and a chance to auction off a new set of tax breaks to interest groups. That's good for Washington, but bad for America."
The idea of a national consumption tax briefly formed part of the debate when President George W. Bush was putting together his bipartisan panel to study options for fundamental tax reform, but did not emerge as one of the final proposals.
The Bush panel came up with two broad plans for tax reform which would have reduced the number of income tax brackets, somewhat simplified corporate and investment taxes and abolished the alternative minimum tax, although the panel’s report was quietly shelved after the Democrats gained a majority in Congress in 2006. However, for many tax reform advocates, the proposals did not go nearly far enough.
The last major round of tax reforms in the US was the Tax Reform Act of 1986 under President Ronald Reagan. But this work seems to have been largely undone by successive administrations and Congresses; there have been more than 3,250 changes to the tax code since 2001 alone - an average of more than one a day.
President Barack Obama has established his own tax reform panel which is due to report back by the end of 2009. Led by former Federal Reserve Chairman Paul Volcker, the only restriction placed on this panel’s remit is to ensure that its proposals do not increase taxes on those earning less than USD250,000 per year. However, it is expected that the Obama panel’s focus will be as much on efforts to close the ‘tax gap’ as on simplifying the tax code, although one of the President's pre-election pledges was to dramatically simplify the act of filing a tax return for the vast majority of individual taxpayers.
It is likely that a national consumption tax will be re-examined during the Obama panel’s deliberations. Indeed Senate Budget Committee Chairman Kent Conrad recently told the Washington Post that VAT must be “on the table” as part of the latest tax reform debate.
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The Bolivian Sales Tax (IVA)

Whether or not you pay a Bolivian sales tax when you go shopping will depend on where you are shopping, what you are buying, and who you are buying it from.
The Bolivian tax on transactions is called the IVA (Impuesto al Valor Agregado – or Value Added Tax, in English). Basically, it all boils down to this: anyone who sells anything should pay taxes to the government on the income they earn from the sale. However, as you’ll soon learn, the IVA is a far more complex matter in Bolivia. I’ll try to explain in the most uncomplicated manner possible.
For all practical purposes, what you need to know is that there are two types of commerce: what we typically call formal commerce and informal commerce.
Formal commerce includes all businesses that have registered with the government, have a Tax I.D. number and pay taxes on each sale made. In order to show how much they’ve earned, ideally they are supposed to issue an invoice (sales receipt) each time they make a sale. The Bolivian sales tax they charge you is then paid once a month to the government. Many of these businesses import the products they’re selling you – they pay import taxes on those products as well, prior to selling them to you and me.
Informal commerce includes all businesses that have not registered with the government, do not have a Tax I.D. number and do not pay taxes on each sale made. Technically this is not legal, right? Let me explain:
Many businesses “import” products without paying import taxes. This means they’ve found a way to obtain the product without taking it through customs. You would think these products (frequently called “black market” products) would be sold only in outdoor markets and in a clandestine manner, but you’d be surprised how many formal businesses actually acquire their products this way too. Stores or vendors who sell this type of product are part of the “informal” commerce that exists in Bolivia.
But, in addition to these, many stores, vendors, outdoor market vendors, and sidewalk vendors sell products that are not imported – they are manufactured in Bolivia. Nothing illegal about that. However, they have not registered with the government to sell anything (ideally everyone should) and therefore, do not pay taxes to the government.
Because both types of “informal” vendors have not paid taxes to the government (either in the form of an import tax or a sales tax) they cannot charge you a Bolivian sales tax either. And, because they are not registered with the government, they are unable to provide an invoice (sales receipt) to their customers. Once in a while the government will send out inspectors to randomly close down informal businesses. But this happens infrequently.
Why has the government turned a blind eye to informal business for so long? Probably because without informal commerce thousands of people and families would have no income at all, and without other viable income and job opportunities to offer them, the government has been slack about making these vendors pay the Bolivian sales tax.

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