Thursday, June 18, 2009

VAT Tax Time

Healthcare reform will have a hefty tag. And Obama has insisted that any reform be deficit-neutral.

So to raise the revenue needed, some in both parties are talking about imposing a value-added tax (VAT). The VAT works by taxing the value added at each stage of production. This is a good description of what happens with a VAT:

“Take a hand-made guitar: When the maker buys the strings and the wood, he receives invoices that show how much value-added tax their producers have paid. By assembling the guitar into an instrument a musician can use, the maker adds value, and can sell the guitar for more than the cost of the materials. He will pay tax on his sales price, but may first subtract the taxes that suppliers have paid, avoiding double taxation. Net, he pays tax only on the value he adds.”

Just a 5% VAT could bring in around $500 billion a year. A higher vat could end up helping us not only pay for healthcare reform, but pay down the immense budget deficit. Moreover, it has the virtue of taxing consumption and incentivizing saving. It would be good for all involved if Americans stopped binging on debt and started saving.

Ironically, the VAT might also cause a temporary increase in consumer spending. If Americans see that a 10% VAT tax is coming in a few months, they might be more inclined to go shopping and buy at lower prices. This spike in consumer spending could help ameliorate the recession.

There are two main objections to the VAT. One is that the tax will be regressive. And there is truth to that. Poor and working class people must spend a greater percentage of their income on consumption. To soften the impact of the VAT, we could exempt some of these people from paying any income taxes, or we could send some sort of rebates back to them. Also, remember that this money will be used to pay for healthcare. Perhaps, it is best then, to think of the money paid out as a VAT as a premium.

The second objection comes from conservatives, who are worried that such a tax will be a cash cow for the government. Government will have a lot of new revenue it can spend on new programs. I too worry that some in congress will want to start new programs we shouldn’t be paying for right now. But I think given our fiscal situation, the government needs a cash cow. This is an idea that should seriously be considered.

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