Politics & Policy

Debating a VAT

(Jojojojo/Dreamstime)

Senators Paul and Cruz have generated a debate on the right by proposing value-added taxes in their economic-reform plans. Conservatives have traditionally opposed value-added taxes, worrying that they are too easy to raise because they are hidden.

At the same time, the value-added tax has some real advantages: Its inclusion in the Paul and Cruz plans helps to explain why the Tax Foundation scored their plans so well against the other Republican plans. The Cruz and Paul plans have a lot of bang for the buck — a lot of projected economic growth for relatively little revenue loss — and the VAT is a large part of that.

At NRO today, Stephen Moore defends the value-added taxes proposed by Paul and Cruz from its critics. His response to concerns that the tax undermines accountability begins with the observation that the payroll tax is partly hidden, too. But that’s not a reason for replacing it in a way that hides even more of the tax burden; it’s a reason for making the burden more visible. Moore’s second response is more constructive: He says that Paul and Cruz should explore ways of making their tax more visible. But he argues against the simplest way to do this while retaining the economic advantages of the Cruz and Paul proposals.

#related#Both of those proposals have a low flat tax rate on income in addition to their VATs. Paul would have a flat tax rate of 14.5 percent plus the 14.5 percent VAT. That works out to an effective flat tax rate of 26.9 percent. So why not just stop hiding part of that tax inside a VAT? Let businesses deduct the cost of wages when they pay taxes — as they do now — and raise that flat tax rate to 26.9.

Moore offers two reasons for keeping the VAT, neither of them persuasive. The first is that there would be no cap on the wage taxes, whereas the payroll tax has a cap: It does not apply past $117,000 in income. (That cap corresponds to the cap on Social Security benefits.) But an income tax doesn’t have to have a cap, either, and neither the Cruz nor Paul plans have a cap on their income-tax plans. So this isn’t an argument against getting rid of the VAT and raising the income-tax rate to make up for it.

His second argument is that the VAT is border-adjustable. Because it taxes imports but not exports, it will be good for the trade balance and mollify protectionists. Cruz made a version of this argument himself in last night’s debate. I am skeptical. First, we should expect a VAT to make the dollar appreciate, nullifying any tendency of it to reduce imports. Second, I doubt that voters who worry about imports are going to find this measure against imports adequate (and, since it wouldn’t actually work, they shouldn’t). Third, making policy as though we think imports are bad seems to me to do more to stoke than to dampen protectionist sentiment. When the VAT goes into effect and the trade balance stays the same, what’s a politician who promised it would come down to do? I’m sure Senator Sanders will have some ideas.

#share#There is one more reason, unmentioned by Moore, why a policymaker might consider keeping the VAT preferable to raising the income-tax rate. It’s that the resulting income-tax rate (26.9 percent for Paul) would look too high. When Paul talks about his plan, he says that he would get rid of the payroll tax and that this would be a big tax cut for workers. He does not mention that much of this tax cut would be taken away by his VAT. A higher income-tax rate would make it harder for him to present his plan as favorably. (Similarly, Cruz would not be able to say that he exempts people making less than $36,000 from taxes if the VAT were visible.) But that strikes me as a bad thing: We should not hide the realities of a tax plan from voters.

I have raised one lesser concern about the value-added tax, and Moore addresses me when he turns to it. But he thoroughly misunderstands what I said. Perhaps remembering debates between supply-siders and Keynesians from the early 1980s, he takes me to be worrying that a tax cut will cause inflation. He then refutes this argument I didn’t make, even throwing in a “Duh.” My actual argument is that these tax plans are structured in a way that will require cuts in quoted pay rates unless the Federal Reserve increases inflation. This Tax Foundation post on Paul’s proposal goes through the math for his plan: A worker making $40,000 a year now would see slightly higher after-tax income as a result of that plan, but his wage would go significantly down. As Alan Viard explains in this paper, monetary authorities typically want (and have good reasons to want) to avoid reductions in nominal wages.

We should not hide the realities of a tax plan from voters.

As I said, this is a lesser concern. A short-term burst in inflation to accommodate a big change in the tax code would not be a disaster. And both Cruz and Paul could avoid any such monetary accommodation or wage cuts by phasing in their plans over four or five years. This is merely something Cruz, Paul, and those considering their plans should keep in mind — which of course would be easier to do if the issue were described accurately.

Another way to avoid any interaction of the plan with monetary policy, of course, would be to refrain from having a VAT at all: Tax employees directly on their wages, as we do now, even if it means squaring with them about their tax bills.

(Disclosure.)

Ramesh Ponnuru is a senior editor for National Review, a columnist for Bloomberg Opinion, a visiting fellow at the American Enterprise Institute, and a senior fellow at the National Review Institute.

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