David R. Henderson  

Henderson on the Case Against a VAT

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Take Europe, where the VAT is a major source of government revenue. When Belgium, France, Germany, Ireland, Italy and the Netherlands adopted a VAT--all between 1968 and 1971--their stated revenue goal was neutrality: Gains in revenue from the VAT were to be fully offset by reduced taxes elsewhere. (France already had a VAT but needed to revise it to meet European Economic Community Standards.)

All failed. Government revenues--and spending--rose substantially as a percentage of GDP. In 1967 in France, the year before that country adopted its EEC-compliant VAT, total government revenues were 33.4% of GDP. In 1968, France adopted a VAT rate of 13.6%. By 2014, its VAT rate was 20% and government revenues were a whopping 45.2% of GDP. When Britain adopted a VAT, the government's stated goal was to reduce revenue. That failed, too.

Only one country, Denmark, adopted a VAT to increase revenues. It succeeded.

This is from David R. Henderson, "It Makes It Too Easy for the Government to Raise Money," Wall Street Journal, February 29, 2016, R3.

On the other side, arguing for a VAT, is Columbia Law School professor Michael J. Graetz.

We didn't get to see each other's various drafts while writing and revising.

By the way, one of the sources that helped me a lot was Randall G. Holcombe and Jeffrey A. Mills, "Is Revenue-Neutral Tax Reform Revenue Neutral," Public Finance Quarterly. Vol. 22, No. 1. January 1994: 65-85, especially the table on Europe's VATs on page 73.

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COMMENTS (8 to date)
JLV writes:

Your second to last paragraph is only germane insofar as fraudulent payments under a VAT system would be more prevalent than under the current system, where the IRS estimates that ~25% of EITC payments are made in error. Not at all clear, and you provide neither evidence nor an argument for why this might be the case.

Note also that if you are right that a VAT would allow for more spending this actually cut against this point: an IRS without the burden of administering the income tax and with additional resources from higher revenues is an IRS that will be able to devote more resources to fraud prevention.

John Strong writes:

A persuasive empirical argument. And Randall Holcombe's article makes clear that VAT carries a heavy administrative burden, which partially undermines what I thought was one of the key attractions: efficient bottom-up compliance enforced by vendors themselves rather than tax authorities. But I am not totally persuaded. The empirical results assume that income tax is left in tact. I've long harbored the hope of a historical compromise in which we could accept a VAT in exchange for the *compete* *elimination* of income & payroll taxes. Might the VAT not be a good idea in the context of a bolder approach like that?

David R. Henderson writes:

@John Strong,
The empirical results assume that income tax is left in tact. I've long harbored the hope of a historical compromise in which we could accept a VAT in exchange for the *compete* *elimination* of income & payroll taxes. Might the VAT not be a good idea in the context of a bolder approach like that?
It might. But in writing my piece, I checked Michael Graetz’s work and he was arguing for keeping income taxes at lower rates and tacking on a VAT. Since I thought he would argue that here, that’s what I argued against.
I would still worry, though, about its being a big revenue machine for government.

Greg Jaxon writes:

We only have an Income Tax by special enumerated authority of the 16th Amendment to the Constitution. Some argue that it may not even have been properly ratified.

Taxing value added (to products at each stage of their production process) does not fit any of the taxation categories which states delegated to the federal government. It literally adds friction to every attempt to subdivide economic activity and so favors vertical integration of industries.

VAT should also require a Constitutional Amendment to grant a new power and simultaneously rescind the former power to tax income. Still I'd hope that would fail spectacularly, as should most authorizations of taxation authority.

ThomasH writes:

I think this needs a much finer pencil to be persuasive. First, the taxes that a VAT would most plausible replace is not the personal income tax which has little dead-weight loss, but business taxes and wage taxes where the dead weight losses (especially of the corporate income tax) really large. So even if more revenue were raised, the dead weight losses could still be lower.

R Richard Schweitzer writes:

Different strokes for different folks.

Given the "pass-through" nature of taxation of business enterprises, a phase-over into VAT would be the most effective form for those transactions.

Phase-over would be necessary to prevent existing tax directed consequences from creating havoc.

We are probably not yet at the stage where professional services can be "valued" for VAT. However, different forms of transactions could be taxed on different scales; such as services to business enterprises.

But the BEEEG thing is to get a handle (and limits) on the functions of governments.

Gene writes:

The picture in the WSJ didn't look like David Henderson!

Sean Leal writes:

Seeing people quibble about the most efficient way to take others' property under threat of violence is, in a word, nauseating.

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