New Podcast: Dr. Randall Holcombe on Why a VAT is Too Costly for the U.S.

July 14, 2010

The Wall Street Journal's John McKinnon recently evaluated the political appetite for implementing a VAT in the United States:

Advocates say a VAT creates less incentive for avoidance compared to a sales tax, while limiting economic damage compared to income taxes. But conservative critics worry it's just another faucet for government to tap. And many business owners regard it with apprehension, in part because of its administrative complexity.

He concludes that there's enough opposition to keep a value added tax at bay in the near-term, but that it might not be that far off in the future, especially if it's paired with a large enough reduction in the corporate income tax (which could soon be the highest corporate income tax in the world). He highlights an important criticism of a VAT — or rather, of Washington — namely, that a broad-based, low-rate VAT would eventually see its rate jacked up and many exemptions carved out of the base as special interests flock to Capitol Hill. And there's no guarantee that any corporate income tax reduction would be permanent:

Also, many critics believe the VAT could start low — but then be steadily ratcheted up. They point to the experience of European countries that started with low VAT rates but gradually saw them increase. Congress also could lower the corporate rate now in exchange for a VAT, only to increase it again later, they worry.

In this week's Tax Policy Podcast, Randall Holcombe, Ph.D., discusses the costs of a VAT and consequences for economic growth, which he addresses in a recent paper authored for the Mercatus Center at George Mason University, "The Value Added Tax: Too Costly for the United States." Holcombe points to international evidence — as well as America's own history with the individual income tax — that shows that tax rates start low upon introduction but dramatically increase over time:

Once the VAT is there, it's a lot easier to raise the VAT rate then it is to introduce a VAT to begin with. And in fact, in almost every country that's introduced a VAT, the VAT rate has gone up pretty considerably after the VAT's introduction. We shouldn't be too surprised at that. … The highest marginal tax bracket in 1913 when the U.S. income tax was introduced was 7 percent. Today, that's higher than the lowest bracket.

Listen to the full podcast here, or check out all of the Tax Foundation's Tax Policy Podcasts.

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