 | | Kip Beckman
Principal Research Associate
Economic Services |
If you think Canadians were angry when the GST was introduced in 1991, wait and see how Americans, who hate taxes even more than us, react when the federal government is forced to implement a value added tax (VAT) of its own. Higher taxes will be required to bring trillion dollar deficits back under control because there is little wiggle room available to lower government spending significantly. A high portion of federal spending is mandated by a number of laws and entitlement programs that automatically increase every year without authorization from Congress. Also, other programs including defence spending and interest on the large federal debt are largely outside of Congress’s control.
A VAT similar to our GST is supported by many economists because it is a broad-based tax that could generate the huge revenues required to place a serious dent in the deficit. Given that U.S. consumer spending is around $10 trillion a year, a VAT of about 10 per cent could generate well over $500 billion annually, even with the typical exemptions for food, children’s clothing and education. The most common form of VAT is one where the government takes a per cent of the value-added at every stage of production. Businesses are charged tax based on their revenues and receive a credit for the taxes paid on inputs purchased during the production process.
In addition to its revenue-generating possibilities, VATs are favoured by economists because they are a more efficient form of taxation compared with many other taxes and are, as a result, positive for economic growth. Given that, under a VAT, savings are taxed less than consumption, households have an added incentive to save more money, a development that could add to the supply of funds available for lending and investment in the United States. Higher investment would result in rising productivity growth and higher wages over the long term.
Of course, VATs are not without their critics. The most frequent criticism levelled against this tax is that they lead to a surge in inflation. While prices for most consumer goods rise after a VAT is implemented, the increase is generally a one-time spike in prices and need not lead to accelerating inflation unless the central bank adopts inappropriate measures to accommodate the increase – something that isn’t expected to occur. In Canada, there was concern that the GST would lead to soaring inflation but, after an initial blip, consumer price increases returned to their normal range after a year or so.
The most common complaint about VATs is that they hurt low income households who spend a larger share of their income on consumption. However, a VAT, if properly administered, need not be regressive if it includes exemptions for food, some clothing and medical supplies. Also, a VAT income-based tax credit could be added to shield low-income tax payers. These adjustments should ensure that a VAT would not place a heavy burden on low income families.
In the present poisonous climate in Congress, where the anti-tax “tea party” movement is quickly shifting the Republican party to the right, the chances of introducing a VAT would appear to be extremely slim. Yet, what are the alternatives? Lowering the deficit by increasing taxes on income would also hurt consumers and have a negative impact on economic growth. Cutting government spending would entail fewer subsidies and services for the poor. Of course, doing nothing, a realistic possibility in the present environment in Washington, implies ever increasing deficits, higher interest rates and lower investment.
Over the near term, it is unlikely that the federal government will take any major initiatives to fight the deficit. The economic recovery, while gaining momentum, is far too fragile to handle higher taxes and lower spending at the present time. Yet, as time goes on and the pressure to lower deficits intensifies, the VAT may end up being the only viable alternative for the U.S. economy – unless Americans decide they want to pay higher gasoline taxes!