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Source link: http://archive.mises.org/10149/the-folly-of-the-national-sales-tax/

The Folly of the National Sales Tax

June 17, 2009 by

Facing a historic national debt that President Obama correctly characterized as “unsustainable,” yet still desiring to implement some sort of national health-care package, US policymakers, notably Budget Committee Chairman Kent Conrad and former Federal Reserve Chairman Paul Volcker, have recently hinted at the possibility of a national sales tax. More specifically, they hint at possible implementation of a national value-added tax (VAT) which would tax at a certain rate the difference between the cost of inputs and the price of the output along each individual step of production. FULL ARTICLE

{ 33 comments }

Tim Kern June 17, 2009 at 8:46 am

Please — a VAT is only one form of sales tax, and it’s not really based on sales. Let’s carp about a VAT, not a national sales tax!

A NST, assessed and collected as are state sales taxes, and instead of income taxes (corporate and individual) would do several very good things:

First, it would eliminate the world’s largest government-sponsored terrorist organization, the IRS.

Second, it would free up hordes of accountants to do productive analytical work.

Third, it would allow infinitely-simpler bookkeeping for hundreds of millions of Americans, saving untold dollars.

Fourth, it would tax consumption, so that those who wished to save and allow investment, could do so. This, of course, would spur investment — and the amount of investment would rise in direct relation to the amount of money no longer being wasted on the IRS itself, its investigation and enforcement operations; and on the productive side of society, in the reduction of audit-prevention accounting.

Now, if people were really concerned about the disparate impact on poor people, they could exempt rent payments, basic foods, and gasoline; but the current system doesn’t do that, at any rate.

The real problem with the proposal from Obama and Volcker is that this is not a substitute for the income tax and all its baggage — it’s in addition to it. With entrepreneurs already facing marginal tax rates in the 80s, what would this leave as an incentive for anyone to be productive? Oh — it’s really designed to force everyone into a planned government-sponsored job, a system that worked so very well in the 1930s.

When we finally realize that the currency of D.C. is not “currency” but power, it makes perfect sense. As one of the current crop of economics texts explained our field, “Economics is about who gets what.” We used to call that “power politics,” but our media and “government economists” (what happened to “economists?”) have changed the meanings of pretty much anything.

Enjoy Every Sandwich June 17, 2009 at 8:49 am

How could they even begin to calculate what the rate of a VAT could be? Millions (or billions?) of products, each with its own production process?

Do their estimates include the cost of compliance? Enforcement? Do they assume that there will be no change in consumption? All of this is important since their stated goal is to fund an expensive program with the revenue.

I wonder what they’ll do when people start buying more second-hand stuff. A second-hand VAT?

How does the VAT apply to imported stuff? If it doesn’t apply, what will the government do if people buy more imported stuff to dodge the tax? A nice fat protective tariff?

I just can’t see this as being anything but a disaster.

Christopher June 17, 2009 at 9:16 am

The great tsunami known as the “baby boomers” are going to put tremendous stress on medicare/medicaid. The system is broken as it is now, and I do not envision the boomers voting for reductions in their benefits. The revenues will have to come from somewhere because the programs aren’t going away. Maybe it’s time for me to leave the country?

Chip Krakoff June 17, 2009 at 10:01 am

In a perfect world, Eric Staib may be right, but it should by now be apparent that the world we live in is far from perfect. So it’s more than a little disingenuous to criticize a VAT for its deviation from theoretical perfection instead of considering it in relation to other methods of taxation.

One of the many faults of Obama’s economic policies – which was evident throughout his Presidential campaign – is his focus on narrowing, instead of widening, the tax base. It is axiomatic (and I have advised governments of at least 10 countries on this) that if you want to increase tax revenues it is far better to lower tax rates and thus encourage more people to pay their taxes than to raise tax rates and increase tax avoidance and evasion. By promising the country that everyone would get a tax cut except for those “rich” people earning over $250K Obama has exempted some 44% of the U.S. population from all Federal income taxes, up from 38% under President Bush. This leads to even more demand for government hand-outs from people confident that someone else will pick up the tab, which in turn will raise budget deficits.

A VAT, if imposed on top of Federal income taxes is a terrible idea, but to the extent that a national VAT can replace some portion of Federal income taxes it is a very good thing indeed. With everyone contributing something to public revenues more people will take an interest not only in what they can get from government but what they will have to pay for it. This can only be a victory for the free market and fiscal responsibility.

All taxes create some disincentive to productive economic activity, but we need to ask whether a VAT is a greater or lesser disincentive than personal and corporate income taxes. Since a VAT is broader-based and can’t be avoided, as income tax can, by exploiting myriad exemptions, preferences, and loopholes, it passes the fairness test much more easily. It is easier to administer than an income tax and it creates a lot fewer jobs for the legions of tax lawyers and accountants who specialize in tax avoidance.

Yes, a consumption tax is regressive, but we already have tools like food stamps that can soften the blow on poorer Americans, and as an earlier commenter pointed out, we can exempt certain basic consumptions items like food and gasoline, for which the VAT burden would fall disproportionately on the poor. Now if we could only introduce a flat income tax too…

knldgskr June 17, 2009 at 10:01 am

I may be wrong, but it seems to me that VAT is a tax on the labor component of every item. If that is true then VAT will encourage the production of low labor added items and thereby increase unemployment.

Jeremie T. A. Rostan June 17, 2009 at 10:07 am

Although I obviously agree with the central thesis, I think the following is a mistake :

“… the introduction of a VAT would tend to distort market signals of consumers’ preferences between certain categories of goods. In the form of higher prices for highly-processed goods, a VAT sends entrepreneurs a phony signal that consumers prefer goods of high processing over those of low processing more strongly than they actually do.”

High-added value goods being more taxed by a tax on added value, entrepreneurs see their COSTS increase in such lines–or, because they cannot get rid of the tax-effect through higher prices to consumers, they see their revenues DECREASE in such lines.
The production of such good would thus decrease, relatively to that of low-added value goods.
This is consistent with a SHORTENING of the structure of production.
Prices of high-added value goods would in the end increase, but only because their stock would diminish.
To put it simply, the false signal is that high-added value goods are relatively less important to consumers than low-added value ones. It is a phony signal of HIGHER time-preference.

Amapola June 17, 2009 at 10:44 am

Christopher:
“Maybe it’s time for me to leave the country?”

If you leave the US, where would you go?

Michael A. Clem June 17, 2009 at 10:49 am

There are all sorts of possibilities for changing tax structures, but most proponents of such changes are assuming the basic rationality of politiicians and bureaucrats. Their decision-making is ultimately irrational, because, as Mises and others have pointed out, they can’t calculate. That is, they have no economic incentives and feedback to tell them when they have taxed too little or too much, and their decisions are strictly political.
As always, the only solution to the tax problem is less taxes, not more, and a greater focus on what governments are spending that tax money on. National health care would surely be disastrous for the U.S., although the currently existing regulations on health care are bad enough.

Dixon June 17, 2009 at 11:10 am

I agree with Jeremie. Seems to me that the increased tax burden on goods with longer stages of production will cut into profits. Signaling to entrepreneurs, a false preference for low value added goods.

greg June 17, 2009 at 11:29 am

I am moving to Nevada where they don’t have a state income tax and a fair sales tax. It works for me!

Then there was our trip to England where we supported their government programs. Visitors paying for our government debt works for me too.

Maximum Liberty June 17, 2009 at 11:34 am

I think this article is off-base for the following reasons:

1. All taxes distort decision-making. The question to answer is how badly. Surely, when looking at a possible value-added tax, one fair comparison is to compare it to our current income tax. Our current income tax is highly distorting. It is also fair to compare it to reducing spending, which could be far less distorting.

2. All taxes require the governmental invasion of privacy to some degree. Again, when looking at a possible value-added tax, one can fairly compare it to our curren tincome tax or a reduction in spending. Our current income tax invades the privacy of bother businesses and individuals. Only businesses have an obligation to file a VAT return. Of course, lower spending invades privacy even less.

3. The author seems to have missed the point of a value added tax. By taxing each business based on [its revenues] less [its cost of inputs on which VAT was paid], the government avoids taxing proportionally to the number of times an end-product is processed. The question of whether capital goods and labor count as inputs can (theoretically) be answered either way. I understand that most VAT countries count capital goods and the labor of independent contractors (i.e. services) as inputs, but do not count the labor of employees. As one commenter noted, this effectively becomes a tax on labor, but spreads it out over time.

Also, one commenter asked how imports are handled. I understand that VAT is levied on goods when they are imported. For example, the EU requires anyone who exports goods intot he EU to register with a member country and pay VAT. I think this is important only for sales of imports directly to consumers. An example in which a business buys a product from abroad shows why. Suppose that business does not pay VAT on the imported good. But, when it sells its own product, it does not get to deduct the cost of the input good from its revenues, thus effectively paying the tax. The only differences are in the timing of the tax payment and the risk that the business goes bankrupt in the meantime.

Max

Christopher June 17, 2009 at 11:48 am

Amapola, I would move to Panama.

Chip I agree with what you’re saying however expanding the base creates all sorts of political problems. It reminds me of a ‘debate’ I heard over the NST “aka The Fair Tax” where the professor who was against the NST basically said in a perfect world the NST would work however the reality is that politics (lobbyists/interest groups) would chip away the base to a point where the NST became unsustainable.

One sad aspect about the idea of the VAT is that it is not a replacment but an addition to our current tax system.

Christopher June 17, 2009 at 11:49 am

Amapola, I would move to Panama.

Chip I agree with what you’re saying however expanding the base creates all sorts of political problems. It reminds me of a ‘debate’ I heard over the NST “aka The Fair Tax” where the professor who was against the NST basically said in a perfect world the NST would work however the reality is that politics (lobbyists/interest groups) would chip away the base to a point where the NST became unsustainable.

One sad aspect about the idea of the VAT is that it is not a replacment but an addition to our current tax system.

Jeremie T. A. Rostan June 17, 2009 at 11:59 am

This is confusing:

“By taxing each business based on [its revenues] less [its cost of inputs on which VAT was paid], the government avoids taxing proportionally to the number of times an end-product is processed”.

The value added by a production process is, in equilibrium, its period times the rate of interest.

A value added tax thus amounts to an increase in the scarcity of capital / rate of interest, from which various lines suffer proportionately to their distance from consumption, length, risk, and durability of their product.

The consequence is a shortening of the structure of production, a decrease in the value of capital, and, a decrease in the productivity of labor.

Walt D. June 17, 2009 at 12:52 pm

Just another form of theft. The real problem is the cancerous growth of the size of government relative to the private sector. Also, the marginal propensity to spend of government at all levels is about 125%. This is economic alcoholism. Government needs to dry out.

College Parasite June 17, 2009 at 1:22 pm

Think of VAT as sort of a capital gains tax… it increases the effective interest spread between stages of production, but does NOT invite more savings because, as far as income earners are concerned, interest rates remain the same. Some effects:

The real capital invested is reduced, leading to fewer goods available.
Effective capital investment in the higher stages goes down a lot more than in the lower stages.
There is NO shortening of the structure of production. That would be the case if there were fewer savings available.

There is a weird “but” here on the third assertion. As consumer goods become more scarce, individuals tend to allocate more of their income to consumption. That will reduce the volume of savings, which would again reduce the amount of consumer goods available. The process could go on until consumers/savers adapt to this new lower level of consumption (the effect might not be so strong since the bulk of savings come from people who don’t consume a lot). So I guess it could be said that such a tax does have a shortening effect on the structure of production “in the long run”.

I’m not too sure about this idea that higher end prices for consumers on goods with a longer production process would generate bubble activity. Enterpreneurs don’t look at the nominal price for good X, but the profits that makers of good X are making. If a VAT is implemented such profits would definitely not be going anywhere up.

Sorry for any terrible analytical mistakes, but I’m supposed to be switching to neoclassical mode for my econ class. That means I don’t have the time to proof read my logic again.

Bogart June 17, 2009 at 1:28 pm

Sales Tax, VAT, Income, Tariff, etc They are all the same, just various forms of theft. All are the same, bad, in this case. And their partners are also bad: debt and inflation.

The point here is regardless of the mechanism, the Federal Government is spending 25% of GDP and the amount is increasing. The States and Localities spend another 15% and amount is increasing. So any mechanism of theft: taxes, debts or inflation, on these percentages of GDP will cause significant mis-allocations of resources and thus slow or even halt economic growth and destroy freedom.

Edward Forster June 17, 2009 at 1:42 pm

Who bears the burden of progressive taxation? For example, if we consider the employees at Walmart, they and their payroll taxes are a cost to every consumer buying at Walmart. That must be the case since the company’s only source of revenue is its customers. Thus, the total company payroll tax bill is a percentage cost of every sales price on average.

Therefore, who is considered to pay income taxes? It surely cannot be the individual employees through their payroll deductions as we can see that they are essentially collecting tax from consumers and passing it on directly to government, without it even touching their own pockets. The great delusion is that by this taxation strategy employees think that they are paying tax, but those employment taxes are translated into equivalent sales taxes and so are all taxes involved in the chain of production down to the consumer.

No, the real taxpayers are ultimately and entirely the retail consumers.
And, the real equivalent sales tax is the same for everyone rich or poor. That is the extent of progressive taxation on incomes. Some might see it more as political.

John Seiler June 17, 2009 at 3:57 pm

We’re already taxed out. People just aren’t going to pay any more no matter what. As Peter Schiff and Jim Rogers keep pointing out, America is the worst place to invest now. Capital is fleeing, and it’s going to start fleeing even faster.

To impose yet another tax, with complex paperwork requirements, is the height of economic suicide.

gene June 17, 2009 at 6:25 pm

The only tax close to justified is the land value fee. Income, sales, property, capital, etc. are all the same, taxing labor or product. The government is taking what is produced by us.

Taxing the land value at least brings back what others and society created in the first place, land value.

It is also the most economically sound. As edward mentioned, the consumer or employee cannot be made to pay it. It cannot be transferred.

Eric Staib June 18, 2009 at 1:11 am

To Mr. Jeremy Rostan:

I had originally written of the relationship between a VAT and the production of high-order and low-order goods just as you did. Deciding whether I thought the increased prices of inputs and outputs would tend to shift production toward high- or low-order goods was (and indeed remains) quite a mental exercise. I see much merit in your argument.

However, I settled upon my analysis because of my belief in subjective, consumer-imputed value which determines prices that travel backwards through the chain of production-that is, from the consumers back to the producers.

To put my point more cogently, if an entrepreneur sees costs increasing, it would seem to suggest that the consumer values the final good highly and that this higher value travels backwards through the entire chain of production. Either way, I think an entrepreneur would tend to, shall I say, “see through the veil” and understand that the price increases are the result of the VAT. The more important effect here, and one which I seem to have left off the copy I submitted to the LVMI staff, is on consumer preferences; because of the differences in tax burdens, under a VAT they will tend to prefer lower-order goods, hurting high-order producers and even destroying prospects for growth.

Thank you for your comments.

Eric Staib June 18, 2009 at 1:22 am

To Maximum Liberty,

1-While I would agree that relative analysis is more useful in a political discussion, my analysis was only an exploration of one form of taxation. I did not make any prescriptions for any other form of taxation.

2-Same as 1. While a VAT would invade on fewer people than an income tax, so too would eliminating taxation! As Austrians, our role ought not to be to pick the least of the various evils while are laid before us, but to be radical defenders of the true market.

3-While I did not know that labor was not counted as an input, and while this would even further exacerbate the unemployment effect, I don’t think this is “the point” of the VAT discussion. The effect on overall economic activity and the destruction of productivity along each step of literally every process is more hazardous than pushing businesses away from labor and toward capital.

AMAI June 18, 2009 at 11:03 am

To gene, who said, “The only tax close to justified is the land value fee. Income, sales, property, capital, etc. are all the same, taxing labor or product. The government is taking what is produced by us. Taxing the land value at least brings back what others and society created in the first place, land value. It is also the most economically sound. As edward mentioned, the consumer or employee cannot be made to pay it. It cannot be transferred.”

All tax is legalized theft and morally unjustifiable. There is no “good” tax. What is done via the initiation of force forfeits the value the action would have had if it were done by voluntary agreement. There appears to be only one way to solve the current mess: revolution.

NO taxes are justifiable.

gene June 18, 2009 at 11:41 am

Hi Amai,

Your idea of taxes as theft is definately worthy of consideration.

Certainly any tax of labor or the product, no matter the disguise is one of “removing” value or property by the threat of force and funnelling it to the government and wherever it goes from there. Agreed.

But, let’s look quickly at land value. Where does the value of land come from?

Why is a vacant, undeveloped parcel located in downtown Tokyo worth thousands of times more than an identical parcel in a remote undeveloped region? What brings value to land that initially was “free”?

People and, believe it or not, the government! It is what is done “around” the undeveloped parcel, citizens work and progress and even the infrastructure work by government through taxation that causes land to value. The owner has zero input into the value of the land itself, other than any improvements which bring value to other’s properties in the same fashion.

This unearned value, gained from the progress of society and other’s enterprise and pocketed by the landowner is in itself a form of taxation. The land owner reaps what other’s sow.

If that increased land value is taxed, at least we are returning rather than taking. Also, the land fee does not have to go to big government, it can be distributed identical to the method used in Alaska, to the citizens.

You will always affect the economy in a negative way when you take from the product. The land fee is a way of letting people keep the wealth they created and reclaiming the value the aggregrate economy creates and “gives” to the land owner. Barring no taxes, it is the best way to go.

Nick Bradley June 18, 2009 at 12:49 pm

Gene,

A Land Value Tax is indeed the “least bad” form of taxation. It is a tax on an area’s positive externalities on land values. If implemented properly, it could form a feedback loop between a local government and its citizens: The higher the quality of services a government provides, the higher its revenues will be — a positvie loop. If a government provides low quality services, the feedback loop will turn negative and the mulicipality will degenerate into a slum.

Goods and services should be acquired on the market, but we all know this is not always the case. I think libertarians sometimes fail to recognize that there is a difference between low quality and high quality government services. For example, I currently live in Nevada where we have high crime, awful public schools, and lousy roads — but fairly low taxes. Prior to living here, I was in Colorado where we had low crime, excellent schools, great roads, and private tollways — for slightly higher taxes. On the other extreme is California, where taxpayers are raked over the coals for relatively little in return from the government; I also understand that Massachusetts has a similar tax burden to California but provides a lot better services.

If you’re going to be forced to buy services from the government, you should at least get a quality product in return. I think a land value tax would provide a better incentive for governments to provide quality services.

gene June 18, 2009 at 1:50 pm

Nick,

Thanks for the great insight, I had never thought of it that way, incentive for better services.

The loop also works if you use the “citizens dividend” instead of just using the tax to grow government. The land tax is routed back to the citizens with just the minimum amount to government for whatever services the population decides upon.

In that case, with much of it devoted to a dividend, the amount of aggregate production will determine the size of the dividend, due to the increase in land rent because of prosperity. Hence, a bigger dividend. So, the loop works that way also.

Nick Bradley June 18, 2009 at 1:59 pm

Gene,

Yes, that could work too, but its not as much of a direct correlation. The addeed value land gains due to its location is primarily the result of community factors, whether they be private, government-owned, or common. If you give out a citizens dividend, you’re not getting that direct feedback loop. What is the relationship between a citizen receiving a dividend and the increase in land values?

damocles June 18, 2009 at 4:07 pm

While the VAT is a wasteful bureaucratic monstrosity–similar to the income tax/IRS debacle we have now–a national sales tax would be far preferable to the existing regime which wastes many billions of man hours in the entirely unproductive activity of trying to figure out incomprehensible regulations. Of course, a sales tax ON TOP of the current tax structure would be an economy-destroying abomination.

gene June 18, 2009 at 6:23 pm

Hi Nick,

It’s a theoretical example using the parameter of a “small” government, which of course, we don’t have!

“Small” government would mean less value was created by the government and more by the private sector, so government needs less of the fee and the private sector deserves more because of the value created. The loop in that case would be between productivity of aggregrate private sector and the dividend [which would increase with productivity]. Your point that there is less “public” feedback is true in that case.

In the case of our gigantic government, we could only hope for elimination of the other taxes in exchange for implementation of the land tax.

Nick Bradley June 19, 2009 at 11:58 am

Gene,

I guess that question depends on whether you’re a Georgist or not. Georgists believe that 100% of the “rent” — land’s added value from community services — should be returned to the community; according to Georgists, this “return” should either go to the government or into a citizens’ dividend fund.

If the government needed less of the fee, I’d prefer for landowners to retain it.

The levy amount could be determined by having landowners vote on what the tax rate should be. Voting rights would be porportional to the amount of taxes paid in the previous year. Each landowner would “bid” what he or she thought the tax rate should be, and the tax rate “bids” would be averaged out. If landowners feel that the government is receiving more money than they need, bid prices will go down.

Another method of determining the tax levy is through a double-bid process — I’ve laid this out in the past at http://crwl.blogspot.com:

All citizens would enter an undisclosed bid on the per acre price of land in the ward, with the median bid being chosen as the land valuation price.

Since land prices should be quite similar throughout the ward, the median bid should be very close to the true, self-assessed value of the land
By picking the median bid, extreme bidders on either end of the spectrum will be marginalized. large landowners who wish to avoid paying taxes will be cancelled out by small landowners or renters who covet their neighbors’ wealth
For example, an agrarian community a low per acre valuation would be chosen, while a high valuation would be chosen in urban areas
The valuation will remain in effect until a majority of the polis elects to re-cast bids; however, individual citizens can change their bid price every year, generating a new land value
After all bids are cast, the bid will be revealed. After the community is made aware of the land prices, citizens will again cast bids, this time to determine the tax rate, anywhere between 0% and 100%, with the median rate chosen. The rate will remain in effect until a majority of the polis elects to re-cast bids; however, individual citizens can change their bid price every year, generating a new tax rate.

If for some reason a rate too high or too low was chosen, the misappropriation of revenue will be reflected in dropping property values. As property values fall, citizens can elect to re-cast bids to lower their tax burden. If the ward limited its scope to basic record-keeping, sewage, water, etc., property values would rise accordingly.

If land prices fall, citizens will move away; new owners will not want to pay the high yield (LVT/market land price) and will change their bid accordingly. If the government is mismanaged to a large enough extent and there is a severe drop in land prices, a majority of the polis will elect to lower their land valuation and/or tax rate
If land prices rise, new citizens who buy in will enjoy their new, low tax yield; word of low tax yields will encourage further immigration into the community and even higher land prices. Current owners, if they are happy with the status quo, will leave values and rates unchanged.

gene June 19, 2009 at 2:54 pm

Hi Nick,

good ideas! the georgists actually think about 10% or so should be retained by the landlord, so that land would remain under “title”.

here’s the geolibertarian version: land rent is determined by subtracting improvement value [capital cost of improvement minus depreciation] from total value of property. land rent is determine by the interest rate against land value[return on capital].

landowners pay rent through county. any landowner who wishes to “opt out” can, and will not receive services. this of course, wouldn’t be possible in neighborhoods, etc. already completly hooked up to county gov. services.

The state assesses the total aggregate land rent for the county and levies each county. any county that wish to opt out of state services can. the feds do the same to the states, with the same option, although it wouldn’t be feasible to opt out of say, defense, etc.

anyway, lots of good ideas, too bad we are burdened with all these “bad” idea taxes!

Nick Bradley June 22, 2009 at 3:16 pm

Thanks Gene.

I think in the short-run, “geolibertarians” can be very effective at the local level. There is nothing stopping a local government from shifting to a land value tax — i.e. a subtraction of all improvements from the total value of the property in the assessment. Local governments would tax the remaining value at the rate necessary to remain revenue neutral. Over time, sales taxes can be shifted on to the land value tax.

Nick Bradley June 23, 2009 at 12:34 pm

Another LVT method is to allow landowners to assess their own land values — with the caveat that the community has the right to purchase the property at any time. With this method, landowners would have to balance their desire to pay lower taxes with their desire to retain ownership of their land. Presumably, self-assessments would be near market value.

From my understanding, Sun Yat Sen implemented this method in China and the KMT somewhat followed this method in Taiwan.

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