(CNSNews.com) – Paul Volcker, chairman of the Economic Recovery Advisory Board under President Obama, suggested this week that a value-added tax (VAT), which is like a national sales tax, may be needed to pay for the federal government’s entitlement spending and the federal deficit.
In answer to a question after a speech at the New York Historical Society on Tuesday, Volcker said a VAT is “not a toxic idea,” and further said, "If at the end of the day we need to raise taxes, we should raise taxes."
Adding a national sales tax on top of the federal income tax and other taxes, however, is not a smart idea, say many conservative critics because it would put a drag on economic growth and encourage the government to keep spending instead of balancing the federal budget.
A VAT is a consumption tax that is similar to a retail sales tax but differs in the way the tax is collected. With a VAT, the government collects the tax at different phases of a product’s manufacture.
In his book, Basic Economics, economist Thomas Sowell explains that a value-added tax “is imposed on products as they pass through the production process, each enterprise in the chain of production being taxed on whatever value its operations added to the product.”
“The advantage of this kind of tax, from the standpoint of the officials who impose it, is that the total amount that the taxes add to the final price paid by the consumer is not apparent, as it is with a sales tax, for example,” says Sowell. “In general, the less visible a tax is, the more revenue can be collected without resistance or electoral retribution by the voters.” Many European countries use a value-added tax as “a major source of revenues,” says Sowell.
According to a Congressional Budget Office study on the general topic of a VAT, if it were imposed as a new tax, the VAT would increase administrative costs and place a burden on the poor.
“(A)s a new tax, a VAT would be more costly for the federal government to administer and more costly for businesses to comply with,” said the CBO report. “In addition, the VAT's heavier burden on the poor could not be offset much by adjusting its tax base.”
Further, the CBO study said that “(t)axing consumption is inherently regressive--that is, the burden of the tax as a share of income is greater for families having lower income. A VAT would be regressive because lower-income families spend more, and save less, of their income.”
“Taxing consumption is also inherently costly, both to administer and to comply with, because no general consumption tax currently exists at the federal level in the United States,” the report added.
In his speech, Volcker did not specify how a VAT would be imposed – added to all existing taxes or substituted for the income tax. Republicans in Congress, however, criticized the idea.
In a statement on Wednesday, Sen. Charles Grassley (R-Iowa), the ranking member on the Senate Finance Committee, said, "To make up for the largest levels of spending and deficits in modern history, the administration is laying the foundation for a large, misguided new tax, a first-time American VAT.”
"If the president wants to add completely new layers of taxation, then he should take this issue before the American people when he runs for re-election,” said Grassley.
The free-market group Americans for Tax Reform (ATR) was also critical of the VAT proposal, stating that the administration apparently wants to use it to generate revenue to cover its federal spending.
“The reason for this is simple: the goal of Obama/Pelosi/Reid regime is to raise federal spending from its historical level of 20 percent of GDP to a ‘new normal’ of 25 percent of GDP,” Ryan Ellis, the director of policy at ATR, told CNSNews.com.
“They want to pay for this, in part, with a VAT,” he said. “Assuming a European-style VAT system, a VAT rate of 5 percent would raise the equivalent of 2 percent of GDP in taxes.”
Last week, even before Volcker’s speech, conservative commentator Charles Krauthammer predicted a VAT was on the political horizon to pay for the new $1 trillion health care plan and other entitlements, as well as a $1.5 trillion deficit for fiscal year 2010.
“With the passage of Obamacare, creating a vast new middle-class entitlement, a national sales tax of the kind near-universal in Europe is inevitable,” wrote Krauthammer on Mar. 26 in The Washington Post. “For the politician, it (VAT) has the virtue of expediency: People are used to sales taxes, and this one produces a river of revenue. Every 1 percent of VAT would yield up to $1 trillion a decade (depending on what you exclude -- if you exempt food, for example, the yield would be more like $900 billion).
“It's the ultimate cash cow. Obama will need it. By introducing universal health care, he has pulled off the largest expansion of the welfare state in four decades. And the most expensive. Which is why all of the European Union has the VAT. Huge VATs. Germany: 19 percent. France and Italy: 20 percent. Most of Scandinavia: 25 percent."
While giving credit to the possible benefits of a VAT, Alan Viard, an economic scholar at the American Enterprise Institute, a conservative group, indicated that although the VAT does not tax savings and investments, it would stunt economic growth if it is used to pay for new entitlements.
“To the extent that the value added tax is used as a replacement for the income tax, I think the growth effects will be positive,” Viard told CNSNews.com. But “if it’s used to finance government spending that otherwise wouldn’t have occurred, then of course the impact is likely to be negative.”
“I think the real disagreement about the VAT that you hear from people, a lot of it is related to the question of exactly how it will be used, how it would change things,” he said.
Last spring, Sen. Kent Conrad (D-N.D.), chairman of the Senate Budget Committee, said “there is a growing awareness of the need for fundamental tax reform. I think a VAT and a high-end income tax have got to be on the table.”
Michael W. Chapman contributed to this story.