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Why Ted Cruz’s VAT Really Is a VAT
Thursday’s GOP presidential debate in South Carolina featured a feisty back-and-forth between Ted Cruz and Marco Rubio concerning Cruz’s tax plan. Rubio said Cruz’s “business flat tax” is really a value-added tax that will blindfold “the American people so that they cannot see the true cost of government.” Cruz argued that a VAT is “a sales tax when you buy a good,” and his new tax is instead “imposed on on business.”
Make no mistake here. Cruz is proposing a VAT add-on to the existing personal income tax system. Specifically, it’s a “subtraction-method” VAT. Cruz explained it pretty accurately in a Wall Street Journal op-ed. A business would pay a 16% tax on its “gross receipts from sales of goods and services, less purchases from other businesses, including capital investment.”
The Tax Foundation — which analyzed the Cruz plan and also describes it as a VAT — explains it this way:
For example, suppose you love watching Disney movies on Netflix. Netflix’s gets revenues from your subscription, and then it uses some of that money to pay Disney for the rights to Disney content. If we counted that money both at the Disney level and the Netflix level, we’d end up taxing the same basic product twice, merely because it involves two different companies. … The way the subtraction-method VAT fixes this is by, well, subtraction. Under this kind of tax system, Netflix would count all of its revenue, but then subtract the amount that it pays to other businesses, like Disney. Disney would then have to account for its own revenue and also file taxes. The result is that everything gets neatly single-counted, and nothing gets double-counted. There’s also one other thing the tax subtracts: capital costs. That is, when Ford builds a new auto plant, it can deduct those business costs as well.
Now the subtraction-method VAT is not exactly like the VATs seen in Europe. Those are “credit-invoice” VATs and are charged per transaction. (This 2006 Congressional Research Service study provides a good explanation of the technical differences and the pros-cons.) But what both kinds of VATs have in common is that they are great ways to raise lots of money (The Tax Foundation calls it a “powerful tax that captures pretty much all of the income in the country”) with the least amount of economic distortion or harm because it does not penalize savings and investment.
VATs also, as Rubio said, can hide the cost of government from voters, who are the ones truly paying the VAT. AEI’s Alan Viard (here and here):
A VAT can be split into a business cash flow tax and a wage tax, with the wage tax collected as an employee payroll tax that shows up on workers’ pay stubs. Or, the total VAT collected from businesses along the production chain can be listed as a separate line item on the final customer’s receipt, the way state and local retail sales taxes are listed. But, the [Rand] Paul and Cruz plans would collect the VAT from businesses without listing it on customer receipts, ensuring that neither workers nor consumers would ever see the tax. … His plan would make the tax hard to see precisely so that people could be told that they’re not paying it. The government would subtly and relentlessly tax away 16% of workers’ real wages while assuring them that they’re paying “no taxes whatsoever.” … If the United States is to have a VAT, it should be adopted in the light of day, not snuck through as a “business tax.” And, once adopted, its tax burden should be made visible to the American people, who have a right to know the full cost that they’re paying for their government.
Why does Cruz not concede this point? Of that, we can only speculate. Is a VAT a good idea? Consumption taxes are more pro-growth than income taxes, an especially important feature if you think the US tax burden needs to rise in the future given demographic pressures. Again, here is Viard in a podcast Q&A with me:
Published in EconomicsLooking out 10-15 years, you know we have to deal with this entitlement problem. We need a tax code that needs to be more pro-growth, more efficient. Factoring in the likely politics as well, what will the eventual reform of the U.S. tax code look like? Will it be a progressive consumption tax or might it be something else?
Well, you know, I’m not an expert on predicting what will happen. I find it a lot easier to sit back and offer my thoughts on what should happen, but I’ll take a stab at your question. You know, I think there is – I would like to see the progressive consumption tax option adopted. I think, though, that the X tax – you know, it’s hard to explain to people it doesn’t really have a footing in our political debate right now. And so the odds are probably against that, sad to say.
You know, I think that what we are more likely to end up doing is to have a value added tax alongside an income tax. It’s definitely not an ideal outcome. It means that we are keeping an income tax system that has a penalty on saving and investment. It means we have two tax systems available to the government, which would make it easier for it to raise revenue. But it is a better outcome, of course, than just jacking up income tax rates to stratospheric levels. So it leaves me with a mixed feeling, but that is where most other countries have ended up and I think that’s the single most likely outcome for us as well.
VATs are a bad idea because the taxes are hidden. Rubio is exactly right about this when he says Cruz’s may be 16% but there’s nothing to stop the next president from making it 25% or 30%.
Not good.
Said it before and am saying it again:
Without first repealing the 16th Amendment, a VAT tax is simply frosting on the already deadly cake we ‘citizen-diabetics’ voluntarily eat each April 15th. Think immigration reform without first building a border fence.
Someone else beat you to it, Mr. Pethokoukis. Consider perusing the Member Feed once in a while.
It isn’t hidden and it isn’t easy to raise. There is a border tax adjustment and business gets credit for taxes paid on inputs, so it isn’t hidden from anybody. If we want to make it blatantly obvious at every consumer level, just require that all invoices show it explicitly as all other VAT’s require. This tax removes double taxation, eliminates the payroll tax, corporate tax and lowers income taxes to 10%. My only problem is that the VAT should be the same as the income tax, linked at the hip so that it is more difficult to raise either of them A sales tax is more difficult to raise as everyone pays it and nobody likes it. It’s the most efficient tax in the arsenal. Since the payroll tax would be eliminated, SS and medicare payments come from general revenue, this enables us to privatize for young people without loss of revenue, but with whopping new incentives to boost savings. This is the best proposal of the candidates.
Yes, puting a line on the bottom of receipts no one keeps or looks at will really keep politicians feet to the fire, especially since the attempts to raise the tax will be painted as a tax on businesses, who don’t vote, instead of on individuals who do. Yes there will be so much accountability built into this plan.
This sounds a lot like Canada’s old Manufacturer’s Sales Tax, which the Mulroney Conservatives replaced with the GST in the early 1990s.
One of the greatest benefits of consumption taxes (IMHO) is that they’re visible to the taxpayer, giving them a price signal with which to make purchasing decisions. Hidden taxes suck.
Adding consumption taxes on top of income taxes also sucks. It’s easy to see why governments might want to do it at this particular moment in history, what with the bulge of Baby Boomers in the process of hitting retirement age at the exact same time that there’s a bulge of Millenials entering the workforce.
Having income and consumption taxes going at the same time captures revenue from both workers and retirees.
I think the Canadian example illustrates that the line on the bottom of the receipt does indeed have a big effect on voter opinion, but not necessarily how one might expect.
When the GST was introduced by the Mulroney Conservatives as a deficit-killing measure, it was hated. The Conservatives promised that the revenue would allow them to reduce income tax rates once the deficit was slain. Voters, understandably, had little reason to trust politicians to keep their word about that. The Chretien Liberals promised to kill the GST and in 1993 the Conservative government fell.
Of course, the Chretien Liberals didn’t kill the GST, the deficit was slain in the 1990s, and income tax rates were reduced (though not eliminated).
Thoughtful economic observers could see that everything the Mulroney government promised and predicted did indeed come to pass, but still voter antipathy towards the GST persisted.
So, when the Stephen Harper Conservatives came along, they found that promises to reduce the GST polled way better than promises to reduce income tax rates.
The GST’s visibility is precisely what makes it unpopular compared to the income tax (which Trudeau promises to increase).
This is unfortunate, in my opinion, but it’s also one more reason why consumption taxes need to be a replacement for income taxes, rather than a supplement to them.
How would Cruz’s plan be more visible than the income tax? Putting a line at the bottom of a sales receipt? That sounds about as effective in maintaining awareness of the tax burden as does showing withholdings on people’s pay stub.
I actually think that a VAT of the Cruz type is roughly the least bad of the alternatives; it beats infinite deficit spending all hollow, and it is based on consumption.
The biggest issue is the fact that as proposed it is a hidden tax. That is easy to fix- don’t hide it. Separate between labor and other expenditures, show the labor portion on employee pay stubs, and require that it be separated on company invoices and reported by the companies at least quarterly.
But I was once a Reagan-inspired “Cut off the kid’s allowance” enthusiast. Now, given that Washington and the voting public has revealed an infinite appetite for more goodies, paid for only by huge deficits so that 75% of the people (encouraged and aided by lefty “tax only the 1%” pipe dreams) believe that the stuff is “free”, I am a “with the meal, serve the dinner check” fan.
Would the tax be paid even though a company is operating at a loss?
Putting lines of information on receipts and paystubs does not make people aware of how much they are being taxed. People don’t look at that. Most people throw away receipts without looking at them. Most people get paid through direct deposit and never look at their pay stub. Even if someone does see it on their pay stub, it is easy to get used to ignoring it and just looking at the take home pay.
Sales tax works now because people see a price for an object and when it comes time to pay, they feel the difference in what they are actually paying and what the price said. If people don’t have to actively hand over cash or write a check, they don’t realize what is being taken from their pockets.
Yes. It is in effect a tax on everything they sell, not a tax on their profit.
Not that you read comments, but rather than speculate, you could engage with Cruz’s policy adviser.
Sean Rushton is dissembling and engaging in sophistry. Payroll and capital are what is left after you deduct payments to other businesses from your gross revenue. A 16% tax on payroll and capital produces the exact same amount of money as a collection system where a business simply paid 16% to the government from every sale it made. He is drawing a distinction without a difference and pretending that he isn’t. What he is saying is that 99% of people don’t know what a VAT is, so calling the Cruz plan a VAT would seem inaccurate to the 99% of people who don’t really understand VATs.
BThompson, thanks Bob. That is what I thought. That in it’s self is reason to oppose it. 16 percent is more than many businesses gross profit.
Well, the plan eliminates the corporate tax and the payroll tax, so that would obviously boost profit margins in a huge way right off the top. Also, presumably producers would simply raise prices. The cost of raising prices would be offset for consumers by the drop in the amount of income tax they pay because Cruz would also set a 10% flat income tax for everyone. Therefore raising prices shouldn’t hurt producers.
This statement doesn’t make any sense. Are you saying a 16% tax on payroll and capital produces the same as a 16% retail sales tax? If yes then I agree the revenue would be similar, but I don’t agree if you mean a VAT without subtractions or credits.
Many business (particularly small businesses) already pay more out in employee payroll taxes (6.2%) and self-employment taxes than profit.
The reason why Cruz isn’t calling his plan a VAT is because VAT = European in the mind of a lot of voters.
I don’t think it would raise prices, as 16% is really not much more than the current combination of payroll taxes and corporate income taxes.
I emphasized the payroll tax specifically. As I understand it Cruz’s plan eliminates both employee and employer SS and Medicare taxes – currently these taxes combine are 15.3% of gross income. So an increase to 16% does little to change the tax on labor.
Except! Cruz’s plan does tax all non-salary employee benefits (i.e. healthcare, disability insurance, retirement, the company truck, etc.) Cruz’s plan would drastically increase the value of cash compensation over benefits. In all I think this is a good thing, as employees today have little understanding of the real costs of employing people.
I’m saying both types of VATs involve calculating the portion of a products price that amounts to the value added at that stage of production. One involves charging a VAT on every sale and then getting a rebate on every VAT paid for the inputs of the end product. The other aggregates total company revenue and subtracts all expenditures to outside vendors and suppliers and taxes that total. The result is the same amount of money, just added up in a different way.
exactly. But it doesn’t even have to be a rebate as the tax on inputs is almost always more than the tax on value added, so they just remit less to the government, getting credit for what they’ve already paid. This makes it almost self collecting and impossible to cheat and eliminates the problem of having to tax the internet. It’s already taxed on the goods they sell so they will want to collect it. This removes a pernicious incentive for the Feds to get after the internet.
Cruz isn’t proposing that sort of “self-collecting” VAT, though.
I get the “hidden” argument, but what tax isn’t in some way? Do businesses actually pay the current tax on profits or do they on closer examination simply collect a tax their customers pony up? One reason for the success of the personal income tax until the great inflation of the 7os is that no one you knew or were likely to know paid a hell of a lot of it. The illusion that someone else is paying is powerful. I think the vague but correct notion that I’m always paying would be enough to provoke healthy indignation pretty much every time the price of anything went up. Consider just the way people suddenly become aware of taxes on gasoline when the price of a gallon goes above $4.
As for raising the tax rate, Congress can do that on any tax and hasn’t ever been all that shy about it.