Progressives for a value-added tax?

Via Megan McArdle is this interesting graph from the Congressional Budget Office showing the impact the recession has had on tax revenues, organized by type of tax:

Progressives for a value-added tax?

I am also surprised to see that revenue from payroll taxes has essentially remained stable through the recession, and like Megan, I’m not entirely sure as to why that is (and if anyone wants to hazard a guess, I am all ears).

What’s more interesting to me though, is what this graph implies about the volatility of revenue.  Assuming that this is an accurate representation of what happens to tax revenues during a recessionary period, it seems to suggest that our most progressive taxes – income taxes – are most vulnerable to the effects of a recession, while our most regressive taxes – payroll taxes – are our least volatile sources of revenue.  And if that’s true, then it has powerful implications for progressive policies.

Since Obama entered office, I’ve gradually come to the conclusion that, above nearly everything else, progressives need to make a concerted effort to change the way we talk about taxation, in the interest of clearing the space for politicians to talk honestly and openly about raising revenue.  After all, we don’t have much of choice.  Most progressives are committed to significantly broadening the scope of the American welfare state; health care is only one part of what is a long-term effort to bring the United States more in line with our European peers in terms of what the state delivers to its citizens.  Taxation plays a critical role in furthering that project.  We simply can’t expand the welfare state without also raising dramatically more revenue than we currently do, since in the absence of any additional revenue, the United States cannot afford much beyond its current obligations (or rather it could, but it’s nice to be able to pay for what we spend).

The problem for progressives is twofold: first, we have to find a way of successfully countering the conservative narrative that taxes are unfair at best and borderline illegitimate at worst, and second, we have to find methods of taxation that are both fair and capable of raising an adequate amount of revenue.

Of the two, I actually think that the second is a far more difficult project, in part because the best solution – a value-added tax of some form – is anathema to a lot of progressives. For progressives, the VAT is simply too regressive; every imaginable form of the VAT would disproportionately affect poor, working-class and middle-class Americans.  That said, there are ways to craft a VAT as to soften its impact.  For starters, you could include exemptions for food and non-luxury clothing items, as well as use some of the revenue – Bruce Barlett estimates that a 20 percent tax could raise up to $1 trillion per year in 2009 dollars – to provide income supports for struggling Americans.  Indeed, if you buy the idea (which I do) that progressive distribution is far more important than progressive taxation, then a VAT is great by progressive standards, as the revenue generated could be used to support both a stronger safety net and significant investment into education and infrastructure.  What’s more, the stability of regressive taxes makes it more likely that you can expand the welfare state while also keeping it fiscally solvent over the long-term.

I don’t expect conservatives to sign on to this project (though it’s worth noting that the United States wouldn’t be the first nation to trade conservative taxation for progressive spending), but I think it’s something they should consider.  If you believe – as I do – that the United States is on a pretty steady march towards a much stronger public sector, then we must raise revenues one way or another.  Considering the alternatives – massive tax hikes on the rich, which depending on the form they take, I’m not necessarily opposed to – a VAT is probably the best possible outcome for conservatives.

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21 thoughts on “Progressives for a value-added tax?

  1. I am also surprised to see that revenue from payroll taxes has essentially remained stable through the recession, and like Megan, I’m not entirely sure as to why that is (and if anyone wants to hazard a guess, I am all ears).

    The payroll tax (except for teeny, tiny Medicare portion) is capped at around $80,000 in personal income. There is just not a whole lot of variability in income in that demographic. Income and corporate taxes are mostly accrued by the last dollar of income. For example, the $250,000th dollar of income is taxes at 40 cents whereas the $10,000th dollar of income is taxed at 10 cents. Despite protestations of free marketeers otherwise, the ability of a person to control whether they make $250,000 or $300,000 is very little and is sensitive to changes in macro activity. Obviously I’m excluding deductions.

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  2. Certainly the Goods and Services Tax (Canada’s VAT) was a significant tool in their arsenal to get that country’s finances back in order. I’d agree that a VAT would probably be a good idea in the US as well though I am kind of leery of the idea of making it progressive exclusively through distribution. Another point in its’ favor is that economists agree that VAT’s are the least intrusive or distorting tax form in terms of their impact on economic decisions and simplicity in collection.

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  3. Don’t you think, besides being “fair” and “raising lots of money,” liberals should also consider the impact that particular taxes will have on economic growth? Or do you think taxation has no effect on economic growth at all?
    I agree that VATs are very economically efficient compared to income taxes; perhaps some sort of compromise in which deductions are removed, the overall income tax rate is drastically lowered, and a VAT is added could raise necessary funds.

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    • Let’s not assume that because I didn’t mention something, it therefore must mean that I didn’t consider it. Yes, I agree that liberals should consider the impact that particular taxes have on the economy, and that one point a VAT has in its favor is that it has a relatively small distortionary impact.

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  4. Alright, just wanted to get that on record. If you are concerned about the distortionary impact of taxation, then I assume you’d also be in favor of the VAT replacing (to some extent) extremely distortionary taxes like the corporate income tax?

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    • Yep. I’m not a huge fan of corporate income taxes. It makes far more sense to me to just raise marginal rates on the highest earners, who are disproportionately members of the corporate governing class. Indeed, and I’ve said this before, we could make it even easier by instituting a continuous marginal tax. Hell, if conservatives could agree to that and a progressive VAT (or as progressive as we can manage), I would be more than happy to back off on reinstating more taxes on capital gains.

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  5. What progressive distribution programs do you have in mind? Centralized health (and old-age) insurance is well-justified by the nature of the market for insurance. But other distribution programs tend to be unnecessarily paternalistic (e.g. food stamps) or stigmatized beyond repair (TANF). Theoretically, we can build a convoluted VAT system that exempts or indirectly refunds spending by lower-income households. Politically, I fear, it would be very easy (maybe not with a Democratic administration) to shift the taxation base to low-income households – but much harder to legislate an expansion of the welfare state that might benefit them.

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      • I’m pretty unimaginative about these things. Aside from the existing array of programs, the only one I could think of was funding for education, both K-12 and tertiary.

        It’s strange that you bring up the EITC. This program is designed to reverse some of the progressivity in the bottom range of the income tax, and it works through the income tax. Funding the EITC through a VAT is, first, bureaucratically complicated, because it requires maintaining both tax systems – whereas I interpreted your original post as wanting to get rid of the income tax entirely. Second, funding an EITC expansion through a VAT raises political problems: you would literally be robbing Peter to pay Paul, where Peter is a senior citizen on a fixed income who is ineligible for the EITC but who must pay the VAT.

        That aside, I think the EITC (assuming the income tax survives!) is a very good candidate for expansion. It has relatively good political support precisely because it is tailored to serve the “deserving poor.” In turn, however, that means that a substantive expansion of the EITC will increase the divide between EITC-eligible and EITC-ineligible low-income households – roughly between those who can work and those who cannot.

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        • You know, I’ve never heard or read anyone refer to post-secondary education as tertiary. Which, now that I think about it, is kind of funny. I mean presumably smart people would know that tertiary comes after primary and secondary but for some reason have stuck with post-secondary.

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        • The first policy that comes to my mind to alleviate the impact of a VAT on those of a lower-income is a universal and significantly raised minimum wage. Benefits include: essentially no administration, minimal distortion of economic motivations, and increased spending-power of a vast section of the population – providing even greater revenues through the VAT. The ultimate source is business without the necessity of corporate income/capital gains tax and absent any bureaucratic/paternalistic/stigmatized/etc social programming.

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          • It takes great fortitude to describe a “significantly raised minimum wage” as having “minimal distortion of economic motivations.” What of the decisions to work, to pursue higher education, to migrate to the US, to retire, to become a stay-at-home parent, to marry, to seek financial assistance from the government, to open or expand a business, to hire workers, to invest in capital..?

            For comparison, minimal distortion of economic behavior might happen in the case of a uniform, universal one-time cash payment. But, in terms of achieving policy goals, that’s neither here nor there. Perhaps distortion is actually necessary, and it is the policymakers’ responsibility to effect the best distortion in the economy.

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            • I completely agree with you, grandmute. When I referred to “minimal distortions” I meant to say that a minimum wage increase avoids negative distortions associated with taxing business processes, such as excessive vertical integration or aversion to reinvestment or capitalization. Those tend to be the distortions that economists talk about, and I’m glad that you mention other and even positive “distortions” because the debate is too often about what the “least harmful” policy is instead of the “most beneficial”. I think there are many beneficial “distortions” of a higher minimum wage.

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  6. I’ll second North’s mention of the usefulness of the GST. I think as much as possible has been done to prevent regressivity: it does not apply to “necessities and there is a GST credit for low-income people (about $100-$200 quarterly in my experience, decreasing as income rises).

    There are substantial downsides to any government passing it, though. Ours was massively unpopular – the government that passed was decimated in the next election (for that reason among others). In addition, figuring out what a “necessity” is takes a lot of trouble and invites a huge amount of lobbying, and you end up having to draw lines in some fairly irrational prices. (I remember, at least before the reduction from 7% to 5%, that 6 doughnuts were cheaper (or close to being so) than 4 doughnuts, because 4 were taxable and 6 weren’t. Don’t recall why.)

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    • Katherine, just when I thought I couldn’t like the GST any more you have to go and suggest that it was responsible for the great Tory train-wreck. I’m seeing pink hearts even though my rational mind is clutching at reality and gibbering about how the Tories did so much to earn their devastating defeat that the GST was just the cherry on the top.

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  7. — regarding the low variability of payroll taxes: this makes intuitive sense. Wages have not significantly declined, and the unemployment rate has “only” gone up 4-5%. Absent significant changes in wages, payroll tax receipts will largely mirror the employment rate. Overall income tax revenue has fallen much more dramatically because the highest income earners are expected to see their income fall by 35%. (derived from: http://finance.yahoo.com/banking-budgeting/article/107702/income-gap-shrinks-in-slump-at-the-expense-of-the-wealthy.html)

    Since we already collect the vast majority of taxes from the top 10% of income (http://www.ntu.org/main/page.php?PageID=6), your progressive project is currently hitched to the wagon of the continued success of the American affluent.

    I’m also going to have to quibble with you about the VAT. If your purpose is to come up with less volatile sources of tax revenue, the VAT is NOT the way you want to go, especially if you are going to include exemptions for food and non-luxury clothing items. Since, combined with rent, you just exempted out the vast majority of the median person’s spending, your VAT will largely be dependent on the sale of luxury items and appliances. Sales of luxury items and appliances fluctuate with income, but at an even greater amplitude.

    Your stated purpose is to try to find a stable source of revenue for an expanded welfare state. Unfortunately for your project, the most stable taxable year-over-year economic transactions are non-investment income and the sales of essential goods.

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