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[Danyelle, Connor Maxwell, Abril Castro, “Systematic Inequality and Economic Opportunity,” CAP – Center for American Progress, August 7, 2019, https://www.americanprogress.org/article/systematic-inequality-economic-opportunity/, accessed July 7, 2023, GDS-LL]

The underfunding and limited scope of anti-discrimination agencies perpetuate inequality

What are the main administrative problems? The introduction of a VAT can facilitate substantial improvements in overall tax administration, particularly the establishment of more integrated tax administration organizations and the development of modern procedures based on voluntary compliance. But there have been some significant weaknesses in the VAT's implementation in developing and transition countries: the lack of coordination of the direct and indirect tax administrations, which are not yet integrated in a number of countries; the difficulty of implementing workable self-assessment systems, under which taxpayers declare and pay taxes on the basis of their own calculations, subject to the possibility of later audit by the tax authorities;

the need for effective audit programs based on risk-analysis selection methods; and the need to give prompt refunds of excess credits to certain taxpayers, particularly exporters. (Because exports are zero rated, exporters will have no output tax liability but will be entitled to a refund of the tax paid on their purchases.) The refund issue has become increasingly problematic in many countries in recent years. There is a troublesome tension between the importance of assuring prompt refunds—without which the VAT loses many of its economic merits—and the desire of governments to guard their revenues against fraud and the temptation they face to strengthen revenues by simply delaying refund payments. Indeed, we find that refunds are the VAT's Achilles heel. Tax policy advice in this area has been greatly influenced by tax administration constraints because adoption of best practice (which is the prompt refunding of all excess credits) is simply not possible in countries with weak administrative capacity. The lack of effective audit mechanisms is usually the primary cause of these problems, and the importance of developing such capacity may have been underappreciated in much of the advice and technical assistance on the VAT. The IMF currently tends to advise paying refunds only to exporters and, sometimes, businesses importing large quantities of capital equipment, with streamlined procedures for those with established, reliable records in their tax dealing, while imposing some delays and carry-forwards of credits on other taxpayers.

Who would bear the burden of a VAT? A.A value-added tax (VAT) is a tax on consumption. Poorer households spend a larger proportion of their income. A VAT is therefore regressive if it is measured relative to current income and if it is introduced without other policy adjustments. A VAT is less regressive if measured relative to lifetime income. Although a value-added tax (VAT) taxes goods and services at every stage of production and sale, the net economic burden is like that of a retail sales tax. Sales taxes create a wedge between the price paid by the final consumer and what the seller receives. Conceptually, the tax can either raise the total price (inclusive of the sales tax) paid by consumers or reduce the amount of business revenue available to compensate workers and investors. Theory and evidence suggest that the VAT is passed along to consumers via higher prices. Either way, the decline in real household income is the same regardless of whether prices rise (holding nominal incomes constant) or whether nominal incomes fall (holding the price level constant). REGRESSIVITY Because lower-income households spend a greater share of their income on consumption than higher-income households do, the burden of a VAT is regressive when measured as a share of current income: the tax burden as a share of income is highest for low-income households and falls sharply as household income rises. Because income saved today is generally spent in the future, the burden of a VAT is more proportional to income when measured as a share of income over a lifetime. Even by a lifetime income measure, however, the burden of the VAT as a share of income is lower for high-income households than for other households. A VAT (like any consumption tax) does not tax the returns (such as dividends and capital gains) from new capital investment, and income from capital makes up a larger portion of the total income of high-income households. AVERAGE TAX BURDEN Using a method more reflective of lifetime burdens, Eric Toder, Jim Nunns, and Joseph Rosenberg (2012) estimate that a 5 percent, broad-based VAT would be regressive at the bottom of the income distribution, roughly proportional in the middle, and then generally regressive at the top. The VAT would impose an average tax burden of 3.9 percent of after-tax income on households in the bottom quintile of the income distribution. (Each quintile contains 20 percent of the population ranked by income.) Yet, households in the top 1 percent of the income distribution would only have an average tax burden of 2.5 percent (table 1).

Abstract: In the context of unprecedented U.S. budget deficits, some proponents of the value-added tax (VAT) are calling for the U.S. to levy a VAT to close the federal deficit. They are seriously mistaken. While a VAT has some advantages to the current U.S. tax code, adding the VAT to current federal taxes—as proponents propose—would realize none of these benefits and would instead depress the economy. The real cause of the massive federal deficit is Congress’s overspending, not a lack of taxation. The value-added tax (VAT) is a major source of tax revenue for every industrialized country in the world except the United States. The Domenici–Rivlin Debt Reduction Task Force has issued the latest call for the U.S. to adopt a VAT to solve its growing debt problem.[1] Some argue that a large tax increase is necessary because Congress cannot reduce spending enough to cut the deficit to more sustainable levels.[2] On this flawed line of reasoning, the VAT is the logical choice because it can raise large amounts of revenue and because the United States is the only developed country without a VAT. Proponents often cite the economic virtues of the VAT as an additional reason for the United States to adopt it. While the VAT has some economic advantages compared to other tax systems, these theoretical advantages would apply only if it replaces all other federal taxes. If Congress simply added a VAT on top of other federal taxes, its comparative advantages would disappear. It would substantially raise taxes, perpetuate the current tax system’s many problems, and create a host of new complications. Even as a total replacement for the current tax code, a VAT would pose several challenges for the nation. What Is the VAT? The VAT is a consumption tax that taxes the value added by businesses at each point in the production chain. It can apply to both manufactured goods and services. This contrasts with the more familiar income tax, which taxes salaries, wages, and the returns to savings, but does not tax purchases. Because the VAT is a consumption tax, it would closely mirror the sales taxes that most Americans pay at the state and local levels. In fact, consumers would experience no difference between a national sales tax and a VAT. A sales tax and a VAT designed to raise equal amounts of revenue would raise the final price of purchases by roughly the same amount. Credit-Invoice VAT. In the credit-invoice method, the most common form of the VAT, a business pays VAT on its purchase of inputs and collect it on its sales whether those sales are to another business or the final consumer. The business then submits the invoices that it receives from its suppliers to the government’s revenue agency. The invoices detail the amount of VAT that the business paid to its suppliers. Once the revenue agency verifies that the business remitted the proper amount of tax on its sales and that the submitted invoices match the suppliers’ filings, the agency refunds the business for VAT paid. The filings by businesses give the revenue agency a simple way to ensure that businesses pay the required amount of VAT. As long as the business can pass the tax on to its customers, which is typically the case, the business ultimately pays no tax. It acts solely as a collection agent for the government, collecting VAT on its sales and remitting to the government the difference between the VAT it collects and the VAT it paid on inputs. The burden of the tax moves up the production chain until the consumer bears the full burden, just like under the sales tax. Chart 1 shows how a credit-invoice method VAT could apply in the production of a shirt. How the Value-Added Tax Works A credit-invoice VAT is generally easier for revenue agencies to enforce than sales taxes and therefore enables more efficient revenue collection. The method of revenue collection makes it more efficient. A sales tax is collected only when the final user of the product makes a purchase. For instance, customers buying a new pair of shoes or a new television pay the price of the item plus the sales tax, which is an additional percentage of the sales prices, at the point of purchase. However, businesses do not pay sales taxes on the items they purchase so that the sales tax does not “pyramid” inside the cost of goods and raise their prices surreptitiously. In practice, businesses end up paying sales taxes in many cases, but they should be completely exempt from paying sales taxes according to sound tax policy. Because a sales tax is collected at only one point in the production process, customers and sellers can work together more easily to evade it. The only check to make sure the seller collects the tax is an audit by a revenue authority. A credit-invoice VAT is more resistant to tax evasion because businesses collect and remit the tax at every stage of the production process. Subtraction-Method VAT. Another viable approach to levying VAT is the subtraction-method VAT, which is economically equivalent to the credit-invoice VAT. Each method has positives and negatives, but almost every country that levies a VAT has chosen the credit-invoice method as the best way to apply the VAT in practice. Of the approximately 150 countries that levy a VAT, only Japan uses the subtraction method.[3] The subtraction-method VAT is similar in practice to the business income tax that the United States and most other countries levy. Businesses calculate their taxable base by subtracting their expenses from their sales (gross income). The major difference between the subtraction-method VAT and the business income tax is that the cost of labor is not deductible under the subtraction-method VAT. Labor’s contribution to output is an integral part of the value added by the business. Among other key differences, all purchases from other businesses are deducted immediately under the subtraction-method VAT, including purchases of long-lived assets (no depreciation system), but interest expense is not deductible. The most important difference between the credit-invoice VAT and the subtraction-method VAT is how they are collected. Instead of collecting the VAT each time a transaction occurs, under the subtraction-method VAT businesses would pay VAT on their taxable base, which is calculated by totaling their gross receipts and subtracting the cost of inputs purchased from other firms. A subtraction-method VAT would have the same economic effects as a credit-invoice VAT because businesses still pay the tax on the difference between the sales of their goods and costs of their inputs. However, the subtraction-method VAT effectively prevents showing the tax embedded in the prices of goods and services. While most countries that levy a credit-invoice VAT do not require— and in some cases even prohibit—displaying the tax on sales receipts, displaying the tax in a subtraction-method VAT is impracticable, making the tax opaque to taxpayers. That most countries’ choose the credit-invoice method over the subtraction method reflects the economic circumstances and the consequences of past tax policy decisions. For example, because the subtraction-method VAT bears a strong resemblance to a traditional income tax, it could be a better, although still problematic, tax system than an income tax, but it would be a poor choice as an additional new tax. Many countries that have adopted a credit-invoice VAT already had some kind of national consumption tax. In searching for extra revenue, replacing a confusing array of minor sales taxes with a comprehensive, operational national retail sales tax in the form of a VAT would make good sense. Further, all countries have problems with tax evasion. Tax evasion is still a problem under a credit-invoice VAT, but the tax is far less susceptible to evasion than most taxes because of the credit-invoice paper trail. The relative difficulty of evading a VAT is particularly important when governments impose high tax rates. Addition-Method VAT. The addition-method VAT is not used anywhere in the world. As its name implies, the addition method is the opposite of the subtraction method. Like the subtraction method, it is applied only once in the production process, and its cost is entirely hidden from individual taxpayers. Yet unlike the subtraction method, businesses add the costs of their inputs, instead of subtracting them from their sales to calculate their tax base subject to the VAT. Inputs could include labor costs, costs of goods and services purchased, and even profits in some cases.[4] The addition method is more of a theoretical application of the VAT and is not used in practice. Even though it is no different in theory from the other types of VAT, when actually applied, the addition method creates problems that the other methods do not. Some businesses, such as businesses with labor-intensive production processes, would pay higher tax bills because their unique circumstances require them to add more to their taxable base. Unsurprisingly, such businesses would seek relief from the government in the form of carve-outs for their specific industry. However, when the government grants relief to one industry, the pressure to offer similar exemptions to other industries soon builds. Special treatment of particular industries quickly spreads and destroys the VAT’s advantage of exerting minimal influence on the market. As a result of these exemptions, the addition-method VAT would create a substantial drag on the economy, unlike the other types of VAT.[5] VAT Strengths The VAT has some key meritorious features. The most important is that it excludes saving and investment from the tax base. Saving and investing are vital for economic growth because businesses use capital to expand their operations. Entrepreneurs use them to begin businesses. Both activities create jobs and grow the economy. Taxing savings and investment reduces their attractiveness to individuals and increases the cost of raising capital for businesses. This reduces the amount of saving and investing and therefore the number of jobs created. Because the VAT taxes only consumption, not returns from saving and investing, it is a better alternative than other taxes that tax saving and investing. Another positive feature of the VAT is its “border adjustability.” All countries that employ a VAT either exempt exports from the VAT or rebate the entire VAT paid on exports. Similarly, all countries that levy a VAT also levy the VAT on their imports. This has two positive effects. Domestically, all goods sold in a country with a border-adjusted VAT pay the same amount of tax regardless of country of origin. Second, in the global market, a border-adjusted VAT places exports on an equal footing with products from other countries because they will all face the same amount of tax regardless of where they are sold. In contrast, a business income tax raises the relative price of exported goods because it is not rebated like a VAT. Similarly, the individual income tax is rolled into the prices of goods produced by businesses that pay individual income tax instead of business income tax. There is no practical way to rebate the portion of the higher price due to either income tax from the good’s total cost. When a business exports that product it must therefore sell at a higher price, making its product less competitive in global markets. All taxes create distortions in the market because all taxes change the behavior of individuals and businesses. The best taxes affect the behavior of individuals and businesses the least. A structurally sound VAT measures up well against other taxes because it exerts relatively little influence on the decisions of businesses and individuals. Yet this feature holds true only if it applies uniformly to all goods and services in an economy because it raises the prices of everything proportionally. In this way, no product or service gains an artificial comparative advantage over another. The moment one good or industry secures an exemption for its goods or services, this relative advantage of a VAT dissipates rapidly. Border adjustments support the neutrality of the VAT because it ensures that all goods face the same level of tax regardless of where they are manufactured. The final strength of the VAT is its relatively low cost of enforcement. Because calculating the VAT is straightforward and businesses need to produce invoices to receive their refunds, enforcing the VAT costs revenue agencies less than enforcing other types of taxes. VAT Flaws While the VAT has some advantages over other taxes, it is far from trouble free. The VAT has several inherent problems. Hidden Tax. The VAT’s biggest flaw is that, unless mandated otherwise, the amount of VAT paid by taxpayers is hidden. (See Chart 1.) In this example, the consumer knows only that the price of the shirt is $22.00. Because the VAT is typically not printed on the sales receipt, the consumer does not know that the price includes a 10 percent ($2.00) VAT. One fundamental principle of sound taxation is transparency, and most nations’ VATs flagrantly violate this principle. State and local sales taxes are explicitly shown on sales receipts so consumers know the cost of the good before and after the tax. Even though a VAT would raise the final cost of goods and services in the same way, the VAT is typically not shown on sales receipts because politicians hide the steep price of the VAT and their policies from taxpayers. Even if the VAT is shown on receipts, taxpayers are highly unlikely to keep their receipts and total their VAT for the year. Politicians especially like the VAT because it obscures the tax burden and the true cost of government services from taxpayers. This can lead taxpayers to demand more government services because they wrongly perceive that the prices of such services are lower than they are. In a democratic state, the cost of taxes and government should be as explicit as possible so that taxpayers and voters can make fully informed decisions about the size of government. Taxing Services. The U.S. economy is becoming increasingly service-based, but the VAT has difficulty taxing services. In fact, all consumption taxes, including state and local sales taxes, struggle to tax services because tax authorities have difficulty determining actual sales when no physical property changes hands. Many state and local governments in the United States often forgo levying sales tax on most services because of this difficulty. Compared to the cost of their services, service providers generally purchase low-cost inputs from suppliers. For example, doctors provide relatively high-cost services for patients, but have low input costs compared to automotive manufacturers. Auto manufacturers must purchase costly inputs such as steel to produce each car. Doctors need equip an office only once to provide their services. The same applies to other service providers, such as attorneys, accountants, and financial service providers. This means the value added (the price of the service minus the cost of inputs) is high for service providers and the VAT they owe as a share of gross receipts is also high compared to traditional manufacturing businesses. This creates a strong incentive for service providers and their customers to collude to evade the VAT by transacting in cash. Alternatively, the service provider can underreport sales to capture all the benefit of evading the tax. In both cases, authorities would have difficulty proving tax evasion without on-site monitoring and inspections. Because services are a large and growing portion of the economy, exempting them from a VAT would necessitate raising the VAT rate considerably higher to collect the expected amount of revenue, another major problem of the VAT. State Sales Taxes. Forty-six states levy a sales tax. A VAT at the federal level would be similar to state sales taxes. States would likely strongly resist any federal attempt to usurp their sales tax authority because they rely on sales tax revenue. A VAT at the federal level would likely force states to apply their sales taxes to a uniform set of goods and services. This would take from the states their ability to tailor their sales taxes to their desires and each state’s unique economy. States would also be forced to keep their rates within a narrow range. Because the VAT rate would likely begin relatively high, it would leave states little room to lower their sales tax rate to increase their competitiveness compared to other states. Further, a federal VAT would increase sales tax evasion, thus reducing state tax receipts, possibly significantly. Underground Economy. No tax is 100 percent enforceable, and the VAT is no exception. The VAT’s ease of enforcement is not an absolute designation. The VAT is easier to enforce than other taxes that do not generate an easily auditable paper trail. Yet some would undoubtedly find ways to evade a VAT. In fact, a VAT would encourage development of a large underground economy. Saving up to 20 percent or more on every transaction would be a powerful incentive for consumers and businesses to work together to evade the VAT. They could evade the VAT by conducting transactions in cash or by bartering goods and services. Neither tactic would leave a paper trail, making it difficult for authorities to prove abuse. Europe’s experience with the underground economy confirms this. Informal transactions and buying and selling on the black market are common in Europe. Avoiding the VAT is part of the culture. In many cases, citizens evading the VAT are not even aware that they are escaping taxation because their evasion methods have become part of their everyday lives.[6] Similar behavior would quickly become endemic in the United States if it adopts a VAT. Fraud. A credit-invoice VAT has an inherent self-enforcement mechanism because of the trail of paperwork required, but even then fraud would still be prevalent. Fraud is different from the underground economy. It consists of businesses engaging in schemes to secure larger refunds than those to which they are entitled, rather than evading it outright like in an underground economy. No matter how well constructed, VATs are always susceptible to scams that allow businesses to claim larger refunds than they are entitled. VAT fraud can take the form of false claims of taxes paid, refunds claimed for nonrefundable purchases, businesses set up only to issue false invoices of taxes paid, and hidden sales.[7] European countries have a long history of administering the VAT, but they still experience considerable VAT fraud. Countries in the European Union (EU) lose approximately $107 billion annually in uncollected VAT. This amounts to a tax gap— the percentage of tax revenues that a tax should collect—of 12 percent,[8] which is a high rate of noncompliance for a consumption tax. Tax authorities will always struggle to gain the upper hand on criminals that game the VAT to their advantage. The monetary gains that the criminals can enjoy by abusing the VAT are a strong incentive to stay one step ahead of law enforcement. For instance, the EU is working to thwart VAT-related fraud and abuse in carbon dioxide emission permits, which are the staple of the EU’s cap-and-trade program. For example, in “carousel fraud,” criminals set up a fake company that purchases the carbon-emitting permit from a company in another country. The fake company then quickly trades the permit to another company in its country, pockets the VAT that it collects from the company purchasing the permit, and quickly disappears with the VAT proceeds. This scheme can use any easily moved good. The fraud involving carbon emission permits alone cost EU countries $7.4 billion over a recent 18-month span.[9] The carbon emitting permits are the latest trend in VAT fraud, but certainly not be the last. Tax evaders will quickly move on to a new scheme once authorities clamp down on this type of fraud.

The main take-away from Table 2 is that the VAT appears to have led to an increase in inequality when inequality is measured based on disposable income. This finding is very robust across specifications, in particular, across different ways of instrumenting the VAT. Since this is a main finding where a statistically significant effect is found, we have also assessed its sensitivity to violations of the exclusion restriction by using Local-to-zero (LTZ) estimation method developed by Conley, Hansen, and Rossi (2012). Figure A1 in the Appendix, shows the effect of the VAT on income-based Gini that also allow for a direct impact of the instrument (NeighbourV) on inequality. These estimates assume that the direct effect of the instrument to be uniformly distributed between zero and δ. The results show that as long as δ remains smaller than 15 in panel C (13 in panel D), the effect of the VAT on income-based Gini remains significant at 10% risk level. Because the corresponding reduced form effect of the instrument is 17.5 (and 15.8) in panel C (and D), the IV results for income-based Gini are robust to substantial deviations from perfect exogeneity.

However, Table 2 shows no impact on inequality for countries which use consumption-based inequality measurement; in some cases the impact is negative but it is not consistently significant. The difference between income- and consumption-based results must be interpreted with care, as the impact can also differ between other dimensions. In particular, high-income countries are overrepresented in the sample where Gini is income based. Additional analysis (not reported for brevity) suggests that the impact of the VAT on income-based inequality is similar in middle-income and high-income countries, Electronic copy available at: https://ssrn.com/abstract=2924448 21 suggesting that the main driving force for the result may be measuring inequality using income and not consumption rather than differences in the income levels of countries. One reason for why the impact of the VAT differs between income- and consumption-based measurement is that in consumption-based analysis, the consumers’ response to differentiated commodity tax structure can also be taken into account.

Our results, stemming from OLS and instrumental variable regressions, suggest that on average, VAT adoption has not necessarily led to increased inequality. However, we have found fairly robust evidence25 that when inequality is measured based on disposable income, countries with the VAT have experienced increases in inequality, whereas in countries where inequality is measured based on consumption, inequality has not increased following VAT adoption. The countries where inequality is measured using income-based Gini are more often high-income countries, and the results therefore suggest that for low-income countries, there is no evidence that the VAT would have led to widening welfare disparities. Admittedly, in the absence of income-based measurement of inequality for these countries, the impact of the VAT on income inequality cannot be examined.

VAT is a regressive tax, putting more burden to the poor than to the rich. Indeed, VAT applies the same rate to everyone regardless of their level of wealth – but the richer you are, the lower the proportion of your revenue goes to consumption. VAT cancels out one-third of the effects of fiscal redistribution.

It is a tax that we pay automatically on certain products that we buy so often that we would sometimes forget what it is for. VAT, which stands for value added tax, is one of the major tools of our tax system. This compulsory levy represents about a third of the state’s resources , at least in France. But if this tax is an excellent tool to finance important expenses, such as education or housing, how does it affect inequality?

Six VAT Myths In addition to damaging the economy, levying a VAT on top of all of the other federal taxes that Americans already pay would overwhelm all of the VAT’s theoretical advantages. While the economy could conceivably be stronger if the VAT completely replaced the entire income tax code,[14] fundamental tax reform is not a high priority in Congress in the current budget environment. If Congress considers a VAT, it would most likely be as a method to raise more revenue to close the deficit. The inefficiencies of the income tax would remain and the inefficiencies unique to a VAT would be added on top to create an even heavier drag on the economy and burden on taxpayers. Six myths are commonly submitted in defense of the VAT. Most result from a misunderstanding of the difference between a VAT as a replacement for all current income taxes and a VAT as an addition to the current taxes. Myth #1: A VAT would increase the savings rate. Some argue that a VAT would encourage saving because it would raise the prices of everything we buy. In this line of thinking, Americans would buy fewer goods and services and therefore save money that they formerly spent. A VAT would undoubtedly raise the prices of everything that consumers buy, but this would not increase the savings rate. The low savings rate is not the result of low prices, but of the current tax code that discourages savings by taxing returns of investment through taxes on capital gains, dividends, and interest. Adding a VAT would not change this. As long as the income tax continues to tax capital income and capital gains, the tax code will continue to discourage saving. In fact, adding a VAT to the current tax code would reduce savings for an extended period and result in a permanent loss in wealth and growth. A VAT would potentially raise the prices of consumer goods and services between 15 percent and 20 percent. To sustain as much of their current consumption as possible, families would need to save less and even dip into previous savings to purchase the same amount of goods and services that they consumed before the VAT. Myth #2: A VAT would increase investment. Since some argue the VAT would increase savings, they subsequently argue that it would also increase investment. Once again, they confuse the effects of a VAT as a replacement for the current tax code with the effects of adding a VAT to the current tax code. Investment would likely decrease if Congress added a VAT to the current tax system, especially in the short term, because households would need to cut back on savings and withdraw previous savings to maintain current levels of consumption. Myth #3: A VAT would encourage economic growth. Few economists argue that tax hikes encourage economic growth. Yet some argue that a VAT would improve economic growth because it would tax consumption instead of income. The income tax’s highly progressive structure[15] and the double taxation of capital income and capital gains strongly discourage working, saving, and investing, which are essential to economic growth. If Congress added a VAT on top of the current system, the disincentives to work, save, and invest would persist. In fact, the disincentives to work and save would actually increase further. The VAT would likely reduce the savings rate for an extended period. In terms of growth effects, the VAT is economically equivalent to a tax on labor and so it would discourage work even more. Myth #4: VAT promotes exports. Because the VAT is rebated on exports and imposed on imports (the border tax-adjustment system), some contend that the VAT would make American products more competitive in the global market. This is false. A VAT would have no effect on the competitiveness of United States exports. Once again, proponents are confusing the potential advantages of a VAT as a replacement for the income tax with the realities of a VAT as an add-on tax. Even if the VAT itself is internationally neutral because of border tax adjustments, adding a VAT does not reduce the disadvantages imposed by the income tax, which lacks these border tax adjustments and is therefore detrimental to U.S. competitiveness. Myth #5: VAT allows for lower income taxes. Some proponents tout the VAT as a solution to massive deficits. Without cutting spending to lower the deficit, Congress will have little room to reduce income taxes because all the income tax revenue plus the VAT revenue will be needed to bring the deficit under control. Nevertheless, if Congress were to pass a VAT, it would likely include some minimal and temporary reductions of the income tax to buy support from the American people and certain lawmakers. However, as long as Congress retains the power to levy an income tax under the 16th Amendment, future Congresses could always raise it back to its previous levels or even higher. This has been the experience in Europe. Income taxes have actually increased after the countries implemented VATs, despite promises to the contrary.[16] The combination of a VAT and the income tax in the United States would likely lead to similar income tax increases as successive Congresses look for more revenue to spend. This would lead to further increases in the tax burden and the slower rates of economic growth from higher taxation. The only way the VAT or any other national consumption tax could be acceptable is if the 16th Amendment were simultaneously repealed. Myth #6: VAT would close the deficit. Congress spends every dollar of tax revenue plus as much as it can borrow from credit markets.[17] It is on track to push the limits of credit markets. There is little reason to believe that Congress would suddenly discover fiscal discipline after levying a VAT. More likely, it would spend the VAT revenue on new programs and continue borrowing as much as possible. Giving Congress more taxpayer money to spend would likely worsen the current fiscal crisis until credit markets decide to stop lending to the United States because they no longer are confident that it can repay its debts. Greece is a good example of how this could happen. Despite its 19 percent VAT, credit markets have stopped lending to it at reasonable rates because of its chronic and unsustainable overspending. The credit market may soon stop lending to other similarly fiscally troubled countries that levy substantial VATs, including Portugal (21 percent), Italy (20 percent), and Ireland (21.5 percent). Given the political realities, the only way to close a budget deficit is to reduce spending. Higher taxes consistently lead to higher spending. An Unnecessary Tax The current and future deficits are threatening the stability of the U.S. economy and have prompted some camps to consider the VAT as a way to eliminate the deficit. Congress’s overspending has caused the threatening deficits, not a lack of tax revenue. If Congress permanently extends the 2001 and 2003 tax relief for all taxpayers and patches the alternative minimum tax (AMT) so it does not affect middle-income families, federal tax revenues will still exceed their historical level of 18 percent of GDP in the coming years. On the other hand, under President Barack Obama’s budget, spending will rise to 24 percent of GDP by the end of this decade—a considerably higher level than the historical average of 20 percent of GDP. Unchecked entitlement spending will push this level even higher in the coming decades. Unless Congress restrains spending, ever-higher tax levels will be required to close the deficits. Yet as European nations are discovering, even the VAT cannot solve their problems. They need to fundamentally restructure their entitlement and welfare spending. Congress should ignore misguided siren calls for a VAT and instead immediately address its spending problems. Tax increases will never reduce the gap. Instead, Congress must cut spending to 20 percent of GDP or lower. This would reduce the annual budget deficit to a more manageable level. The national debt would stabilize as a percentage of GDP and the threat that credit markets will stop lending or raise interest rates would abate. None of these necessary steps requires a VAT. —Curtis S. Dubay is a Senior Analyst in Tax Policy in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation

Economic Drag from Exemptions. Many wrongly claim that the VAT is regressive. They argue that the poor consume a higher percentage of their income and therefore would pay a larger portion of their income as VAT than the rich would pay. While measuring income tax paid relative to income is reasonable, measuring VAT tax paid relative to consumption is also reasonable because consumption is the base of a VAT. On this basis, a VAT is proportional because all taxpayers would pay the same amount of tax as a share of their consumption. This is an important distinction because, if lawmakers fall for the flawed regressivity argument, then any VAT law would likely exempt certain necessities, such as food and shelter, which often constitute a larger portion of a low-income person’s consumption spending. One major advantage of the VAT in the abstract is that it exerts less influence on the decision making of individuals and businesses. However, once certain goods and services receive preferential treatment, the advantages of a VAT rapidly dissipate because some businesses—more accurately, the goods and services they produce—receive more favorable tax treatment than others. Businesses that receive such exemptions can sell their goods at lower prices than their competitors’ goods, which would be subject to the VAT. This would increase the profit margins of VAT-free businesses compared to businesses that must pay the VAT, attracting more investment to the VAT-free businesses. Thus, exemptions would distort investment, and this misallocation of resources would ultimately lead to less value produced from the nation’s resources than would occur if there was no VAT. More Power to Government and Lawmakers. The more government spends and uses tax and regulatory policies to micromanage economic affairs, the more power it amasses. Private citizens and businesses react to the government’s accrual of power by seeking more access to decision makers. The large benefits that businesses can gain from receiving a VAT exemption for their product will cause them to seek VAT relief from the government. Carve-outs for businesses will give government more power to pick winners and losers in the marketplace and make business success more dependent on procuring government favors rather than providing a product demanded by the public. This concentrates more power in government and increases the power of businesses and industries with strong lobbies at the expense of those with less political sway. This will only increase the alienation that many feel from the government that is increasingly beholden to the powerful. Government-Growing Tax A VAT can collect a staggering amount of revenue. In the present budgetary context, some experts are calling for a VAT large enough to close massive current and future deficits.[10] For example, the Domenici–Rivlin Task Force report calls for a 6.5 percent “deficit reduction sales tax,” which is in reality a VAT. The additional revenue needed to close the existing budget gap would require a VAT between 15 percent and 20 percent,[11] which would be in line with VAT rates in other economically developed countries. In fact, the EU requires its members to levy a VAT of at least 15 percent, and in some countries, the VAT is as high as 25 percent.[12] At 15 percent, a VAT would collect about 6 percent of gross domestic product (GDP). In 2019, this would mean more than $1.2 trillion in higher taxes. If the rate was 20 percent, the VAT would raise 8 percent of GDP, just under $1.7 trillion in higher taxes in 2019.[13] A tax increase of this magnitude would raise the federal tax burden between 33 percent and 44 percent above its historical average. Once a VAT is in place, Congress could easily increase the VAT any time it wants more taxpayer money to pay for new programs. Continually increasing the size of government would become considerably less painful because small increases in the VAT rate could raise substantial sums of revenue. An increase of just 1 percent would raise more than $80 billion per year by the end of the decade. The ability of the VAT to raise money will almost certainly prove irresistible to Members of Congress. The experience of other industrialized countries bears this out. As Table 1 shows, 29 of the 30 countries in the Organisation for Economic Co-operation and Development have implemented VATs. The United States remains the lone exception. In the years since they began their VATs, 20 of the 29 have increased their rate by at least 1 percentage point. Denmark leads the group with a 10 percentage point increase from 15 percent to 25 percent. On average, the 20 countries have raised their VAT rates by 4.5 percentage points. VAT Rates Typically Rise After Implementation Permanently Slower Economic Growth Adding a VAT to the taxes currently in place would permanently slow U.S. economic growth for several reasons. First, the VAT would transfer trillions of dollars per year from productive private hands to the less efficient public sector. Over the long term, fewer resources in the private sector would produce a lower standard of living for succeeding generations than they would have enjoyed without a VAT. This lower standard of living results from the government allocating the VAT revenue for political reasons. On the other hand, if the private sector is allowed to keep these resources, it would allocate them based on market considerations. A politicized allocation is generally less efficient than market-based allocation because political decisions do not consider the highest-value use of resources, while the market considers such issues and therefore does a better job of assigning resources where they will contribute the most to economic growth. Second, the VAT would weaken the economy by weakening the incentives to work. VAT proponents often highlight that the VAT, unlike the income tax, is neutral between saving and consumption. However, they downplay that fact that the VAT, like the income tax, discourages work. This long-established fact may not be immediately obvious, but it is evident after analyzing why people work. People work for many reasons, but economically, the primary reason is to earn income to purchase food, clothing, housing, health care, and all of the other goods and services of modern living. Given an individual’s skills and capabilities and the available market opportunities, each individual can command a wage commensurate with the economic value that they can create. Given that wage, the individual then knows how much he or she can earn by giving up a certain amount of free time or leisure and can choose what work to perform, how long to work, and how much leisure to take. This is the essence of the labor–leisure tradeoff in the absence of taxation. Of course, it is also a broad abstraction and simplification of complex market processes, but is nevertheless a reliable portrait of the issues in this argument. When government taxes wages, such as with a payroll tax, the tax reduces a worker’s after-tax wages and therefore reduces the return to work or, equivalently, reduces the “price of leisure.” Such a tax predictably reduces the number of hours that workers desire to work. Consequently, workers have less after-tax income to consume or save, limiting their ability to buy goods and services. If the government imposed a VAT in lieu of a payroll tax, the worker’s after-tax income would be unchanged, but the VAT would cause prices to increase, reducing the worker’s ability to purchase goods and services. In this case, the true value of the worker’s wages has declined because their purchasing power has declined. From the worker’s perspective, what matters is what he or she can buy in exchange for a certain amount of work. Whether through a payroll tax reducing after-tax wages or a VAT raising consumer prices, both taxes disadvantage the worker equally, reducing the worker’s incentive to work. Economically, the VAT is equivalent to a payroll tax. Both reduce work effort and therefore output and incomes.

[Najma, “Universal Basic Income: A Fundamentally Flawed Concept,” Penn Political Review, April 10, 2021, https://pennpoliticalreview.org/2021/04/universal-basic-income-a-fundamentally-flawed-concept/, accessed July 2, 2023, GDS-LL]

As the last few months have proven, UBI is not as disruptive to our normative system of government as one might assume. However, it is not enough. A consistent cash transfer alone will not remedy wealth and income inequality, the lack of access to adequate healthcare, and, overall, the government’s failure to redistribute tax dollars and provide a financial safety net. Our current system offers an overly complicated tax process, yet insufficient social benefits to account for many Americans’ difficulties.

[Betsy, “Universal basic income doesn’t work. Let’s boost the public realm instead,” Guardian US, May 6, 2019, https://www.theguardian.com/commentisfree/2019/may/06/universal-basic-income-public-realm-poverty-inequality, accessed July 2, 2023, GDS-LL]

A study published this week sheds doubt on ambitious claims made for universal basic income (UBI), the scheme that would give everyone regular, unconditional cash payments that are enough to live on. Its advocates claim it would help to reduce poverty, narrow inequalities and tackle the effects of automation on jobs and income. Research conducted for Public Services International, a global trade union federation, reviewed for the first time 16 practical projects that have tested different ways of distributing regular cash payments to individuals across a range of poor, middle-income and rich countries, as well as copious literature on the topic.

How Universal Basic Income Can Worsen Wealth Inequality, and Potential Fixes Without balancing the budget, giving people money could make the wealth inequality worse from its already unacceptably high levels Source: Jack Moreh from Freerangestock.com Universal Basic Income (UBI) is a proposal to address multiple social and economic problems plaguing modern societies. The main advantage of the UBI concept is that the money is paid in cash and comes with no strings attached on who receives it or how they can spend it. Unlike traditional welfare schemes that require means-testing to determine eligibility, everyone qualifies for UBI to do whatever they wish to do with the money. Neither policy formulation nor its implementation can ever be perfect in terms of its effectiveness, efficiency and fairness. The UBI will be no different with its owns challenges. The fears of negative consequences are plenty. Some feel that giving free money will make people lazy or encourage them to stop working. None of these concerns have basis in strong empirical evidence, however. Some pilot studies (e.g., done in Finland) suggests no such outcome. In fact, while the Finland work reported that no “revolutionary” outcome in terms of employability from giving away free cash, it improved recipients’ mental health. Since the free cash helps people meet their essential needs without significant worry or stress, they have more ‘brain energy’ to spend on productive uses for improving/upskilling themselves rather than stressing out where their next meal will come from. Nonetheless, the whole UBI program will require loads of money. For example, paying each citizen (or say resident) in the USA $15,000 every year will require $15 billion for every million people. So, serving 260 million (adult population of the USA) under UBI will require nearly $4 trillion every year. So, the obvious question is: do we have to pay for it? If so, who is going to pay for it and how are we going to collect it? The purpose of this blog is not to discuss the socioeconomic implications of UBI at individual or micro-level. The blog rather presents a possible macroeconomic impact that will intensify the socioeconomic disparities, an undesirable outcome the policy aiming to rectify the very issue. The rest of the blog explores some of the macroeconomic consequences and potential ways of fixing them to make UBI work better. Why can we just print the money? Some suggests that government has authority to create money without balancing the budget. The basic tenet of Modern Monetary Theory (MMT) is that the government deficit does not matter, as advocated by Stephanie Kelton in her quite popular book “Deficit Myth”. According to the author, the Federal Reserve, on behalf of the US government, can print unlimited amount of money and give it to the government for free to spend as the policy makers wish. In fact, even if the Fed charged an interest rate, that should not be a problem. The Fed is legally obligated to return the interest earned back to the government, which essentially makes the impact of any interest rate meaningless. So, $4 trillion can readily come from simply printing money without raising taxes. While this is practically true and I also strongly support unlimited spending — especially for building physical infrastructure and renewable energy systems — I disagree that there are no negative consequences. One common criticism is risks of hyperinflation. I partially agree with the critics, who point out several concerns (e.g. trade imbalance), including the fact that large amounts of money in a society will lead to inflation. We are already aware of the on-going inflation problem partly driven by stimulus money. The stimulus boosted the demand when the supply was already under pressure from many constraints, leading to a classic supply-demand mismatch. Imagine what would happen if every more money was injected into the economy as stimulus checks every year. Nevertheless, the critical point is where all that money will accumulate once people start spending it. For example the pandemic and resulting stimulus has worsened the wealth and income equality in the USA, and the central banks’ loose monetary policy to be partly blamed for it. So, the follow up question should be why that is the case. How did giving people money exacerbate a social evil that many such welfare schemes try to eliminate? Where money trickles up the ‘food’ chain In my opinion, the issue is not how much money people receive, where the funding comes from, where people spend it, or even whether it leads to (temporary) hyperinflation. It is how many will ultimately receive (and accumulate) it after it travels (trickles) throughout the economy once people start spending it. Our production and consumption economic structure has embedded inequality. The major cause of wealth inequality is huge disparities in control or ownership over means of production, assets, and the governance. For example, while between 60–80% of the households have some equity in housing and car assets, many lack other form of assets. A minority (less than 10% of the richest families) own nearly 85% of overall equities. Although the exact information on the ownership distribution is unclear, 50 families own 1.3% of the USA landmass. There are about 6.1 million employer firms that employ about 135 million private sector employees, with over 70% working in service sector. This means that not many own a business/farm/factory that can produce physical “stuff”. You can draw your own imagination about Big Pharma, Big Agro, and all those big corporations. Whenever people spend money by consuming things, the money travels along the supply chain and reaches the owners of the system that produced those goods/services or controllers who receive the maximum profit from the sell. Unless the government is running surplus or deficit, the money can neither be created or destroyed. It can only move from one hand (spender) to another (receiver). Now, imagine that the wealth inequality that the circulating such large quantities of money from UBI would create. So, the issue with UBI is not the magnitude of the money supply itself, but rather how to manage the overall flow of money to prevent the whole UBI initiative from becoming counter-productive. Therefore, fiscal balancing is necessary to prevent wealth inequality and someone must pay for UBI— either now or in future. Running large deficits eternally is unsustainable. Taxation is one of the ways of keeping printed money in circulation to avoid any excessive, stagnant concentration in among a few wealthy individuals. The tax rates must be set in such a way that the remaining deficits in UBI funds can be collected via income taxation. Of course, the additional taxation will also be required to fund regular government spending. However, the avoided expenses from eliminating many existing social welfare schemes, such as social security, pensions, will moderate the overall financial impact of UBI. During initial years, the government may run large deficits to avoid sudden impacts from new tax systems, but the overall tax collection must match the spending. In addition, we need to reform the tax code, rebalance the production-consumption inequity, and accept certain abuses of UBI. 1. Simplify the income tax code Since the savings from terminating the existing social programs will not be enough to fund UBI, additional taxes from incomes may become necessary. For that, the current tax code needs to be reformed (or scrapped entirely) first and revised into something so simple that a child with basic arithmetic understanding can file the tax return. This is an extremely important fix to ensure that any spending does not get accumulated in the hands of few. One way to achieve it is to simply account all earnings by person, irrespective of the nature (salary vs capital gains) and impose a flat (or graded) tax rates on the total income without any reductions. It means remove all deductions and exceptions no matter how logical or important they seem from an economic or social perspective. If there is a deduction available, someone, who can hire expensive experts and consultant, will always find a way to use it and reduce their tax burden, or people will start lobbying for more deductions to suit their own person agenda. Therefore, no exceptions should be granted to anyone. Reducing complexities of tax code will also keep the bureaucracy costs to a minimum. The same principles of simplicity must also be adopted for designing and collection ecosystem service tax. 2. Fixing production, governance, and ownership imbalances People must be empowered to own means of production, such as farmland, electricity, data, knowledge, and whatever can be used to generate material and intellectual wealth. Decentralization of power (rooftop solar, community farming) are some of the ways people can regain the control over production, thereby ensuring that the money stays within the local community. Open sourcing of knowledge platforms and software applications as well as cryptocurrency are such initiatives to balance the scale in favor of people from big corporations. In fact, the concept decentralized autonomous organization (DAO) is becoming increasingly popular. 3. Accepting some drawbacks and abuses Giving free cash to everyone will feel unfair to some who think their hard work is getting devalued by people who are getting paid without work. Some recipients might even do drugs or play casinos. Therefore, it seems logical for such skeptics to expect some form of means-testing requirements before the government issues UBI checks. Source: B P Miller from Unsplash While the concerns are valid, any restrictions will only increase bureaucratic and admin costs, which could be even higher than the money “wasted” on drugs/lottery in absence of any restrictions. Also, these restrictions are susceptible to political ideologies since the politicians, for obvious reasons, may want to keep some people out based on racial, religious, gender, or some other criteria. Though digital technologies will minimize such misuse, some people will find a way to take advantage of it. Therefore, “free for all and do whatever you want” is an essential evil of UBI needs to be accepted. Final words The purpose here was not to support or oppose the program, rather to explore some potential downsides as well associated fixes to reduce the risks of unintended consequences. UBI is an excellent initiative to restore balance within the society. In fact, I would prefer if it replaced many other welfare schemes altogether. I believe that a single national-level program that directly transfers sufficient money into people’s accounts can be a far more efficient approach to social welfare and to eliminate significant bureaucratic costs. The optimal solution will always be a mix of everything and none of the above fixes will alone address the current levels of inequality, they would slow down or prevent it from getting worse. And in the long run, it is possible that the overall wealth distribution falls within an acceptable levels of inequality while continuing the UBI program. Acknowledgement Most of this content is based on my own reading of the secondary material (books, blogs, videos, course material) while in college or at work and discussing with (equally crazy) friends over the past 11 years. A couple of points were based on the arguments by some participants in an online meetup on Meetup.com. The recording of the discussion is available here.

Let's set aside electoral politics for now and focus solely on democratic socialist policies. Helpfully, we have a country that very closely approximates the democratic socialist ideal. It's a place that is not only very far from a hellish dystopia, but also considerably more successful than the United States on virtually every social metric one can name.

I'm talking about Norway.

Sure, most workers and households get as much money, if not more, in countries with socialist societies as they do under capitalism. And sure, socialist societies appear to be more healthy, happy, and equal, while having more free time and fewer preventable deaths. But maybe it’s because they are somehow free-riding on the backs of innovations that are due to the magic of capitalism.

Nope. Capitalism does not have a special ability to innovate. While the most socialist country (Norway) ranks less than the U.S., the U.S. ranks below Sweden and is comparable to Finland. Overall, the trend is fairly weak, with even more variation than previous trend lines. And “innovation output” is a more murky concept to measure than money, health, equality, and leisure. But this data does not support the idea that socialist countries rely on innovation from capitalism.

John Molyneux, 10/1/19 Socialism is the only realistic solution to climate change https://climateandcapitalism.com/2019/10/01/why-socialism-is-the-only-realistic-solution-to-climate-change/ B.D.K.

A lot has been written, including by myself, on why capitalism, by its very nature, cannot tackle or stop climate change. The purpose of this article is not to repeat those arguments but to make the positive case for socialism as necessary to deal with this existential crisis for humanity.

The score derives from four components, with each made up of several subcomponents. The “State Ownership Score” combines data on the market value of State-Owned Enterprises relative to the overall economy, the share of government financial assets as a percentage of GDP, and the share of total public wealth as a share of total overall wealth. The “Public Goods and Welfare Score” combines government expenditures on welfare transfers, education, housing, etc. as a share of GDP. The “Democracy Score” simply comes from Freedom House’s “Freedom Ratings.” And the “Union Score” combines the percent of the workforce who are members of unions and the percent who are covered by collectively bargained contracts. To appropriately average these scores into a single overall score, I converted them into “standardized t-scores.”

Now that we have a way to approximate the degree of socialism in countries, we can see how socialism correlates with important indicators of the population’s quality of life. By looking at actual life outcomes across countries, we can see whether it’s justified to argue that socialism is incompatible with living the good life. If we find that more socialist countries are more productive or healthier than capitalist ones, that’s not proof that socialism causes such outcomes—but it does offer a hint. And more importantly, if we find correlations that move in the opposite direction of what a capitalism-booster would argue, it’s powerful evidence against the idea that capitalism has unique features that lead to prosperity.

On one hand, the accusation of envy is beside the point. Proponents of any moral or political doctrine, such as nationalism or social conservatism, might be compelled by any number of psychological motivations, but those ultimately matter less than the implications of the ideology itself. Likewise, socialism should be judged not on the motivations of socialists but on its content — that is, whether a socialist society is both feasible and desirable compared with what we have now.

But even if it were possible to accurately judge a political project by the motives of its supporters, socialism couldn’t be dismissed this way, because the actual moral case for socialism has nothing to do with envy. Socialism is not about settling scores between the “haves” and the “have-nots,” but creating a better world for all. In fact, a socialist world would be one in which antisocial motivations like envy are less pervasive and powerful.

A UBI could turn this merely formal right to exit into a meaningful ability to exit, and various forms of UBI allow various forms of exit. Simon Birnbaum and Jurgen De Wispelaere (2016) distinguish between weak, strong, and radical forms. The weak form is the ability to drop one’s hours, creating a shorter working day or week, the money from the basic income picking up the slack. The level of the grant in this case would not need to be liveable, in the sense described in the last section. The second option, strong exit, gives workers the resources to sustain a longer search for a new job once they have left the old one, making their threat of exit more credible and thereby reducing power imbalances in the workplace. Alternatively, those workers could simply use this power of strong exit and find a different, less dominating job. Again, the level of the grant required to provide strong exit would not have to be liveable, since it does not rely upon enabling independence from all work, just independence from one’s particular job.

["DESIGNING A BASIC INCOME GUARANTEE: TARGETING, UNIVERSALITY AND OTHER CONSIDERATIONS,” Institute for Economic Justice, October 2021, https://www.iej.org.za/wp-content/uploads/2021/10/IEJ-policy-brief-UBIG-3_2.pdf, Accessed 6/26/23, GDS – PL]

***UBIG – Universal Basic Income Grant

Secondly, and more importantly, the universal basic income, in asserting everyone’s right to a material existence, accomplishes some important work in our cultural consciousness, in Marxist directions, in terms of dissociating or de-coupling the work people do from their ability to have their material needs met and, more to the point, to share in the fruits of our collective labor.

In other words, the implementation of a universal basic income can begin to erode the powerful meritocratic ideology that, as I have argued elsewhere in the pages of People’s World, is a centrally insidious ideology sustaining capitalism. As a culture, we are for the most part perfectly happy valuing people’s work unequally, regardless of how essential it is to our lives. Our capitalist culture makes it seem normal and just that the doctor doing the important work of keeping us healthy deserves a lot more money—and hence access to more resources—than the farmworker who does the important and essential work of feeding us. As a culture, we lack a recognition that this very way of valuing work is a product of a capitalist economy, that the way we determine the “merit” of work grows out a capitalist mentality.