A VAT crushes US economic growth – Taxing consumption distorts markets and investment through prioritizing exempt businesses AND reduces worker purchasing power, disincentivizing work and crushing the labor force

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.