A VAT Tax would require unprecedented levels of IRS commitment

It is sometimes said that a value added tax (‘‘VAT’’) would simplify taxation.16 A VAT is a kind of sales tax on gross receipts, except that a VAT entails lots of paper work along a chain of production and supply. The extra paper work improves compliance. VATs necessarily entail complexities. When adopted, the UK VAT had four categories of goods: normal tax, exempt, zero tax and mixed. For zero tax goods, taxpayers further along the production chain got credit even though no tax was paid. The whole system was administered by the Bureau of Customs and Excises which had a tradition of viewing every taxpayer as a smuggler.17 Even now, the European VATs have large and growing evasion problems they need to deal with.18 Net operating losses expire after 20 years. At 5%, a twenty year annuity is worth 3⁄8 of present value of a perpetuity. Deductions at 35% for 20 years would be worth 3⁄8 of 35% or about 20%. The calculation depends critically on discount rates, life of the business, future tax rates and other assumptions. VATs have no way to exempt the Little Match Girl at the cashier counter. It is also not all that simple to find the Little Match Girl by other means to give her a refund of VAT that we really do not want her to pay. Inevitably VATs get complicated as legislators try to avoid freezing little girls. For example, most states exempt from sales tax food for home consumption to help those with lower incomes, but they tax restaurant food, which affects those with higher incomes.19 Thus, caviar at $2,400 a pound is tax exempt, while a White Castle meal at $2.99 is taxable. In Texas, tax is due on candy but not on cake. Are Rice Crispies with marshmallows a starchy cake or a sweet candy? Popsicles are subject to tax or not depending on whether they are more or less than 50 percent fruit juice. Texas sales taxes also get complicated because of exemption for products covered by other taxes, e.g., natural resources. VATs inevitably become Rube Goldberg machines with very high elasticities across complicated dividing lines, as the tax adjusts to inequity of a simple VAT and to other kinds of taxes. Those lines yields a tax that does a great deal of dead weight damage.20 A VAT in this country, moreover, will not replace the income tax, but will be imposed on top of the income tax. That means no reduction in the complexities of the current income tax, nor pressure to improve it, but instead a whole new complicated tax system in addition to current complexities. The issues in the administration of a VAT do not overlap very well with compliance with an income tax, so that an addon VAT will require a new set of tax specialists for every business. In 1984, the Treasury estimated it would need another 20,000 IRS employees to administer a VAT.21 That implies that a VAT would also require another block-long limestone building in Washington DC. An add-on VAT is necessarily an increase in complexity. Since add-on VATs are not justified by simplicity, the surviving ‘‘justification’’ for an add-on VAT is just to shift the burden of tax from Uncle Scrooge to the little Match Girl. We can get a progressive consumption tax, more simply, with a ‘‘cash flow consumption tax.’’ A cash flow consumption tax would use the same tax officers, even the same Form 1040. All that would be needed to be changed from current law is a deduction for investment and disallowance of interest deductions.22 The VAT is offered instead of a cash flow consumption tax because a cash flow consumption tax would not naturally shift tax from Uncle Scrooge to the Little Match Girl, while VAT would. Beware of the VAT and the gifts it brings. Simplification is just a cover.