Third installment in the "They're Burning Your Money Series" featured all week on Fox Business
The new bipartisan federal debt commission is set to report on how the US should cut its deficit December 1, as Congress recesses without a budget for the fifth time in seven years after enacting massive deficit spending, and the Bush tax cuts are now subject to horse trading in a lame duck session.
That means the federal debt commission’s findings could reshape government tax and spending policy in a dramatic fashion.
And some fear they smell a VAT, akin to a new national sales tax.
But a value-added tax is not tax reform, as it would most likely not replace, but get layered on top of, the US’s tangled barbed wire of a tax system.
A VAT is a symptom, not a cure, for fiscal incontinence.
Often installed with great fanfare as being debt busters in Europe, a VAT didn’t cure Europe’s debt problems—spending and debt only continued to grow under VATs there.
And so did Europe’s VATs, which started at 5% in the ‘60s and early ‘70s, and now average 18%.
Also, a VAT is the most micro form of taxation on consumption that needs the most macro form of law enforcement, an even bigger, all consuming IRS.
A VAT is similar to a national retail sales tax but is collected at every stage of business production until its entire burden ultimately falls on the consumer.
However, the debt commission could provide political cover to a middle class tax hike in the form of a VAT, which would hit the lower brackets hard.
A VAT would undercut President Barack Obama's promise not to raise middle class taxes—even though Vice President Joseph Biden said earlier this year that President Obama is “open to listening” to a VAT.
House Speaker Nancy Pelosi(D-Calif.) has said that a VAT is “on the table.” The debt commission co-chairman Erskine Bowles said, “There are many good arguments that you can make for a value-added tax,” Republican Rep. Paul Ryan’s fiscal “road map” includes a VAT.
But economists fear a VAT would slow GDP and job growth, as it has in Europe.
Also, research submitted to the Organization for Economic Co-Operation and Development, a policy group for developed countries, shows that a VAT is a hidden tax subject to massive corruption in Europe.
This is how crazy a VAT can get. According to a reportfrom the newspaper the Telegraph, relying on research from Deloitte & Touche, wheat-based snacks or tortilla chips are not subject to a VAT in England, but potato crisps are. ''Freshly baked food'' from supermarket bakeries is not subject to a VAT in England—but if they have chocolate in them, then you pay a VAT. Also ''takeaway hot food'' from grocery takeaway counters attracts a VAT.
If you buy nuts and dried fruit in the bakery aisle of a store in England, you likely won’t pay a VAT. But buy them from the snack aisle and you'll pay a VAT.
The US’s debt crisis has engendered increasing talk of a VAT. The nation's total federal debt next year is estimated to surpass $14 trillion, fast approaching the size of the entire economy. The cost to retire the debt is about $47,000 per citizen. Deficit spending is supposed to add $8.5 trillion to the nation’s debt in this decade.
And that is based on rosy government assumptions of 10 years of 3.4% GDP growth—when so far 2010’s growth rate is hovering around half that.
Estimates indicate that in 10 years the federal government will be paying more than $1 trillion per year in interest alone on the national debt.
Right now, the interest on the debt would cover the cost of about two dozen government agencies, and is about the size of Argentina’s economy.
The bipartisan commission is not a “stalking horse for a VAT,” as Republican Congressman Jeb Hensarling says, and the commission may be structured to come to a stalemate. Democrats appointed 12 of its 18 members, and any policy changes must be backed by 14 members, meaning two Republican appointees.
However, supporters of the VAT say the U.S. is the only industrialized nation without one, and a VAT has appealed to members of Congress.
Its backers argue a VAT would be difficult to evade relative to the income tax.
Not so. Analysts who’ve submitted research to the International Monetary Fundand the OECD show that VAT evasion is rampant in the European Union, triggering revenue shortfalls so large that many EU countries have to spend even more government money to hire more tax cops to prevent the abuse—tax police subject to much bribery.
VAT fraud in the EU creates annual revenue shortfalls as high as 30% of potential tax collections in some countries, says Curtis Dubay of the Heritage Foundation. The U.S. Department of Treasuryestimated the net tax gap for all taxes in 2005 (the latest available data) stood just under 12% of potential tax receipts, Dubay says.
Here’s how VAT works, under the most typical form of the tax, called the credit-invoice method:
Businesses pay the VAT on all goods that go into final production of an item, and then turn around and charge the VAT on their sales to recoup their costs.
They then subtract the taxes they intially paid on purchases from the taxes they collected on sales, and then send the difference to the government.
Here's how fraud creeps into a VAT system:
1. Falsified VAT Documents: Businesses often gin up fake invoices for the purchase of inputs they never bought in order to get bigger deductions for taxes paid than they are entitled to, says Curtis Dubay of the Heritage Foundation.
2. Faking Items Exempt From the VAT: Governments exempt certain items from VATs, such as essentials like food or certain health care costs. But things like luxury foods are taxed. So businesses that sell both VAT-exempt and non-exempt items have an incentive to say they produced more non-exempt items. Or they allocate the purchase of supplies they use to produce exempt items toward the production of non-exempt items. This improper shifting increases the business’s tax refund because it allows them to claim deductions on their tax returns for the taxes paid on inputs where there should be none, Heritage’s Dubay says. This fraud is common because it is difficult for authorities to prove which supplies the business used to produce the different products, Heritage’s Dubay says.
3. Fake VAT Paper Mills. There is a cottage industry in Europe where businesses are set up exclusively to produce VAT invoices so other businesses can claim refunds on taxes they never paid, Heritage’s Dubay says.