Treasury Secretary G. William Miller buried a proposed value added tax (VAT) under a mass of negative comments in testimony yesterday before the House Ways and Means Committee.
Miller did not oppose the tax outright. Instead, to avoid offending Ways and Means Chairman Al Ullman (D-Ore.), its prime sponsor, he walked a fine line between opposition and laying out the host of problems Treasury sees in it.
Another committee member, Rep. Charles Vanik (D-Ohio), labeled Miller's tightrope act "a noiseless demolition of the idea of a VAT."
Ullman would like to substitute a value added tax -- a form of federal retail sales tax -- for $130 billion worth of present personal and corporate federal income taxes and Social Security payroll taxes. Ullman believes this change in the nation's tax structure would spur business investment, improve productivity and reduce inflation.
A value added tax, which is widely used in Europe, is levied at each stage of production of goods on the value added at that stage. When a partially finished item is sold, the tax is paid on its entire value at that point, with the seller getting credit for all of the taxes paid at earlier stages of production.
In the end, the buyer, normally a consumer, pays the full tax, and in that sense, VAT similar to a retail sales tax. The tax would not be collected on capital investment goods used by business.
Miller ticked off several key questions about a VAT in the United States. "Would it encourage capital formation? What impact would it have on the price level? Would it improve on the trade balance? Would it be regressive?" he asked. (A regressive tax is one that causes lower income persons to pay a relatively larger percentage of their income in tax than do persons with higher incomes.)
Advocates of a VAT argue it would encourage investment and improve the U.S. trade balance, while its basic regressivity can be offset by exempting some types of goods and substituting VAT for other regressive taxes. Even its proponents acknowlege a VAT would increase prices, however.
But Miller declared, "The responsiveness of saving the more favoravle taxation is an unsettled issue. If one concludes that savings will rise in response to reduced taxation, then substituting a value added tax for the corporate income tax should encourage saving."
But even if that occurred, Miller went on, it alone would not be enough to produce added investment This substitution leads to more investment only if any increase in savings gets channeled into domestic financial markets, leading to lower interest rates and therefore the cost of capital, and then to more business investment in the U.S.
"In contrast income tax, neither the Social Security tax nor a value added tax applies directly to the return from saving," Miller continued. "Consequently, substituting a value added tax for the Social Security tax would be unlikely to affect savings decisions.
"A value added tax, by itself, will probably increase prices, since the tendency for business to pass the tax on to consumers is unlikely to be offset by an unduly restrictive monetary policy.
"The important question, then, is whether the inflationary impact of the value added tax would be offset by reductions in other taxes," Miller said. Cutting the corporate income tax would have little effect on prices, and cutting the Social Security tax would by no means offset all of the price impact of a VAT, he stated.
VAT proponents believe its use would imporve the trade balance because the tax would be rebated on good that are exported, making their export price lower than their domestic price.
But Miller challenged this argument by noting that if a VAT of 5 percent were imposed and the corporate tax rate cut, prices of goods sold in the U.S. would go up by that amount and the price of exports would be unchanged. If the price of exports did not change, they would be no more attractive to foreign buyers than they are now, he said. And since the VAT would be levied on imports, their prices would be rise at the same rate as those of domestic goods and therefore would remain just as attractive to U.S. buyers as before.
"There, might, of course, be a positive trade impact in the long run if the substitution led to an improved investment climate, enhanced capital formation and a more productive and competitive U.S. economy," Miller acknowledged.
But Miller's strongest criticism relate to the regressive nature of a VAT. "The combination of the current income and social security taxes is progressive, while a value added tax, even with necessities excluded, is regressive," he declared.
At present, families with incomes of less than $5,000 pay, on the average, only 2 percent of that income in income and Social Security taxes. If a $100 billion VAT with no exclusions were substituted for $100 billion worth of those two taxes, families in that income bracket would pay 17 percent in taxes, Miller said.
Excluding necessities and providing for income tax rebates would mitigate, but not reverse, this effect, he said.
Collecting a VAT would be a major new burden for the Internal Revenue Service, Miller said . It probably would increase by 30 percent the number of returns IRS would have to handle each year, he said.
Ullman conceded little to Miller during the hearing, telling Treasury Secretary he had failed to address the "productivity crisis" in the U.S. "The only reason I am proposing a value added tax," Ullman said, is because of the "productivity and inflation crises" in this country.
Miller questioned whether a VAT would provide a solution to either.