Don’t laugh, but Ted Cruz and Rand Paul have a really compelling tax proposal.
So why won’t they own up to it?
For context, these two Republican presidential candidates have backed some completely bonkers economic ideas during the campaign. Both want to eliminate the Internal Revenue Service, even though doing so would leave no one to collect tax revenue. And both want to return to the gold standard, which means our money supply would be determined not by the coolheaded economic experts at the Federal Reserve but rather by, say, China. (China is the world’s No. 1 producer of gold; Russia is No. 3.)
Still, buried among such monetary meshugas is an interesting, serious and provocative idea: a value-added tax.
A value-added tax, or VAT, is a tax on consumption. It’s sort of like a sales tax. But rather than being collected only when a product is sold to a consumer, the tax is paid at each stage of the production process based on how much “value” a business has added to that product — for example, by spinning cotton into cloth, or sewing that cloth into a T-shirt.
Even though the tax is collected at various stages of production, economists believe it is generally borne more by consumers than businesses. Companies pass on the cost of the tax in higher prices down the production chain, keeping their profit margins roughly unchanged.
More than 160 countries, including every developed country except the United States, has some form of VAT. The VAT is also one of the first proposals out of the International Monetary Fund’s bag of tricks for countries that need to raise money.
That’s because it’s a really, really useful tool.
Unlike an income tax, it doesn’t discourage saving or working; it’s efficient and broad-based; and, at least most of the time, it’s harder to evade than income taxes because it can be designed with a clever self-enforcement mechanism.
In most countries that have value-added taxes, businesses get a credit for the taxes that previous companies in the supply chain have already paid. This means companies pressure their suppliers to pay the tax, too — effectively allowing the government to outsource some of the expensive enforcement of tax collection.
The main downside of a VAT is that it hurts the poor more than the rich, because the poor spend a larger share of their incomes on basic necessities.
There’s an easy way to counteract that problem, though: Just make the income tax system more progressive. What matters is the progressivity of the entire system, rather than any one component. Unfortunately, both Paul and Cruz want to make the personal income tax less progressive, too.
The United States has flirted with a federal VAT for centuries. In recent years, policymakers of all political persuasions, including Paul Ryan, Nancy Pelosi, Alan Greenspan and Paul Volcker, have expressed interest in creating one. Sen. Ben Cardin (D-Md.) even introduced legislation that would create a “progressive” VAT.
Strangely, though, neither of the presidential campaign’s VAT champions wants to openly call his plan a “value-added tax.”
Cruz euphemizes his as a “business flat tax”; Paul dubs his a “business-activity tax.” These rebrandings are probably intended to make their proposals sound more like business income taxes — which both candidates would entirely repeal — even though consumption taxes and business income taxes target different things.
After all, for all their pluses, VATs come with peculiar politics. Already , conservative commentators have denounced these candidates’ “hidden,” “European-style” VATs because they might make it too easy to raise revenue — and thereby increase the size of government.
This fear that VATs might work a little too well has a long history. Back in 1988, economist Lawrence Summers quipped that we don’t have a VAT because liberals think it’s regressive and conservatives think it’s a money machine. We’ll get one, he said, when they reverse their positions.
Such ingrained suspicions of VATs might be one reason Cruz and Paul didn’t design their VATs particularly well. Perhaps to make them look more like corporate income taxes, both forgo the clever self-enforcement mechanism I mentioned earlier — which seems shortsighted, since partly outsourcing tax collection to companies could actually help justify their efforts to gut the IRS.
But despite their proposals’ shortcomings, it’s good these candidates have given voice to The Tax That Dare Not Speak Its Name. There’s only so much revenue a country can wring out of an income tax system, particularly one as Swiss-cheesed as ours. A well-designed VAT could help get our fiscal house in order.