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Tony Fratto: Going to Bat for the VAT

Monday, 17 May 2010 | 11:56 AM ET


The value-added tax has been knocked around more than baseballs this spring.

President Clinton, in his CNBC interview with Maria Bartiromoon Friday, was the latest to advocate the benefits of a VAT by noting it would “make us much more competitive with our exports.” Former FED Chairman Paul Volcker and current Speaker Nancy Pelosi have also weighed in.

The VAT has been attacked by both the Left and the Right, and I’m sure I’ll hear howls of protest from both sides, but the time for a VAT in the U.S. is coming.

Liberals see the VAT as regressive, arguing that it would disproportionately impact lower income groups who spend a relatively larger portion of their disposable income on consumption. Conservatives argue a VAT on top of the current tax system would merely raise more revenue to fund an ever-expanding federal government. They also argue that the tax is so efficient that nominally tiny increases in the rate of the VAT would result in huge revenue increases for federal coffers.

Bill
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Bill

There’s something to each of criticisms, but all fail to persuade me that a VAT isn’t desirable. And if we’re serious about reforming what is clearly a broken tax system, we need a VAT sooner rather than later.

The United States has the most impressive voluntary tax collection system in the world, but it’s also the most inefficient – and for a large, mature economy that inefficiency is a drag on productivity growth, limiting increases in our standard of living.

The economic argument for a VAT is unassailable. It is an extremely efficient tax collection tool, that virtually eliminates tax evasion, and – if coupled with an elimination of corporate taxes – would make U.S. firms more competitive globally.

The political case is trickier.

Most advocates of a VAT argue it’s needed to increase revenue since we’ve apparently maxed out on the political will to cut spending and exempted most Americans from paying any income taxes, all while making huge and unsustainable claims on future revenues – including the costs of President Obama’s expensive new health care entitlements.

Not only is that a losing argument with a public that wants to see spending cuts, it’s an inappropriate response to how government should operate. The size of government should not be a function of how much we can squeeze from taxpayers. It should be based on the appropriate role of government in American society, with our own unique characteristics and goals. In the U.S. we generally believe in a minimal role for government, with a bias toward the private sector and individual responsibility -- not a role equal to our maximum ability to tax. How we then choose to pay for an appropriate size and role of government is – and should be – a separate question.

Liberals who bemoan the regressive nature of the VAT as well as Conservative advocates of a pure flat tax need to accept two core principals shared by the overwhelming majority of Americans: first, most people should at least pay some taxes; and second, the wealthy should pay some more.

As it is, about half of Americans pay no income tax, and higher income households are assuming an ever increasing share of the overall tax burden. Conservatives will need to accept some progressivity in our tax system while liberals will need to accept a more broadly applied revenue collection system to fund government.

A VAT should not be seen as a magic, cost-free source of new revenue, or simply layered upon our current inefficient system. It shouldn’t be about deficit reduction or revenue increases. Again, those are entirely separate questions. But as an efficient replacement tax, it’s time for the VAT.

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Tony Fratto, a CNBC contributor, is Managing Director of Hamilton Place Strategies – a strategic economic policy and communications firm based in Washington, DC. He is a former White House Deputy Press Secretary for the George W. Bush Administration and Assistant Secretary of the Treasury. You can follow him on Twitter at http://twitter.com/TonyFratto.

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