StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between



The Wall Street Journal Publishes Erroneous and Dubious Anti-VAT Arguments

17 Oct 2009
Posted by Bruce Bartlett

The other day the Wall Street Journal editorial page ran an article by Ernest S. Christian and Gary A. Robbins attacking the idea of a value-added tax for the United States. This is the second anti-VAT op-ed the Journal has run this year on top of two highly negative editorials. Only one piece has appeared favorable to the VAT and that was written by former Clinton administration Treasury official Roger Altman. Apparently, it's okay for Democrats to get space in the Journal to promote the VAT because it allows the editorial page to maintain the fiction that only liberals favor such a tax as part of their nefarious plan to eventually tax 100% of everything. When I've queried the Journal about an article on why conservatives ought to support a VAT I did not get a reply.

Griping about rejected article ideas is not my point. I would rather look more deeply at the arguments used by those the Journal does publish on the subject of a VAT. Two things about the Christian-Robbins piece jumped out at me.

First, they make this extraordinary argument: "Modern economists in the US take the view that consumers bear only about 50% of the VAT, basically through higher prices and fewer product choices. Because of market forces, the rest of the tax ends up back on the owners and the employees of the companies that produce and sell the goods and services subject to the VAT."

The reason it is extraordinary is because the universal view of economists has always been that 100% of a VAT is shifted onto consumers. That's what makes it a consumption tax and not a tax on capital, which is the main problem with income taxes. Reflecting the conventional wisdom among economists, a recent Congressional Research Service report put it this way, "In estimating a VAT's revenue yield, economists and public officials use the operating assumption that a VAT would be fully shifted to final consumers in the form of higher prices of goods."

I searched through the various VAT books and public finance textbooks in my library, as well as searching the Internet for academic research showing that 50% of a VAT is borne by producers, and couldn't find anything supporting this argument. Just to be on the safe side, I e-mailed some experts to see if they were aware of any reputable research making such an argument. Harvard economics professor Greg Mankiw, Stanford University economics professor Charles McLure Jr., Syracuse University economics professor Len Burman, and Tax Policy Center director Roseanne Altshuler all told me that they were unfamiliar with any such research.

If it is true that only half of a VAT is passed through to consumers then we would observe in cases where a VAT is introduced or increased that the prices for affected goods and services would rise by only half the amount of the VAT rate. In fact, we do not see this at all. Experience shows that prices do in fact rise by the amount of the VAT, exactly as one would expect under the generally-held assumption that consumers bear all the tax and that monetary authorities accommodate a one-time increase in the price level. (Of course, there are cases where prices didn't rise by the amount of the VAT because it replaced other taxes already incorporated into prices, but when this is accounted for the effect of the VAT on the price level is the same as everywhere else.)

At a minimum, the Christian-Robbins view of the incidence of the VAT is eccentric and not one that can simply be asserted as if it is the conventional wisdom among economists. This wouldn't matter so much if the point were made in a professional economists' forum, but appearing in a publication primarily read by non-economists the assertion that "modern economists" hold a view that none except Robbins appear to hold is liable to make some people assume that something which is generally considered by economists to be untrue is true. (Mr. Christian is a tax lawyer.)

In the past, corporate executives have been among the VAT's biggest supporters. They especially like its border adjustability. If a VAT replaced some tax that cannot be rebated at the border, such as the corporate income tax, a VAT would greatly improve their competitiveness. But corporations will certainly think twice about supporting a VAT if they believe that they will bear much of its burden. Indeed, if a VAT is in fact not fully shifted onto consumers then the whole rationale for border adjustability falls apart. It is only because world trade law assumes that the burden falls entirely on consumers that permits the VAT to be rebated at the border while corporate income taxes may not. (Although some portion of the corporate tax is incorporated into prices, there is no agreement among economists on what that is. Estimates vary widely.)

I assume that undermining support for a VAT among corporate executives is the principal reason why Christian and Robbins made their assertion in a forum heavily read by such people. If they had attempted to make it in a peer-reviewed academic journal it undoubtedly would have been rejected absent a vast amount of supporting data, analysis and econometrics proving the point. Indeed, if true, such an argument would be so novel that it would be considered an extremely important theoretical breakthrough that would call into question the justification for border-adjustability and force massive changes in world trade law and practice.

But this is not the only problem I had with the Christian-Robbins article. Later on they argue against a VAT on the grounds that it raises too much revenue. According to them, a rate of 17% to 18% -- about average for Europe -- would increase federal revenues from 15% of GDP to 30% of GDP. In other words, they are saying that a VAT would tax between 83% and 88% of GDP; that's what would be required to get revenue equal to 15% of GDP from a tax rate of 17% or 18%.

Again, this is an absolutely extraordinary assertion that is passed off as if it is common knowledge. The Congressional Budget Office is given as the source of this estimate.

I searched in vain on the CBO web site for anything that came close to showing a potential VAT tax base of 80% to 90% of GDP. In fact, every CBO estimate I could find showed nothing of the kind. Various CBO publications consistently estimated the maximum tax base for a VAT as 70% of GDP. But a more reasonable tax base that didn't attempt to tax things like the implicit rent homeowners pay to themselves, medical care, religious and welfare activities and other items that are both hard to tax administratively and impossible to tax politically reduce the potential tax base to about a third of GDP.

This is consistent with the experience in countries with VATs. I calculated the VAT tax base for countries comparable to the US and found that these were the percentages of GDP covered by the VAT: Germany, 29.5%; Italy, 30.2%; Canada, 32.8%; France, 37.1%; and the UK, 37.2%. The average for these countries is 33.4% and the median country is Canada. It's also the country most like the US.

Therefore, it is reasonable to assume that a third of GDP is the most that could be taxed by a US VAT. To raise 15% of GDP in revenues on such a base would require a VAT tax rate of 45%, not 17% to 18%, as Christian and Robbins erroneously assert. The highest VAT rate I am aware of anywhere is 25% in Denmark, Norway and Sweden, three countries long known for exceptionally high taxes. For reference, the rates in countries more comparable to ours are these: Canada, 5%; Australia, 10%; the UK, 18%; Germany, 19%; France, 19.6%; and Italy, 20%. I should note that these are the standard rates; almost all countries have lower rates on some things and higher rates on others.

There are certainly legitimate arguments that can be made against a VAT for the US. But in its zeal to discredit the idea for purely partisan and ideological reasons, the Wall Street Journal has published an article making erroneous and highly dubious arguments.

WSJ's integrity

When I attended Michigan State Univ. in the mid- to late-80s I took a ton of econ classes though I received my degree in Business. I loved both the profs and the topic. Most of our econ instructors required we read the WSJ daily so most students got a subscription. I've had mine since then.

One thing that became immediately evident was how totally dishonest the opinion pages of this paper were while the straight news division did some of the best reporting on the planet. While I don't think the opinion section has gotten any worse, it certainly is little more than a bully pulpit for the Republicans regardless of their positions - with a scintilla of exceptions to justify their false claim they're loyal only to their mantra "free markets, free people".

One would think that a position on the Editorial Board of the WSJ would provide easy access and in fact a serious dependence on the perspectives of leading economists to frame and sustain their arguments; instead they treat their readers to a set of mental gymnastics in logical and rhetorical fallacies necessary to defend a party who has avoided sound economic principles for many years now.


WSJ editorial antidote

The brainless propaganda of the Journal's editorial and op-ed pages forms a dramatic contrast with the Comment section of the Financial Times, to my mind the best op-ed page in the English language. The FT columnists - e.g., Rachman, Munchau, Philips, Wolf, Gapper -- almost uniformly exhibit deep (if often understated) expertise, fact- and evidence-based exposition, wide-angle perspective on large-scale trends, and theses based more on observation and analysis than ideology.


Rational thought

Since VAT is assessed at every stage of production, and if the final seller is Wal-mart or Costco (for example), it is clear that the consumer does not see 100% of the VAT. Too bad economics is light years away from being a science.


Not clear at all

Perhaps you could explain your reasoning, because it's not clear at all.

I'm hardly an expert on VAT, not living in a VAT country, but my understanding of how the VAT works is that it all gets accounted for throughout the chain of sellers and that the consumer, in the end does pay 100% of the tax. In some cases, of course, a company is the consumer and I would presume that the cost of the VAT for the stuff it consumes would count as an expense like any other expense it has during business.

VAT is no longer a novel or even unusual taxing regime and it shouldn't be too hard to figure out how it would look in a US context. Like the Health care debate, there seems to be some assumption that the US is so different from Europe that practices that work just fine over there (like universal health care and VAT) just can't work here because we are different. This is an assumption and rarely supported with fact-based arguments. Europe and Canada are hardly all that different than the US.


Re:Rational thought

This comment just shows ignorance of how VAT works and the difference between a VAT and the Sales Tax as used in the US.

At every stage of the production the seller collects full tax from the buyer, and then subtracts from it the taxes that the seller has paid, and pays the difference to the Treasury, If it is an export customer, then the tax is not collected but gets a credit as if it had.

The only way for a producer to absorb a tax is for them to be selling below the cost of the inputs.


WSJ and the VAT

VAT's disproportionately affect those who need to spend a larger part of their available capital on purchasing daily items, unless, an exemption for necessities is part of the system. Upon engaging in a contentious argument at a family party about taxes, I commented to a sympathetic relative that the opposing forces did not even wait to hear that I favored a VAT, on the condition that necessities were exempt. She said, "Exactly. Like right now, they tax diapers! Only a bunch a men would think that wasn't a necessity!"


Regressivity

The imact of a VAT on the poor is overstated because taxes are compared to one year's income. But when viewed over a lifetime consumption taxes are roughly proportional to income because consumption is roughly proportional to income.

It goes without saying that we are never going to implement a VAT without relieving the burden on the poor to some extent. But it would be far better in terms of efficiency to do so on the spending side of the budget rather than glog up the VAT with exemptions.


RE: WSJ and the VAT

I think this is a much more legitimate concern about the VAT,although hardly one that would trouble the Wall Street Journal much.

We already have many taxes that already affect those with limited means disproportionately such as Sales taxes, sin taxes and property taxes. Most of these taxes are levied at the state and local level and I think any US VAT should address this problem through some sort of revenue sharing process.


WSJ & Veracity

I'm shocked! shocked! that conservative Bartlett has just discovered the disconnect between Truth and the WSJ Opinion Page. Where HAS he been?

The WSJ under Opinion Page Editor Bartley was admittedly biased in favor of ideas that didn't have to be factually true. He admitted to being advocates of things that he and his ilk simply asserted forcefully, including, but not limited to, slander against V Foster, saying the Clintons smuggled drugs, saying that the M Lewinsky affair was the worst thing that ever happened, deifyig Ronald Reagan, and on and on. In fact, Bartley called himself "the mouthpiece of supply-side economics." If that's not damnation enough I don't know what is. Since his demise the paper's editorial strategy has not changed. It was pure sycophancy in the Bush/Cheney Years of Malfeasance & Misfeasance. A bald man will grow hair before they acknowledge their mistakes.


WSJ's Integrity

I was also required to read the WSJ in college and remained a grateful subscriber for almost thirty years, till last week. But from the beginning I found the contrast between the respect for facts in the news articles and the blithe disrespect for facts in the editorials to be incomprehensible. It really bothered me, for years. And, as others have, I eventually found the Financial Times supplied the analysis and perspective I couldn't get from the WSJ. So last week I finally let the WSJ go—I think thirty years is a fair trial—and I now rely only on the FT and the Economist. As for the VAT: accompanied by a refundable Income Tax credit for essentials it is long overdue. The US has no future now that does not include disincetivizing consumption.


Why are suppliers immune from the VAT's incidence?

Bruce, I love your writing, and I agree that the 50% number they peg as incidence is completely speculative.

However, I have to push back at your complete dismissal of their argument. Tax incidence sharing is a deeply accepted principle of public finance. I'm quite certain Mankiw's introductory Economics textbook explains how suppliers and consumers split the costs of a simple lump sum excise tax (again, it's not necessarily 50/50 -- it depends on their respective elasticities -- but they do share the cost).

My question is this: in a competitive environment, why ought a VAT be any different? Imagine a US with a 10% VAT and all the bottled water companies competing to sell 16 oz of spring water for $2. Yes, maybe at first they stubborning cling to their $2 underlying price, and consumers face a final price of $2.20. But what's to prevent one firm from lowering its price to, say, $1.90, meaning the after-tax price is now $2.09? They've eaten some cost ($0.10 per bottle to be exact) in return for a temporary price advantage, and the consumer still eats some as well ($0.09 per bottle). This being a competitive market, other firms should follow suit.

Note that the consumer still "pays" the "whole" tax at the checkout counter, but since the tax motivated the firm to set prices lower than they otherwise would have, the consumer is really only paying about half the tax compared with the counter factual world where the tax doesn't exist.

If you're arguing that Christian/Roberts are wrong in principle, then you're arguing that there's some feature of the VAT that prevents the market from adjusting in the manner I've described. What is it about the VAT in particular that make suppliers immune to its incidence?


WSJ and VAT

and yet in years gone by, the VAT was the darling of the conservative RIGHT! All through the 60's and 70's until the income tax slashing of reaguan make the superrich realize that they were better off with income taxes.

Just hypocricy, and they know it.




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