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The Value-Added Tax, or VAT, is a horrible idea. I'm surprised Becker favors it. Here's an interesting article on the VAT by Murray Rothbard, which originally appeared in The Freeman during the Nixon administration (1972), which was considering a limited form of the VAT: http://mises.org/daily/4 2 9 6 "The VAT is essentially a national sales tax, levied in proportion to the goods and services produced and sold. But its delightful concealment comes from the fact that the VAT is levied at each step of the way in the production process: on farmer, manufacturer, jobber and wholesaler, and only slightly on the retailer. The difference is that when a consumer pays a 7 percent sales tax on every purchase, his indignation rises and he points the finger of resentment at the politicians in charge of government; but if the 7 percent tax is hidden and paid by every firm rather than just at retail, the inevitably higher prices will be charged, not to the government where it belongs, but to grasping businessmen and avaricious trade unions. While consumers, businessmen, and unions all blame each other for inflation like Kilkenny cats, Papa government is able to preserve its lofty moral purity, and to join in denouncing all of these groups for "causing inflation." It is now easy to see the enthusiasm of the federal government and its economic advisers for the new scheme for a VAT. It allows the government to extract many more funds from the public — to bring about higher prices, lower production, and lower incomes — and yet totally escape the blame, which can easily be loaded on business, unions, or the consumer as the particular administration sees fit." Some points made by Rothbard in this article: 1. Like the sales tax, the VAT is regressive, falling mainly on the poor and the middle-class. To alleviate this burden, no doubt some form of "rebate" -- to the poor, to be paid mainly by the middle-class -- would be instituted. Thus, the VAT would probably require (i.e., politically) yet more income redistribution, and possibly be one step closer to a policy of guaranteed minimum income. 2. Proponents of the VAT argue that it taxes producers in proportion to the value they add to the product at each step along the production process. In theory, if Corporation A adds $1,000 value to a widget, and Corporation B adds $1,000 to that widget in a subsequent step in producing it, and if the VAT, for example, were 10%, Corporation A would pay $100 to Uncle Sam and Corporation B would also pay $100 to Uncle Sam. But this ignores the fact that each has to absorb administration costs for tracking and collection involved in the VAT, leading to incentives for vertical mergers. The effect of a VAT would be to disincentivize small businesses and startups, and to incentivize vertical mergers into large conglomerates --- all of which would become yet more fodder for antitrust suits. 3. At the time of writing (1972) Rothboard points out a problem with the VAT in Europe: "In the VAT, every firm sends its invoices to the federal government, and gets credit for the VAT embodied in its invoices for the goods bought from other firms. The result is an irresistible opening for cheating, and in Western Europe there are special firms whose business is to write out fake invoices which can reduce the tax liabilities of their "customer." Those businesses more willing to cheat will then be favored in the competitive struggle of the market." 4. While higher costs of production will undoubtedly be passed on to consumers who will then pay higher prices, there are 2 additional effects of a VAT mentioned in the article: (i) a large, short-run reduction in business profits; (ii) a long-run fall in wage incomes. Re profits: The reduction in business profits will take place during a time of recession when profits are already reduced, or when many businesses actually incur losses; these businesses will be severely affected by a VAT. Also, innovative startups, which usually have low profits, will be severely affected, too. Re wages: unemployment is already high during a recession. Firms can deduct the VAT from their own tax liability, but they cannot do so if they hire more workers; thus, there will be an incentive for "over-mechanization" and a firing of workers. The long-run effect of this will be to lower the demand for wage-incomes, and since union practices and minimum-wage laws would no doubt still apply, there would be higher unemployment. In sum, with a VAT we could probably expect to see: (i) higher consumer prices, (ii) lower demand for wage-incomes therefore a lower wage rate in general, (iii) short-run reduction in business profits, (iv) tendency for more firms to vertically integrate therefore less competition especially from small, innovative firms (that might be one reason big firms are often in favor of a VAT), (v) the move to vertical integration would spur yet more pointless antitrust suits, (vi) incentives to over-mechanize and fire more workers hence higher unemployment. Rothbard quotes one of Parkson's Laws of bureaucracy: "for government, expenditure rises to meet income." If classical liberals, libertarians, and fiscal conservatives wish to shrink the size and scope of government, implementing a VAT is the exact opposite of what they should do.
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Sep 4, 2011