Value Added Tax
What exactly is a Consumption Tax?
First, I should explain how a consumption tax works. It is a voluntary tax that requires no end of year reporting on income. Instead, the tax is levied, much like a national sales tax on consumable goods.
This sort of tax benefits manufacturing at least on the surface. The tax will essentially act as an additional cost for the goods they are trying to sell. The flaw in this thinking is almost too simple to state. These businesses would have raised prices if they thought the consumer would buy them. The inflationary effect of higher prices, even with the elimination of income taxes would not offset each other equally.
Nay sayers are quick to point out the gap between what the government now receives in income tax and the cost of the goods with taxes included would be wide enough to create a lucrative black market.
Supporters of such a tax plan point out that dividends and savings would be free of the long reach of IRS. And that is true but the IRS should never of had a hand in that particular pocket in the first place. As I explain below, this is of greater benefit to the wealthy but every tax payer would benefit in some way if this was the only reform enacted.
States would be faced with the problem of converting to some sort of similar program in lieu of their current revenue gathering methods. States that currently have sales taxes instead of income taxes would find themselves wondering if the newer, higher prices in the marketplace as a result of the federal effort would create a paradox. Often cited as a negative, consumption tax may discourage consumption at exactly the same rate that it fails to raise revenue. Predicting the outcome of that problem would be harder for many states than their current budget balancing efforts.
Taxes are admittedly too complicated and too easily evaded by the lawyers that Mr. Bush talks so much about - the ones who aid the wealthy in their quest to keep even more of what they earn. With a consumption tax, Republicans believe that dilemma will be solved . It may be called many things from a flat tax to a sales tax, but at the core of the suggestion is a tax based on consumption.
Edward J. McCaffery published a book several years back attempting to explain the virtues of just such a system. Fair Not Flat: How to make the Tax System Better and Simpler was not the first workable portrayal of a reformed tax code. Unfortunately though, it is also an inherently flawed attempt at appeasing both sides of the argument. Republicans want savings and investment to be free from taxation. Democrats want the code to be fair which means progressive.
Even with McCaffery's suggestion in his book, the complications are many and complex. Progressive consumption tax as yet to be outlined by the administration would likely include a flat sales tax and a graduated supplemental tax. To make value added taxation (VAT) a workable solution, exemptions would be made for a level of income, perhaps the cut-off point for the Census Bureau's poverty level. This would allow for the taxation of everything beyond those expenditures at a flat national sales rate.
Higher income earners would find their rates accelerating much faster as they spend more. The author also points out that the removal of savings and investment deductions makes income subject to consumption tax. The hope is in the creation of Trust Accounts to hold this previously taxable income and keep it until it is needed. Only then, would it be taxed as income.
Dating back to 1921, the first time consumption taxation was introduced, Republicans were trying to place the burden of taxation on the consumer not the industries that create jobs. Twice again it would be attempted, dissected for flaws and rejected with the most recent attempt in 1995. Mr. Bush's plan is clearly looking for angels in the abstractions rather than the devil in the details.
The truly wealthy would still be able to avoid a good deal of tax through greater savings incentives and the ability to borrow from those savings, not only tax free but interest free as well. This would be significant shift with a return to monetary power akin to nothing this country has seen since the days of the Revolution.
The President's attempt at shifting to consumption tax as a way to keep the wealthy from legally dodging taxes is misplaced. The change to VAT would instead create more wealth in a group that was recently reported to be controlling two thirds of the cash and three quarters of the investments.
With only 33% of a wage earners income in excess of $200,000 spent on consumption, the lion's share of that taxes would be shifted to those least likely to afford it. Currently, on an income of $30,000, 93% of that money is spent and under the Bush tax plan, would be taxed.
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