Why a VAT Tax Is Where It's At

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"French for Big Government"

To be sure, a VAT has never gained much traction in the U.S. Many liberals oppose it because they believe it falls heaviest on the poor and elderly. Many conservatives dislike it because it's a new tax—and an efficient one. "The greater (but often unspoken) fear of many conservatives is that a VAT would be too efficient a revenue-raiser," writes Joel Slemrod, tax economist at the Stephen M. Ross School of Business at the University of Michigan. A number of conservatives worry that an efficient VAT might allow government to get even bigger. Perhaps Grover Norquist, the longtime tax opponent at the conservative lobbying group Americans for Tax Reform, put the opposition best. "VAT," he said, "is French for big government."

Yet it's the very efficiency of the VAT that makes it attractive for taking a large step toward meeting America's future obligations. The VAT works best as a supplement to the income tax. Indeed, President Bush's bipartisan White House commission on tax reform in the middle of the decade did consider the option. Businesses would pay tax on the difference between their sales receipts and the cost of their inputs purchased from other businesses. The VAT would be joined with a greatly simplified income tax system.

It's an idea worth reviving. No one really defends the current income tax system anymore. It's far too complicated, with all kinds of loopholes and special interest favors, from various tax-sheltered retirement savings plans to multiple tax deductions and credits for home ownership to separate tax treatment for asset sales. Worse yet, arbitrary phase-outs of various levies, such as the estate tax, needlessly complicate the tax code and add to a widespread sense that it's fundamentally unfair. Congress and the Administration could reward taxpayers with serious tax simplification. They could lower income tax rates greatly by broadening the tax base through eliminating as many credits and deductions and shelters as are politically practical. The highly efficient VAT would then supplement the income tax to restore long-term fiscal discipline.

Melding Einstein With Emerson

The University of Michigan's Slemrod wonderfully opened an essay on tax reform by quoting Ralph Waldo Emerson: "We ascribe beauty to that which is simple; which has no superfluous parts; which exactly answers its end." He ended the discussion with Albert Einstein's legendary admonition that "everything should be made as simple as possible, but not simpler." Taxation involves contentious issues of ethics, values, efficiency, and social goals, Slemrod says. Pure simplicity is possible only on paper, not in the real world.

But much can be done with the tax code, keeping Einstein's caution in mind but moving closer to Emerson's standard of beauty. Simplify the tax code and embrace the VAT. Together, the actions would show that the American democracy can run a sound fiscal policy. Investors around the world could continue to sleep soundly, knowing their money is safe in U.S. Treasuries.

Farrell is contributing economics editor for BusinessWeek. You can also hear him on American Public Media's nationally syndicated finance program, Marketplace Money, as well as on public radio's business program Marketplace. His Sound Money column appears on BusinessWeek.com.

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