Value-added apostates.

Photographer: Drew Angerer/Getty Images News

Republicans Learn to Love VAT

Ramesh Ponnuru is a Bloomberg View columnist. He is a senior editor of National Review and the author of “The Party of Death: The Democrats, the Media, the Courts, and the Disregard for Human Life.”
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For conservatives, the phrase "value-added tax" once amounted to fighting words. Grover Norquist, the head of Americans for Tax Reform, warned other conservatives in 2010, "Don't give Obama a VAT." Such a tax, he argued, would be "an extremely efficient money machine for big government."

Because VATs embed taxes in the price of goods, he said, they're typically hidden from taxpayers and thus easy to raise. Adopting one would bring the U.S. closer to the social-democratic states of Europe. Norquist was sufficiently worried about that threat that he organized an anti-VAT caucus in the House.

But now a VAT is back on the agenda, and not thanks to Bernie Sanders or some other fan of Scandinavian socialism. The tax is integral to the economic plans of two presidential candidates who want a smaller federal government: Senators Ted Cruz and Rand Paul. Their surprising support for a VAT shows its appeal, its flaws and its complicated politics.

Perhaps because the concept has been controversial among Republicans, or perhaps just because it's not a commonly understood term, both senators avoid using the phrase "value-added tax." Paul talks about a 14.5 percent "business activity tax," and Cruz about a 16 percent "business flat tax."

In both cases, businesses would be taxed on their gross receipts minus their purchases and capital investments. That differs from today's corporate taxes in two crucial respects: All investments would be written off immediately under these plans, and businesses wouldn't be able to deduct wages. That's what makes these taxes VATs.

One way of looking at the VAT is as a tax on wages that's collected from companies before they pay their workers. But wage-earners would come out a bit ahead in both these plans because the new VAT would replace the payroll tax as well as the old corporate-income tax.

Relying heavily on VATs allows European governments to have corporate tax rates that are lower than the U.S. and capital taxes that are competitive with ours while still collecting more revenue (as a percentage of total economic output). Compared with those other taxes, VATs don't fall as heavily on investment -- which makes them a lot more efficient.

And that's why they're increasingly attractive to Republican tax reformers. The Tax Foundation, a conservative group, has estimated the impact of the Republican presidential candidates' various tax plans on government revenue and economic growth. Compared with the rest of the field, the Cruz and Paul plans come out looking pretty good on both counts. Both are said to raise growth by 13 percent or so, which is more than the non-VAT plans offered by Donald Trump and Jeb Bush would do.

The VAT plans are also less of a drain on government revenue. Trump's plan, even counting the effects of higher growth, is said to lose $10 trillion in revenue; Bush's plan would lose $1.6 trillion. Cruz's, by contrast, would lose $800 billion, and Paul's would actually raise $797 billion. To the extent all these plans aim to stimulate growth, Cruz and Paul offer a bigger bang for the buck. 

These rosy estimates are a function of the foundation's view that taxes on investment are highly distortionary. Replacing corporate taxes with VATs reduces those distortions, thus boosting growth while still bringing in a lot of revenue.

The flip side of those estimates is that VAT-centered reforms don't do much to cut taxes directly for average wage earners. The Cruz and Paul plans resemble those of other Republicans in cutting rich people's tax bills a lot, but they offer less for the middle class. Taxpayers in the 40th through 50th percentile of filers, making between $29,000 and $35,000 a year, get a 1.2 percent increase in after-tax income from Cruz's plan. Bush's plan gives them a 2.7 percent boost and Trump's 5.3 percent. (All of this, again, is from the Tax Foundation.) Swapping the payroll tax for the VAT doesn't net people much money. Any additional gain is indirect, from the added growth the reform may cause. 

Conservatives aren't as concerned about the Cruz and Paul VATs as they would be with plans that were added on top of the current system. But there is some worry. Norquist tells me he thinks it would be better to let companies write off the cost of both investments and wages, which would make such plans easier to explain and defend. Lawrence Kudlow, the influential supply-side economist, says he likes a lot of the components of the senators' plans but resists this part: "The inclusion of a VAT troubles me. Have we thought this through?"

Value-added taxes pose a trade-off: They make taxes more efficient but less visible. Conservatives have long wanted taxes to be easy to comprehend and thus to resist. Ronald Reagan went so far as to say that he thinks "taxes should hurt." Cruz and Paul, in passing over their VATs in silence and omitting any mention of the way their "business" taxes would affect workers and consumers, are merely accentuating the attractive side of their plans. But they're also lending credence to the old worry that tax burdens can indeed be hidden. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Ramesh Ponnuru at rponnuru@bloomberg.net

To contact the editor responsible for this story:
Timothy Lavin at tlavin1@bloomberg.net