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Dipping into the VAT

The national debt, for the moment, is at its highest level since the close of WWII.  Now equal to 84% of the gross national product, it jeopardizes the federal treasury's AAA Moody's rating.  Fed chairman Ben Bernanke sums up the thinking of many in saying that "the nation will ultimately have choose among higher taxes, modifications to entitlement programs such as Social Security and Medicare, less spending on everything else from education to defense, or some combination of the above."

Social Security, Medicare, and Medicaid alone account for about half of the government's noninterest spending.  If tax revenues continue to equal 18%-19% of gross domestic product while government spending constitutes 25% of GDP, within the lifetime of many people the government will have to borrow just to pay interest on the national debt's interest!

Hence the revived interest in a value-added tax (VAT).  (Bill Thomas, the Republican chairman of the House Ways and Means Committee, flirted with this idea in 2005.)  Used by more than one hundred countries. the VAT is a consumption tax, a tax on both goods and services that is collected at every step along the production and distribution chain.  (Here's how a toaster would be taxed.)  Thus the VAT differs from a sales tax, which is collected by only the product or service retailer.  Like the sales tax, however, ultimately the VAT ends up being paid by the consumer.

Unlike an income tax, the VAT does not discourage saving.  This link plainly explains why the VAT is efficient, broadbased, and self-enforcing.  The VAT, however, has the rare capability of alienating both conservatives and liberals.  Conservatives see the VAT as a money machine, promoting Big Government and Big Spending.  Liberals, on the other hand, deplore the VAT's regressive nature; the VAT raises revenue on the backs of the poor, who spend a larger share of their income as consumers.

One path toward fiscal sanity and sustainability might be to combine the carrot (a greatly simplified income tax code with lowered tax rates and a broader tax base--but without the credits, exemptions, deductions, shelters, etc.) and the stick (a comprehensive VAT).

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