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Why the US Should Introduce VAT and Carbon Taxes

Economists of every stripe agree a consumption tax has fewer negative effects than an income tax.

Economists of pretty much every stripe will agree that a consumption tax has fewer negative effects than an income tax does. That’s because incentives matter.

If you want more of something, then tax it less; if you want less of something, tax it more. It’s about that simple.

If you want more income and jobs, tax them less. So if you can substitute a consumption tax for an income tax(even if the two generate the same revenue), the incentive structure you create is superior under the consumption tax regime.

If we want to avoid a recession and really boost the economy and jobs, then we need to get “medieval” on income taxes. Don’t take a scalpel to them. Bring out the axes and chainsaws.

Why “A Better Way” Won’t Work

The House GOP’s “A Better Way” proposal creates a border adjustment tax in order to reduce income taxes. The problem is that the reductions, while significant, still just amount to tinkering around the edges. I wrote extensively about the BAT in Part Two of my series on tax reform in Thoughts from the Frontline.

The top rate is still 33%, although the pass-through business tax rate is reduced to 25%, which starts to become a significant tax cut for small businesses.

And while that will help, I don’t think it is the jumpstart to the economy that they think it will be. Ways and Means Chairman Brady was bold enough to introduce the concept of a consumption tax. So, with consumption taxes on the table, let’s look at alternatives: The Value-added Tax, and the Carbon Tax

The Time-Tested Value-Added Tax (VAT)

The value-added tax, or VAT, is a great deal more difficult to avoid paying by going to the black market.

Most of the world uses a VAT as a main tax system, including our large, industrialized peers. A VAT is not a great deal more complicated than the sales tax that many states now impose.

The difference is that it applies at every level of production, not just to final consumers. It is a well-tested option and generates abundant revenue with minimal side effects. The VAT is a system that the rest of the world developed at their own risk. In other words, they worked out the bugs, yielding a proven, well-defined methodology that the US can easily adapt with very predictable results.

The other thing about a VAT is that you can take it off at the border for exports. That gives it the same positive feature that the BAT has, just without picking winners and losers. Every business is treated the same in terms of the corporate tax they pay. It just makes us far more competitive as an exporting powerhouse, which translates into jobs.

You want real tax heresy?

A Carbon Tax

Why would I propose such a radical thing? Let me hasten to assure you that I think the carbon tax would have absolutely no effect on climate change. But it would be an excellent form of consumption tax.

And would it reduce the use of petroleum products over time? Sure. Would it result in a somewhat cleaner environment? Absolutely, and I’m all for that.

But essentially, a carbon tax is just another form of a consumption tax.

A $15 per ton of CO2 tax should generate about $80 billion per year of revenue. Raise it by $10–$12 per year and after 10 years you’re generating roughly $400 billion in revenue.

The first level adds about $0.13 to a gallon of gas. In my SUV that’s not inconsiderable on an annual basis, but the Europeans have shown us that they can live with 15 times the taxes on gas that we live with.

In Germany, they pay about $5 per gallon just in taxes (give or take).

Consumption Taxes Are Probably the Only Way Out

The point is that a combination of consumption taxes could allow a radical reduction in—or even the elimination of—income taxes and a far lower corporate income tax.

That would give a real boost overall to the economy. Of course, every combination requires trade-offs, but that’s what makes the approach possible and workable.

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