Barro and the Bipartisan Argument for the VAT tax

One of the most interesting parts of Getting it Right was Barro's discussion of "Retroactivity and Other Capital Levies" (pgs. 123-126). In this section, he argues that the federal income tax is an inefficient raiser of revenue for several reasons. This was a surprising revelation to me. 

The best way to raise revenue from the income tax, Barro argues, is to increase rates across the board or tax labor income or consumption at a flat rate with no deductions.  Indeed, Barro notes that relative to the income tax, the simple social security tax on wage earnings has had much more success in generating higher revenues at higher tax rates. Since mid-1991, the federal government "gotten more from social insurance receipts than from the entire individual income tax."And if the U.S. government implemented a value added tax (VAT), it would raise revenue much more efficiently. 

So why not implement a VAT system? The most astute point here was actually the one Barro attributes to Larry Summers:

"Republicans are against VAT because it is a money machine, and the Democrats are against VAT because they think it is regressive. The VAT will be enacted, he went on to say, when the Democrats realize that it is a money machine and the Republicans realize that it is regressive."

I didn't quite agree with this almost tongue-in-cheek insight. Even if Democrats realize it is a money machine, they will still know it is regressive; even if Republicans realize it is regressive, they will still know it is a money machine (and might thus increase government spending). What is necessary is a way to convince Republicans that the VAT being a money machine is actually a good thing and convince Democrats that it is not actually regressive. Fortunately, such a way exists. 

The Case for Republican Support
Republicans might reconsider the VAT tax if it is framed as a partial solution to America's long-term debt problems, and a more economically efficient form of taxation. The VAT would not unilaterally solve the country's fiscal problems, but it would help. A 10 percent VAT with a relatively broad base could raise $750 billion a year, enough to pay for about a fifth of the federal budget. This would make room for cuts in other taxes. Moreover, VAT taxes have a broad base and they don’t discourage investment (unlike capital gains taxes). They can raise a lot of money without causing nearly as much economic damage as income taxes. And they are much harder to evade than sales taxes.

The Case for Democratic Support
While the VAT is extremely regressive with respect to current income, it is only moderately regressive  with respect to life time income. That was the conclusion of a study published in the National Tax Journal. Here is the basic gist of the study:

"Over the life  cycle, a VAT  looks  substantially  less regressive  than  when  viewed  in  the  context  of  a single  year.  In contrast, when  current  consumption  is  used  as a  proxy  for  life-time  income,  the  tax  is by  definition  proportional.  When food, housing,  and medical  expenditures  are  zero  rated,  the VAT  looks  somewhat  less regressive  in the  lifetime  income  analysis.  If current consumption is used to  measure  economic  welfare,  the  VAT  now  looks mildly  progressive."

That substantially undermines the Democratic argument against the VAT tax. But what if Bernie Sanders and his crew (if he has one) say "No, even a mildly regressive tax system is unacceptable." Well, then, I would highlight the myriad ways to make the VAT tax even less regressive.

A recent book, written by tax experts Bob Carroll and Alan Viard and published by the American Enterprise Institute, proposes such a progressive VAT tax called an “X Tax.” Surprisingly, the AEI publication actually takes fairness/equity concerns very seriously. It also cites President Bush’s tax reform panel, which concluded that a very comprehensive X Tax could mimic the distribution of tax burdens under the current income tax with rates ranging from 15 to 35 percent.

Such a proposal, it seems to me, would be just as equitable and more efficient than the current income tax system. It would be an example of what Alan Blinder calls “hard-headed, soft-hearted” tax policy. And it would merit bipartisan support.

Sources:
http://ntj.tax.org/wwtax/ntjrec.nsf/9774429EBFAD6E118525686C00686E27/$FILE/v47n4731.pdf
http://www.amazon.com/Progressive-Consumption-Taxation-X-Tax-Revisited/dp/0844743941