Thursday, September 2, 2010

Beat the VAT Make Large Purchases Now

By Larry M. Elkin, CPA, CFP®

The United Kingdom has one. Canada has one. So do Australia, France, Germany, Japan, Russia and Spain. But the United States does not.

The value-added tax, or VAT, is a kind of national sales tax that has become a key source of government revenue in developed nations around the world. While many Americans have never heard of the tax, the prospect of a VAT will be lurking in the background of this fall’s inevitable tax debates.

The VAT has been discussed in American academic and policymaking circles for years. In a 2008 book titled “100 Million Unnecessary Returns,” Yale law professor Michael J. Graetz estimated that a VAT of 10 to 14 percent would generate enough revenue to eliminate income taxes on families earning less than $100,000, about 90 percent of households, and still lower rates for the remaining 10 percent. These calculations, however, predate the recent recession and the explosion of federal spending in the last few years.

Paul Volcker, the former Federal Reserve Chairman and current White House economic adviser, called Graetz’s suggestion “a sensible plan for reform,” according to The Washington Post. Earlier this year, Volcker said that the VAT is no longer “as toxic an idea” as it was in the past.

Consumers are the ones who ultimately pay the VAT, though it is collected at all steps of the production process. At each of these steps, producers pay tax on the materials they purchase. Then, when they sell a product containing those materials, they collect payment plus VAT from the purchaser. The sellers then take a credit for the taxes they have already paid and pass the rest of the tax collected to the government. This system makes the VAT more difficult to evade, while still handing the bill to consumers rather than manufacturers. In some places, including Canada, the VAT applies to services as well as tangible goods.

I don’t think a VAT is in our immediate future, but it is not out of the question. The stark reality is that Uncle Sam is going to need vast piles of money to try to keep many of his promises. He can’t get it all from the wealthy, and raising business taxes just drives commerce and jobs overseas, underground or back into the imaginations of would-be entrepreneurs. Unless this country develops a sudden willingness to sharply cut entitlements and government spending, the middle class is eventually going to have to pay up. A VAT could make this happen.

Since wealthier households tend to save more of their income than low- and middle-class families can afford, a VAT would have a lower percentage (though higher dollar) impact on the affluent. Any VAT system in this country would doubtless include some form of credit or rebate for low-income households to mitigate this tendency, known as regressivity. But there is no getting around the fact that to accomplish anything worthwhile, whether that means reducing government budget deficits, paying for unfunded entitlements or creating a more tax-competitive business environment to foster American jobs, a VAT is going to have to raise a lot of revenue from people who currently pay little or no tax.

We could raise this revenue through the income tax system, but that is politically unpalatable. Witness President Obama’s verbal contortions as he tries to project himself as a deficit-fighter while sticking to his campaign pledge not to raise taxes on families earning less than $250,000. A VAT would allow politicians to embed a tax increase in the prices of goods and services.

The big fear, of course, is that a VAT would simply raise extra revenue for politicians to spend, without offsetting other tax burdens and without promoting a more competitive economy. This certainly seems to be a well-founded fear given the track record of the current crowd in Washington, on both sides of the aisle.

Even a well-implemented VAT would hurt retailers, since higher prices for consumers would mean fewer sales. British retail sales are 1.5 percent this expected to fall by about year, due in part to a scheduled increase in the VAT, Richard Hyman, a strategic retail advisor to Deloitte, told the Reuters Consumer and Retail Summit. But a hit to the retail sector here would not necessarily be a bad thing if it prompted this country to focus on producing more and consuming less.

If the VAT becomes a more immediate possibility, consumers will want to prepare by accelerating large purchases. If a 15 percent VAT goes into effect while you’re deliberating over a $30,000 car purchase, you’ll find yourself suddenly contemplating a $34,500 purchase instead. For now, however, it’s still too soon to take any concrete steps. But it is not too soon to begin imagining life with an American VAT.

Larry M. Elkin, CPA, CFP® is president and founder of Palisades Hudson Financial Group LLC, in Scarsdale, NY. For more articles on financial, business, and other topics, view the company newsletter, Sentinel, or subscribe to his daily opinon column, Current Commentary.

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