Here is a letter I sent to the Wall Street Journal on 4/12/10, indicating that one of the biggest problems with the VAT is that a VAT is, in the end, just another tax and, like all other taxes, it will inevitably cause people to alter their behavior.  Specifically, it will raise the effective price of all goods and services sold, and, because demand curves slope down, the VAT will reduce sales and cause a negative ripple effect on everything, including overall tax revenues.

In “Volker on the VAT” in the April 8 Journal, your Editorial group neatly summarized the case that there is a big difference between raising tax rates and raising tax revenues.  As has been previously demonstrated by David Ranson (You Can’t Soak the Rich, May 20, 2008 WSJ) and, on numerous occasions on your pages, by Alan Reynolds of The Cato Institute, tax revenues tend to remain a constant percentage of GDP regardless of whether tax rates go up or down; the figure you quote, 18.5%, appears to have been drawn from the Ranson piece, and Mr. Reynolds arrives at a similar percentage while differentiating his data and conclusions more precisely among the different categories of income and taxes.  In any event, the point is that raising tax rates does not cause any significant increase in tax revenues, because taxpayers tend to alter their behavior in response to changes in the tax code.  That point, of course, exposes the fundamental fallacy of the static analysis that underlies all “Paygo” legislative schemes and, indeed, the entire financial structure of Obamacare – the notion that the cost of a new program can be paid-for by imposing new taxes or increasing the rates of existing taxes.

Curiously, your editorial suggests that this phenomenon is class-related: you state that “the wealthy adjust their behavior or shield more income via loopholes,” and thus “Democrats have to soak the middle class because that’s where the real money is.”  In other words, you imply that a VAT would be successful in increasing overall Treasury revenues because, while dynamic assumptions are needed in order to predict the behavior of the wealthy (as the class affected most strongly by changes in the income-tax rates),  static analysis is sufficient in the case of the middle class (as the primary target of the VAT).

The problem with this approach is that the imposition of a VAT might also lead to altered behavior, because demand curves for nearly all classes of goods and services can be identified for nearly all classes of purchasers.   If you impose a VAT on the sale of plasma TVs sold by WalMart, either Walmart sells fewer TVs (if the tax is primarily absorbed by the customer) or Walmart makes less money on the TVs it sells (if the tax is primarily absorbed by Walmart by means of cutting the nominal price in order to maintain the effective total price to the customer) – in either case, behavior has been altered, the negative effects ripple throughout the economy, people and/or businesses lose wages or profits, GDP is adversely affected, and federal (and state and local) taxes suffer.  Why does your Editorial group believe that a new VAT, unlike an increase in income-tax rates, would result in any significant increase in the absolute dollar amount of total tax revenue, especially considering the current state of our economy?

[Posted on mecmoss.com 10 Feb 2012]