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What Is Your Opinion About A Value Added Tax?

By Mark Riddix

In the midst of rising unemployment and a surging deficit, the United States government is thinking of ways to increase revenue in order to fund government programs. The government has been considering implementing a fat tax, eliminating capital gains taxes, and raising taxes on higher wage earners. The government is trying everything possible to plug budget shortfalls and raise needed funds. Recently, the federal government has even began considering adopting a value added tax. There has been much debate over whether a value added tax would help or hinder domestic production. Let’s take a look at this controversial proposal known as the value added tax.

What is a value added tax anyway?

A value added tax (VAT) taxes the value that is added at each stage of production of certain commodities. A VAT discourages consumption even moreso than the current sales tax system because it would apply to all goods and services. Many products that you buy off the internet are not subject to sales tax. For example, internet retailer Amazon.com does not charge a sales tax in most states. VAT’s are indirect taxes and they are imposed on every area of production. Manufacturers, distributors, and consumers would all have to pay some part of the VAT. VAT’s discourage consumption because they raise the prices of goods and services. It would apply, for instance, to raw products delivered to a mill, the mill’s production work with those raw products, and so on up the line to the retailer. The tax is initially placed on every stage of production until finally being applied to the end consumer.

Value added taxes are the norm in many European countries, but have never been instituted in the United States. So, why is the US government considering a VAT? Rising unemployment has cut into tax deposits and the government is looking for different sources of revenue to fund entitlement programs. Entitlement programs such as Medicare, Medicaid, Social Security, and veterans benefits make up the bulk of the federal government’s budget. Entitlement spending continues to grow at a faster rate than the federal government’s revenue. The government either has to cut entitlement spending or raise taxes to pay for these programs.

The VAT is being considered in addition to a sales tax. Sales taxes are big revenue boosters for states. They are used to support state and local government projects and services. A VAT, on the other hand, is like a national sales tax where the revenue would go directly to the US government. Therefore a VAT is a form of double taxation. A sales tax at the state level and a VAT at the federal level.

The Good

A value added tax would help us deal with the major economic issues plaguing the United States economy. The money raised from a value added tax could be used to help lower the massive $10 trillion dollar national debt. A value added tax also encourages people to save more money to avoid paying taxes on consumption. A nation with a higher percentage of people saving money is a prosperous nation.

The Bad

A VAT could disproportionally affect the poor. Since the tax will be the same for the rich and the poor; the tax will be a higher percentage of an impoverished person’s income. Taxes on food and clothing will keep poor people from obtaining necessary items needed for survival.

Why are the poor disproportionately hurt? A VAT disproportionately hurts the poor because the tax would eat into their already limited income. For example, let’s say you have 2 different people (Tim and Robert) living in Texas both having to pay a value added tax. Let’s assume that the VAT is 5% on all purchases in Texas. Tim makes $50,000 per year and spends $6,000 annually on purchases such as food and clothing. Tim pays $300 per year in value added taxes ($6,000 x 5% = $300). Robert also lives in Texas but he only makes $20,000 per year. He spends $6,000 on purchases as well. He will pay the same $300 VAT as Tim. But are they really paying the same thing? The VAT is only 0.6% of Tim’s income whereas it is 1.5% of Robert’s income. Even though they are both paying the same amount of money, the VAT is a larger percentage of Robert’s money. VAT’s represent a much larger chunk of lower income individual’s money than other individuals.

Senior citizens and people that live on fixed incomes would also be adversely affected. Another negative is that a value added tax discourages consumption. The US economy is built on consumption and any decline in spending will hurt businesses and its employees.

If businesses aren’t able to cover the cost of the extra taxes by passing it off to the consumer, it may continue to cause higher unemployment, because businesses will lay off more workers to cut costs because of the higher taxes.

How do you feel about a value added tax? Do you think that this is a good time for the US government to impose a value added tax? Would you be in favor of a valued added tax if it led to decreased income tax rates?

(Photo credit: No VAT – Facciamo Breccia)

Mark Riddix
Mark Riddix is the founder and president of an independent investment advisory firm that provides personalized investing and asset management consulting. Mark has written financial columns for Baltimore and Washington, D.C. area newspapers and is the author of the book, Your Financial Playbook.

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  • http://hackmylife.typepad.com Rex

    Instead of increasing taxes by adding a VAT how about we cut spending. Stop fighting wars that no one wants to be in. End social programs that will be saddling our nation with debt for generations. Stop providing subsidies for corn and soybeans that make junk food cheap and fatten up our country. Prevent the move towards universal healthcare, stop bailing out everyone. What happened to responsibility? If we stop socializing everything we wouldn’t even need to discuss a VAT, taxes would be low because government would be minimized. With the extra money in hand the entrepreneurial spirit of the country would return providing jobs.

    Sorry for the rant.
    -Rex

  • Bob K

    I agree with Rex on all counts.

    The author writes “The government is trying everything possible to plug budget shortfalls.” I wish this were true. The government is not trying the most obvious solution, which is to reduce spending. You do it and I do it when faced with personal budget problems, but somehow due to the magic of Keynesian deficit spending, politicians act as if the rules don’t apply to governments. They want Keynes to be right. But Greece is providing a powerful counter-example.

    One major negative of VAT is that it is highly deceptive. At least with a sales tax a consumer can clearly see the impact of taxes on their purchases – if I buy something that costs $1.00, I pay $1.05 due to a 5% sales tax. With the VAT, the tax is hidden throughout the distribution chain, so the end consumer only sees $1.05, without any tacit indication of the level of taxes. Thus it is easier to raise the VAT as well.

    It’s a sly, deceptive, and regressive tax.

    “The art of taxation consists in so plucking the goose as to get the most feathers with the least hissing.” ~Jean Baptist Colbert

  • Mike Z

    I also agree with Rex, but I would be in favor of the VAT but only if we eliminate all the other taxes. I think it makes sense to tax consumption instead of production because we want to encourage people to produce weath, not consume it.

    In reality, this isn’t a question about either/or – but having BOTH taxes. Therefore, I am not in favor of it. Increasing government (both taxes and spending) does not improve the standard of living. It does not create more wealth. It only shifts wealth from the people to a small group of government representatives that think they are smarter than the people. It takes away our freedom to make our own decisions on how to spend our money.

  • Olivia

    Once a tax is in place it is never recinded and there are always other ways the money is used or siphoned off after the “need” is taken care of. We had an increase in our state highway taxes to cover certain repairs on the highway system. It was supposed to be temporary…

    I think the government should do what individuals, responsible ones at least, have done. If income decreases, decrease spending. Very simple. But once a program is in place with all it’s automatic yearly increases, it is almost impossible to cut back. Why not have a pay cut every year for legislators until the deficit is taken care of? Why not put a cap on the amount of money a person is allowed to spend on their campaigns, (thus evening the playing field). Why not elimnate the govenor’s or senators’ or congress’ massive pensions and medical coverage once they retire? They do it in business. This would cut back the “greed” factor for public office. Why not eliminate cabinet posts, cosolidate security agencies or at least make their computer systems compatible? Eliminate all the “free” literature our government officials give to us? Why do “entitlement” programs cost so much? Is it the actual amounts given to people or is it the infrastructure used to maintain it? Sadly this kind of stand will not win any elections, so it won’t get done.

  • Mike Z

    Why do politicans spend millions and millions of dollars of their own personal money to get a job that pays much less? Just a question to think about.

    Also, I would be in favor of increasing the number of representatives from 435 to 30,000 – not because we need more politicans but because we need each politican to have less power. There is too much power and money behind too few representatives.

  • Bob K

    @Olivia – you’re on to something. It would be interesting if politicians were provided with a financial incentive to reduce costs. Right now the financial incentive is primarily from special interest groups, lobbyists, unions, etc. There is no financial incentive to say no to these groups.

  • Eric Sherwood

    I like the concept of a consumption tax, but only if all of the other taxes were eliminated. I honestly would not mind paying a 15% or so federal sales tax if I didn’t have to pay federal income taxes.

    In my current tax bracket, I would actually probably lose out in that particular scenario, but I would feel better about it because paying it would be my choice.

    Also, while I understand the concept of a VATs “adverse effect on the poor,” I HIGHLY doubt that the federal government would put a sales tax on staple foods and simple clothing for that very reason.

  • http://www.yourfinances101.com/blog David/yourfinances101

    I’d rather see something like the Fair Tax instituted.

    I think the VAT would make things worse.

  • Mike Z

    Don’t we already have a VAT? It’s called corporate income taxes. Every company involved in the chain of production pays taxes on the profits they make.

  • http://www.pfsdebtrelief.com Stephan

    i am all in favor of a vat, the debt needs to get dealt with, and all you people who think cutting spending would fix the problem are naive. Taxes will have to go up, there is no way around it. Unless we eliminate or drastically cut entitelemnt programs,( no chance because of politics), our revnues will not keep pace with expenses. Taxes need to be raised, and i would much rather be taxed on consumption, because i can control that.

  • Bob K

    @Stephan, care to substantiate your comment “all you people who think cutting spending would fix the problem are naive” ?

    I could just as well claim that raising taxes will not fix the problem and anyone who thinks so is being naive. At some point, no amount of taxation can dig you out of the whole you’ve dug.

    But perhaps you were commenting on the lack of willpower to remove entitlement programs. Entitlement programs need to be drastically reduced or eliminated, and the “third rail” will need to be touched at some point soon. We certainly shouldn’t be ADDING new entitlement programs. I would gladly opt out of paying into social security – and collecting from it – but our nanny state prevents me.

  • http://www.pfsdebtrelief.com Stephan

    its not just willpower bob, from a political standpoint, you cant cut any of hte programs that cost so much. cut social security, and any politician who suported the cut will be booted out of office because he will lose the senior vote. im being realistic, cutting these programs wont happen, and honestly, they probably shouldnt be as the elderly and sick are the msot vulnerable members of our society. as to taxes, do you honestly think our country can afford to cut taxes? we already run a deficit, and we cant possibly cut enough spending to balance the budget, so the only option left is a new tax. look, i live here too and pay taxes too, and even i know that we have spent too much over the past few decades and now have to pay for it. why not a vat? it encourages saving, reduces consumption, and everyone gets taxed, not just the rich or the poor or the middle class.

    regarding your social security idea of opting out, sure that would be great, but there still would need to be a program to support seniors, even if this was allowed. what if you opted out, lost all your money in a stock market crash, then what?

  • Bob K

    @Stephan – I meant collective willpower in reducing spending.

    No I do not think we can afford to cut taxes – I didn’t say that. I’d even support increased taxes IF we were on a clear path of reduced spending.

    I absolutely think we can afford to cut spending, and we must cut spending. We can reduce entitlement programs without eliminating them; some level of safety net makes sense. But the current entitlement programs are simply unsustainable even if you taxed at the maximal point (at some point of taxation, tax revenues actually decline even as tax rates go up of course).

    Regarding social security opt-out – why is this not my own choice, to invest in the stock market if I so choose, and suffer the consequences of success or failure? I am willing to take those chances myself. By what right does the federal government compel me to participate in its broken Ponzi scheme? By what right does it compel me to purchase medical insurance? These are not enumerated powers, but rather well-meaning, good intentioned expansions of entitlement and social dependency. The path to unsustainable debt is paved with such good intentions.

  • Bob K

    @Stephan – “what is wrong with VAT?”

    This is what’s wrong with it:

    1. It will be an additional tax, not a replacement for existing taxes. You know it and I know it.

    2. It is regressive (in theory), placing higher burden on the poor. But as Eric Sherwood points out in the comments above, the federal government will select certain categories of purchases to be exempt from the tax, at least initially to address this problem of regression. But anyone who was not born yesterday knows that the set of categories will expand in myriad ways to favor whatever social engineering agenda is on the plate of the administration (Dem or Rep, doesn’t matter). It will grow tentacles and unintended consequences.

    3. It is easier to raise the tax rate – as it is largely hidden from view – without causing revolt in the streets.

  • http://www.pfsdebtrelief.com Stephan

    the reason they have the right is because you would still fall back on them if you messed up. if however you would agree to not accepting any help at all no matter what happened, then sure, do your own thing. problem is, we live in a civilized country, and we cant let our seniors rot away because of a bad investment decision.
    and im with you, cut spending, and i think the first place to start is the pentagon, ridiculous new weapons programs that cost billions but arent useful at defeating an enemy that uses primitive weapons in a civilian environement. we arent fighting the soviet union, so why invest in new tanks, bigger guns, and fighter jets? its nuts, and again, its politics. we cant cut that spending because some people will say we are weak and others will want to keep manufacturing jobs in their home states.

  • Bob K

    “the reason they have the right is because you would still fall back on them if you messed up”

    Nonsense. I intentionally used the word “right”. There is no place in the constitution nor bill of rights which allow this. Congress has no such enumerated power. It’s just one of the many travesties against the Constitution and people enacted by FDR.

    I have no doubt that the pentagon can be cut, but at least “providing for the common defense” *is* an enumerated power of the government.

  • http://www.pfsdebtrelief.com Stephan

    Come on Bob, we aren’t talking about constitutional law, and you ignored my point. What if you mess up or better what if the market tanks because of problems outside of your influence? Will you lose your home and live on the streets when your 80? I doubt it and honestly I don’t want that happening to anyone.

    Do you believe that the constitution is a living document, that is its interpretation needs to be adjusted as time moves on. Or do you believe in the strict reading and interpretation of it? I think it needs to evaluated for the time, so a health care debate cant be conducted in 2010 with the same rules and points as one that took place in 1800. times change, what worked 100 years ago cant work now.
    And in regards to your military comment, I think we both know we are way past a common defense budget at this point.

  • Bob K

    Stephan, I already said that some level of safety net makes sense, but much smaller than today. If the market tanks, then (a) I hope that I have done a decent job of preparing for that eventuality – I certainly work to that goal today – (b) family, (c) church, community, (d) aforementioned safety net. Social Security is not a safety net, it is forced savings.

    Regarding the Constitution – no I do not believe it should be reinterpreted for the times or the prevailing whims. Doing that renders it meaningless, as the Constitution can be stretched to support whatever the current administration (or past administration, take your choice) wants it to mean. Entitlement programs? Sure thing! Internment camps for Japanese Americans? Sure thing? Expanded wiretapping? Sure thing!

    I believe the founding fathers were extremely careful in how they constructed the set of checks and balances in the system, possibly the most brilliant set of people the world has seen in one place.

  • http://www.pfsdebtrelief.com Stephan

    well clearly we wont agree at any point then because i do think it needs to evaluated for the times we live in, but hey, thats the beauty of america, we can disagree.

    so what kind of safety net did you have in mind? i dont see how SS isnt exactly that now. you pay into it, you get it back when you retire. yes its forced, but thats because the majority of americans dont save for retirement. and it already isnt extravegant anyways, living on only SS each month isnt easy to do. the problem with SS has been that money we pay into it has been diverted to a whole variety of other places in our government, which a reason why there is such a gap in the SS budget.

  • Mike Z

    The problem here is that both Bob K and Stephan are right.

    If we raise taxes (by adding on a new VAT without removing/reducing existing taxes), spending will also rise. Why? Because this is what has always happened in the past. Increased taxes = increased revenue = increased opportunities for our government to blow that money on new programs.

    While we SHOULD cut spending, it is not politically doable…unless you change the rules of the game. Anytime you cut spending, you are cutting somebody’s “entitlement” to freebies. In doing so, you will lose their vote, which could cost the politican his job when he is up for re-election.

    Therefore, we need to change the concept of being a politician from a career to a public service. We need one term limit per position. This means the representative cannot make a career out of his position and will make those hard decisions that need to be made.

    The only other alternative to raising taxes or cutting spending is doing nothing. The result will be that the government will default on its debt when China decides they aren’t going to pay our credit card bill anymore. Then, the government will no longer exist and all the spending will go away until we have a new government.

  • Bob K

    @Mike Z – I agree we need to change the game, but will a public service ethos really lead to the type of behavioral change we need to see? I’m not sure how that would work… wouldn’t people want the short-term happiness of providing more services, entitlements, spending to their constituents? After all, they are only their for the short term.

    To me, the game needs to be changed for a different reason, and it has to do with incentives. Right now the incentives for Congress are the exact opposite of what we need.

    On one side of the equation, there are many incentives in favor of increasing spending: more programs / giveaways to more citizens helps ensure their votes, lobbyists for special interest groups (corporate, union, etc.) encourage increased spending or decreased regulation and taxation), campaign contributions implicitly tied to increased spending, etc. etc.

    On the other side of the equation there are basically zero incentives to reduce spending (other than “Pay-Go”, hah hah, or the occasional Tea Party activist). Hold on, there is one massive hammer of an incentive, in the form of Chinese and others not buying any more of our debt. God help the politicians who are in power when that feces hits the fan.

    Adding a tax will merely feed the first side of this equation, and do nothing to alter the other side of the equation.

    It’s a toxic soup of incentives to increase spending, lack of incentives to decrease spending, and an enabling monetary system that enables seemingly endless ability to borrow and print money.

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