In Tuesdayís Dealer Outlook, I speculated that President Obamaís debt and deficit commission is likely to recommend the imposition of a value-added tax ó also called a goods and services tax (GST) ó as a solution to the nationís debt and deficit crisis.
I also noted why the commission could embrace a VAT when it makes its recommendations after the November elections. (Thanks to those who have commented so far, both pro and con.)
So how does a VAT work? Basically, value-added is described by economists as the money a business gets when it sells goods and services, less whatever it paid for materials and/or services. Hereís an overly simple example: If a resin maker sells materials to a boatbuilder for $1, the boatbuilder sells the finished boat to a dealer for $2, and the dealer, adding electronics, prep and delivery, etc., sells the boat to a boater for $3, each of the businesses has added value of $1. So the value of the boat ($3) is the sum of the value-added at each point in the chain. If the VAT is, say, 10 percent, a total of $0.30 tax would have been collected along the chain.
In truth, the VAT does about the same as a retail sales tax. So you might be thinking, wouldnít it be easier for Congress to just impose a 10 percent sales tax at retail? Then the boat dealer would just add 10 percent to the price of the boat. Yes, it might be easier, but it probably wouldnít go over big with the voters back home.
A 10 percent tax on value-added could be much easier to sell because itís not so obvious. Back to our example. The resin maker raises his price to $1.10, the boatbuilder raises his price to $2.20 (reflecting both the tax and the higher price of resin), and the dealer ups it to $3.30. No matter how you do it, the consumer pays the same 10 percent more at the end but doesnít see it.
Proponents will likely point out that, besides being less obvious, some tax experts contend a VAT collected all along the production chain is better for overall collections because a retail sales tax is often easy to avoid. Still others will point out that a VAT is like a sister idea to the flat tax championed by some. In addition, those favoring a VAT say itís the best way to generate revenue to keep up with a government thatís long on giving benefits and short on finding ways to pay for them.
On the flip side, those who would oppose a VAT will loudly label it unfair. Even though the tax is the same for everyone, rich or poor, the poor will clearly be paying a higher percentage of their income. More opposition can be expected from those who say the size of government should be reduced and that a VAT would be a growth hormone. And the flat tax clan will lobby against a VAT primarily because flat taxers want to replace the current tax system, while the VAT would be an addition to our tax structure.
Finally, the VATs in Europe are complicated. They contain a variety of exceptions ó food, for example, as well as many other products with VAT rates lower than the main rate. That causes the main rate to be pushed higher (25 percent in Scandinavia) to make up for the products taxed less so the overall target revenues are still realized.
So is a VAT good or bad? Itís actually neither. Itís just a tool to raise revenues. How itís applied and, therefore, its relation to all other taxes already on the books is what will define it. That will be the battle ground. But be aware that regardless of the details, and even though the burden of the VAT ends up on the final customer in the chain, if it comes it will be all the businesses in the supply chain that will have to shoulder all the compliance obligations, penalties and work.