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A proud member of the reality based commentosphere since 2000. You can find my two Eurocent mainly at liberal and centrist discussion threads, but also at some other surprising places. Also tweeting now, as user "graygoods".

Thursday, November 18, 2010

A VAT for the US? A very bad idea!

Somewhat surprisingly, Paul Krugman has been stomping for the "value added tax" (VAT) recently, as an allegedly better way of reducing the deficit. But among left leaning economists, there shouldn't be any argument about the negative impact of this national sales tax on the low and middle income households. The only VAT liberals should like is Vat69, really! And the history of the VAT in Europe, where it became the main source of income for many governments, and resulted in rising inequality and lower domestic demand, isn't especially inspiring. So, WHY, for heaven's sake, does a good guy like Krugman support THAT?

The Prof now, finally, came up with explanations for his stance:

There’s a lot of backlash against the new Rivlin-Domenici proposal for suggesting a significant VAT — and people are right, sales taxes are regressive taxes. But while I haven’t had time to evaluate the whole thing, the sales tax itself isn’t a killing point in my view.
Why? Because we know that countries with strong social safety nets generally rely a lot on consumption taxes:
...
More generally, it does seem that countries with strong welfare states have less progressive tax systems than those with weak safety nets; see this, from the Luxembourg Income Study (pdf).
...
All of which says that if I can trade a somewhat regressive VAT for guarantees of decent retirement and universal health care, I’ll take it.

Well, color me unconvinced. I've never been a fan of the "millions of flies can't be wrong" kind of argument, imho the discussion should always center on the pros and cons, and that a certain misguided policy is widely used still doesn't make it more reasonable. In the case of the VAT, imho the negative side vastly outweighs the positive one, and Krugman fails to weigh this honestly.

Firstly, he totally underestimates the danger. Once you open the box of Pandorra, it's impossible to get the beast back into it. Not a single European government, no matter how far left, managed to do it. And the beast will only become bigger and bigger over time, as experience shows. With serious consequences on domestic demand, which Krugman doesn't mention at all.

Secondly, imho the REAL reason why the VAT is used by so many nations all around the world is that it's so CONVENIENT for politicians! The small percentages (at first) added to sales don't look like a big deal to the voters, but they flush VAST amounts of money into the coffins of the treasury. And it's even easier to raise the percentage by one point, instead of trying other, more difficult and controversial, measures to get a deficit under control. Consequentially, the VAT only goes up and up and up.

And lastly, as even Krugman points out, the VAT only is tolerable for the low and middle class incomes if it's counterbalanced by a strong social net. But how likely is it that a VAT for the US will be coupled with such measures to reduce the impact on the poorer half of the population? Imho that's just wishful thinking! And that's why I think Krugman is irresponsible with his lightheaded, not really thought through (he admits that) stomping for the VAT. This will most probably result in the US combining policies that are the worst of both worlds, more taxes for the lower 90% of incomes without any compensation for the hardship! That's madness, and Krugman should be ashamed of advocating such a dangerous "solution" to the US deficit problems in such a frivolous manner.

Even more so since his own prefered paper, the NYT, recently showed that it's possible to put the US finances on a solid footing again by simply going back to the Clinton era taxes and cutting some other budget points, without hurting the vast majority of US households. Everybody who recently played with the interactive "fix the budget" feature should have noticed that actually it's very easy to close the gap until 2015, and get the 2030 outlook into reasonable (=controllable) regions. Without any VAT involved! So, really, why should anyone, especially a good guy like Krugman, advocate yet another new tax that will hurt the lower and middle class incomes now? I don't get it.

(Based on comments at Brad DeLong's blog)

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