Recently, progressives have made noise about introducing a value-added tax (VAT) in the United States. The VAT is an indirect tax—that is, Americans wouldn’t pay the tax directly to government, but would pay it to businesses as part of the retail price of things we buy, and businesses would then remit the tax to Uncle Sam.
A VAT is set at a fixed rate—say, 10 or 15 percent—added to the price of a good at every step of production, with a deduction allowed for the amount of VAT paid during earlier stages of production. The more steps there are in transforming raw materials into complex consumer goods, the higher the resulting consumer price as a result of those multiple layers of taxation.
Many countries have VATs, including Canada, Mexico, and the European Union. One might say that a VAT is an emblem signifying that a country’s government consumes a large percentage of its GDP, for VATs seem to go hand-in-hand with big-budget nanny states.
The reason for this phenomenon is simple: Any government that seeks to be all things to all people, and therefore seeks to spend ubiquitously, must inevitably seek to tax ubiquitously. Such governments have insatiable appetites for revenue. Because VATs are cash cows, diverting huge sums of money from consumers to government, they are favorites of big-spending governments.
Unfortunately, though, VATs have significant negative economic consequences.
Because they inflate consumer prices, quantities demanded fall. Most often, the marginal buyers who can no longer afford to pay the higher price are poorer citizens. When government policy raises prices (see “Government Intervention and Higher Prices”), the first victims are poor people.
The second victims of a VAT are the workers who will lose their jobs as a result of falling demand for the newly higher-priced goods.
Many affluent Americans may not curtail their consumption, but because more of their money is diverted to the government treasury, their savings must correspondingly decline. This results in decreased capital accumulation, which, in turn, slows business expansion, development, and formation. It also slows the growth rate of labor productivity, hence retarding economic progress for workers.