VAT for the US Economy

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Macroeconomics

Metals companies should brace themselves for the possibility that an administration increasingly focused on the growing budget deficit turns to the imposition of a value added tax as a way for raising revenue if a NY Times article is correct. Two former federal reserve chairman and many in President Obama’s team appear supportive of the idea pointing out it would bring the US in line with every other industrialized (and some 100 emerging) economies around the world. Vat rates vary widely from as low as 5% to as high as 25% in some Scandinavian countries but they all work in a similar way, taxing all or virtually all consumption. The tax burden is therefore broadly based and arguably fair in that the more you spend the more tax you pay, so richer people pay more than the less well off by virtue of their higher spending. It is considered in the long run at least as less of a drag on the economy because the alternative, income tax, tends to discourage people from spending money and thereby making capital available to business. Liberals argue that the rich spend proportionately less on consumption than the poor and consequently vat is not as fair as it first appears but this can be countered by simplifying the whole tax code to re-balance matters fairly something which is long overdue. The last major tax revision was 1986. The most obvious is just raising the lower limit at which people start paying tax.

The drawback is it pushes the administrative cost largely onto businesses and not just those selling in a retail environment. Every company in the supply chain from primary producer through to retailer has to charge vat on its sales and pay the difference between what it paid to its supplier and what it took from its customer to the government. So firms inevitably increase accounts departments or take on additional IT costs in order to handle the tracking and monthly payment of vat bills.

It is precisely this tax that under certain circumstances Chinese companies are allowed to reclaim when they export goods. Of course they cannot claim vat from overseas clients. Exports in nearly all other countries are vat free but in China companies are expected to pay vat on their  material purchases but don’t have the mechanism to claim it back unless the product they are exporting is granted a vat rebate. Rather than being an unfair advantage, vat rebates really just put Chinese exporters on a similar footing to western exporters. However, in a sophisticated tax regime like the US, mechanisms would be built in to allow exporters to claim back their vat payment without any disadvantage much as they are in Europe.

There are challenges of course. Every industrial sector appeals for special treatment. Large parts of Europe allow children’s clothes, food and sometimes books to be vat free, and how do you apply vat to financial services it’s difficult enough to judge how much value is added in a financial services transaction. Some would argue none and that’s just the problem but that’s another issue. The usual solution is to exempt financial services but that takes a big chunk of economic activity outside of the tax system in a country like the US.

In the short term, any vat scheme would impact consumption (and feed inflation) in a way that would not be acceptable to a still recovering economy, so regardless of the musings from Capitol Hill we do not expect anything in the short term. But there are many like Nancy Pelosi who would like to see it happen within the term of this administration.

–Stuart Burns

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