Why a VAT tax is better than a flat tax

June 16, 1998|By Benjamin L. Cardin

YOU DO not have to be an anti-Washington talk show host to be fed up with our federal income tax structure. Millions of Americans are overwhelmed by the complexity of our tax system; corporate America is snowed under a myriad regulations.

Washington is brimming with talk about doing away with our graduated income tax. From flat tax proponents to champions of a national retail sales tax, tax reform is a "hot" issue on Capitol Hill.

But many of these proposals are flawed. For all of the problems with our current tax system, one of the things it does reasonably well is collect the revenues needed to run our federal government on a progressive basis.

Under the current tax system, we collect 32 percent of individual income taxes from the top 1 percent of taxpayers. Ability to pay is an important principle in this process. Tax reform does not mean having the middle class pay more while the wealthy pay less.

The flat tax fails badly to meet this test. Because it would tax only earned income, totally exempting interest and dividend income as well as capital gains, the flat tax would shift the tax burden down the income ladder to working-class Americans.

The flat tax also would treat economically similar taxpayers very differently. Wage and salary earners would be taxed on their income, while those with investment income would get a free ride. One result of this system would be that Americans with the same income levels would have very different tax burdens.

Tax fairness must mean treating people in similar situations the same. One of the serious problems with our current system is its failure to meet this test of fairness. We don't need to replace the current system with a new plan that makes things worse.

Finally, at the 17 percent rate proposed by Rep. Richard Armey, the flat tax blows a huge hole in the balanced budget. According to the Treasury Department's analysis, the flat tax as proposed by Rep. Armey falls $138 billion short each year of meeting current revenue receipts.

A national sales tax

In reforming our tax system, we must adhere to four basic principles: simplicity, efficiency, fairness, and neutrality. A value-added-tax (VAT) -- coupled with a modest income tax on high-income Americans -- accomplishes these goals in addition to rewarding savings and improving international competitiveness. It also would allow us to eliminate the corporate income tax and most individual income taxes.

In proposing a VAT, I am suggesting that we adopt a form of taxation that is easy to institute, that rewards savings and improves international competitiveness. By eliminating the corporate income tax, a VAT would greatly simplify the tax system.

This is how it would work:

The VAT is a broad-based tax on every level of production, resulting in a kind of national sales tax. A 1 percent VAT, without exemptions, would generate about $37.8 billion in revenue. A 5 percent VAT would provide enough revenue to replace the corporate income tax.

A VAT, coupled with a flat income tax on upper-income Americans that allows for only a few deductions -- for state and local taxes, mortgage payments and charitable deductions -- would remove some 75 million Americans from the income tax rolls. We also could allow for some rebates for low-income families to address the regressivity problem.

By marrying a VAT with a streamlined income tax, we come up with a fairer, simpler tax that could ease the potential regressivity problems that come with a VAT or any pure consumption tax reform proposal.

Businesses often make decisions on the basis of what the tax code says they should do rather than on the long-term economic interests of workers, shareholders or the community. By eliminating the corporate income tax and instituting a VAT, we could remove tax considerations as a driving factor for thousands of American businesses.

We should also consider that a VAT would benefit our international trade situation. A border-adjustable VAT is one of the most attractive features of a VAT. Unlike the corporate income tax, a VAT applies to imports and is rebated on exports.

Good for trade, savings

A VAT would aid U.S. exporters by putting them on an even playing field with their international competitors. A VAT also would remove existing tax incentives for companies to base their operations abroad, which will protect U.S. jobs.

Another major advantage of a VAT would be the potential increase in savings. According to the Employee Benefit Research Institute, personal savings as a percentage of disposable income has steadily declined from more than 9 percent a generation ago to 3.8 percent in 1997.

A VAT could help change that. By taxing consumption, rather than all income, we would provide an incentive for Americans to save rather than spend. At the same time, a simpler and more efficient tax system may help restore the confidence of the American people in their government.

Benjamin L. Cardin represents the 3rd Congressional District in the House of Representatives. He is a member of the Ways & Means Committee.

Pub Date: 6/16/98

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