Tax policy colloquium, week 10: Ajay Mehrotra on US history and the VAT

Yesterday at the colloquium, Ajay Mehrotra presented an early stage of an interesting and important long-term research project that's entitled "The VAT Laggard: A Comparative History of U.S. Resistance to the Value-Added Tax." The project aims to explore why the U.S. remains the only advanced industrialized nation that doesn't have a VAT or other such national consumption tax.

One underlying datum for the inquiry is that there have been at least five particular moments in U.S. fiscal history when the enactment of a national consumption tax has been on the agenda poliitically, and seemingly had some chance of happening, but didn't. So among the questions posed is whether these were unique events, or instead had common causation, perhaps even sounding in "American exceptionalism." The moments were as follows:

1) Early 1920s - With post-World War I fiscal retrenchment taking place amid a switch from the Wilson Administration to Republican leadership, major tax changes were being considered. The great Treasury economist T.S. Adams, known to tax folks today mainly by reason of the Graetz-O-Hear article that described his central role in creating the international tax credit, also more or less invented the VAT in 1921, and tried unsuccesfully to get it adopted by Congress. Business ambivalance and opposition to such an instrument, which was not as yet well understood or in place anywhere, apparently played a role in this outcome. So did the fact that the income tax had helped finance World War I and that the Republicans were not aiming to go back to pre-World War I finance. What happened instead was mainly just a lowering of income tax rates, which had risen to very high levels in order to help finance World War I.

2) 1940s - The Roosvelt Administration publicly considered the possible adoption of a national retail sales tax, in order to help finance World War I.  States' opposition, reflecting that many of them had recently adopted their own retail sales taxes, was one of the factors behind the decision to rely instead on expanding the income tax.

3) 1970s - The Nixon Administration publicly floated the idea of replacing residential school property taxes with a national VAT to fund public education. The 1976 Blueprints tax reform study also discussed the adoption of a national consumption tax, and Ways & Means chair Ullman notoriously lost his 1980 reelection bid after advocating the national adoption of a VAT. The late 1970s tax revolt and election of Reagan appears to have shut this down. Tax reform in 1986 was really focused on the income tax, although the 1984 Treasury "bluebook" report did discuss consumption taxation as an alternative option.

4) 1990s and early 2000s - By this decade, national consumption taxation had become a standard feature of tax reform discussion, such as in the 1995 Nunn-Domenici plan, and the report of President Bush II's 2005 Presidential Advisory Panel on Tax Reform.

5) 2016 and 2017 - Ted Cruz's "business flat tax" proposal in his presidential campaign would have been a VAT by another name, and then the DBCFT, as I discuss here, would have replaced corporate income taxation with a VAT plus wage deduction.

A further important point to reflect on here is that, at the global level, countries with VATs tend to have less progressive tax systems than the US, but more progressive fiscal systems. This reflects that VATs often help fund larger-scale social welfare benefits. But the correlation raises underlying causal questions, such as which caused the other insofar as there wasn't independent causation for each. One might also note that, at the state level in the US, states that rely heavily on sales rather than income taxes seemingly do not tend to have more progressive fiscal systems. But this may partly reflect both (a) using sales taxes in lieu of income taxes, rather than both as distinct from just the latter, and (b) the lesser market power underlying states' sales taxes than those of many countries, given the ease of moving between states or even just avoiding retail sales taxes via cross-border / online / mail order shopping.

What might be some of the leading theories regarding why this never happened? (The word "this," of course, embraces a range of very different options - e.g., VAT as add-on and VAT as income tax replacement.) An initial list, pending the fruits of Mehrotra's research, might include at least the following:

1) General VAT enactment obstacles - There's no need for American exceptionalism to support the observation that voters around the world generally do not leap up and cheer when a new and potentially capacious tax instrument is proposed. The two main stimuli that have led to VAT adoption in other countries are: (a) replacement, as per the VAT's introduction in continental Europe in the 1950s as an improvement on prior gross receipts taxes that imposed cascading tax burdens on interbusiness sales, and (b) outside pressure, as in cases where countries were pushed by the EU to adopt VATs as conditions of membership, or by the IMF to adopt them as conditions of receiving aid. Another example of the same phenomenon is New Zealand's adoption of a VAT in the face of significant budgetary pressure.

In the US, (a) has been attempted  but perhaps the taxes targeted for replacement haven't been unpopular enough, while (b) hasn't happened to us at least yet. (Future fiscal crisis, or at least entitlements funding crisis, anyone?)

2) American exceptionalism - When one is speaking about American exceptionalism, the leading suspects include (a) slavery and the indelible sin of ongoing racism, (b) the importance of the frontier, among others. Each of these could arguably play a role here. (A) helps explain the lack of a broader social welfare system that would strengthen the need for VAT financing, given our heterogeneity's effect on voter interest in helping the poor. (B) helps explain anti-government sentiment that might heighten opposition to higher taxes. But Mehrotra's research may help to illuminate any connections.

3) The Larry Summers joke - Someone please ask Larry Summers: Did he actually make the famous VAT joke? I'm told that a mention of  this first appeared in the NYT in the 1980s, but apparently even this reference isn't a direct quote but rather refers to the report that he said it.

The joke, in any event, goes something like this: The U.S. doesn't have a VAT because conservatives view it as a money machine while liberals view it as a tax on the poor. But if only liberals came to realize that it is a money machine, and conservatives that ti is a tax on the poor, then surely we would get it immediately.

As I've noted elsewhere, the joke is "deliberately paradoxical. Why should each side be so fixated on the bad outcome, rather than the good one, as judged from its normative perspective? The underlying empirical claim would therefore appear to be nonsensical, if not for the fact that it also appears to be true." With regard to current non-adoption of a VAT, including as a hidden component of corporate income tax replacement via a business flat tax or the DBCFT, I've suggested the relevance of risk aversion. From the standpoint of both Democrats and Republicans, a fiscal system with a VAT could be BETTER by their lights than the existing one if they get to control the other adjustments to taxes and outlays, but WORSE by their lights if the other side gets to do so. This creates a bit of anxiety and uneasiness about adding this instrument to the fiscal system even if one is currently in control.

4) Path dependence - Mehrotra will also, in the project, be exploring the idea of critical moments at which, perhaps, something just because it happens (or more specifically, for reasons idiosyncratic to that era), but then it has broader ramifications down the road because it has set the path. The QWERTY keyboard is of course the classic path dependence story. Assuming the literature is right, it was initially adopted to slow typists so they wouldn't jam early machines, but is not suboptimal for modern keyboards yet locked in. As applied to the VAT, however, one question to keep in mind is whether, or to what extent, recurrence of the national consumption tax issue implies fresh causation each time - with or whether out common explanations, e.g., from something in the "American exceptionalism" area.

I don't rule out possible future U.S. adoption of a VAT, although I consider it neither imminent nor especially likely. Or, to put it differently, if there are 100 most-likely U.S. national futures, let's say in parallel universes any of which might prove to be ours, some of them surely feature a national consumption tax, with or without the name, although I'm not here offering to bet on just how many or how few. (That would be a subjectivist, rather than a frequentist, measure anyway.) Multiple pathways to a national consumption tax might include (1) conservative control and it replaces a lot of income taxation without Graetz-style adjustments to retain progressivity, (2) liberal control and it funds new programs such as free college tuition or Medicare For All, and (3) fiscal crisis where it's deployed to "save Social Security and Medicare."