Wednesday, November 15, 2023

NYU Tax Policy Colloquium, Ajay Mehrotra on the lack of a U.S. VAT

 Yesterday, at our penultimate public session for 2023, we discussed a pair of items (one already published, and one an early partial draft) by Ajay Mehrotra discussing U.S. tax history, and in particular our distinctive fiscal character.

As the papers note, the U.S. tax system, considered in isolation, is unusually progressive by peer country standards, but also unusually small. So Americans are not "over-taxed" (as some liars like to assert) by peer standards. But the broader U.S. fiscal system is unusually lacking in progressivity.

Nearly everyone but us has a national-level VAT or something quite similar, and peer countries almost invariably have more generous social spending. The US is unusually unequal, both before and after considering taxes and transfers.

How might one explain the correlation between our lack of a VAT and of generous social spending? Without more, the causal relationship between the two could be explained in any of the following ways:

a) No VAT -> less generous social spending, as the latter therefore lacks adequate funding.

b) Less generous social spending -> no VAT, as the latter therefore isn't fiscally needed.

c) Exogenous factors -> no VAT and less generous social spending.

It's plausible that each of these has some degree of truth. Be that as it may, the broader project's aim is ask why there is no US VAT, using case studies to look at different periods, and reflecting a normative as well as descriptive interest in both sides of the ledger. By using case studies, it explores questions of fortuity and path dependence, on the view that there may have been particular periods when the U.S. tax policy Overton window was potentially open to VAT (or VAT precursor) adoption, although it never ended up happening.

I see 3 topics of particular interest in responding to the papers, set forth as follows below.

1) American exceptionalism: Consider the following two alternative views of American history:

a) America is unique, due to factors X, Y, and Z. Therefore, of course we have no VAT and relatively low social spending.

b) It's all a matter of historical contingency. On several historical occasions, a VAT could have happened, but it just didn't for one very particular reason or another. For example - relying on the case studies' details - suppose TS Adams had happened to find a powerful sponsor in 1921 in his efforts to enact a proto-VAT. Or suppose that, in 1942, FDR had happened to want a national consumption tax (as Treasury Secretary Morgenthau was suggesting) rather than just a huge expansion of the income tax to help fund World War II. Or suppose that in Richard Nixon's first term, when his Administration was studying and floating proposals to enact a VAT to replace state and local property taxes in funding public education, he had managed to make a deal to this effect with Congressional Democrats. Then our country would be at a very different place fiscally today.

Evaluating these very different views is made difficult by the fact that history only happens once. But one can plausibly have a theory that mixes American exceptionalism with contingency such that, if we could run history forward 100 times (with the butterfly effect allowing it to proceed independently each time), one might predict that the US would end up with a VAT more rarely than other countries, but not necessarily zero times.

In effect, one might think of US enactment of a VAT as requiring the poker equivalent of drawing an inside straight, rather than merely having two of a kind. So perhaps we'd get a VAT 10 or 20 times out of 100, rather than 0 or (obviously) 100. Meaning that, if one accepts this view, American exceptionalism and contingency are both at work here.

That said, I have in mind the X, Y, and Z factors that help to explain why a US VAT was ex ante so unlikely (even if not impossible). I'd characterize them as follows.

X is the power of white supremacy in American history. Fueled by our history of slavery (followed by apartheid) and Native American genocide, and kept bubbling as well by our history of immigration by people who were socially coded as non-white, we have had a lack of social solidarity that undermines political support for social spending. White voters don't want to fund (as they see it) large benefits that they view as going to "them" rather than to "us."

Y is America's anti-state, anti-tax, and individualist tradition, reflecting Revolutionary War era resistance to British rule along with the frontier experience. 

Z is our having a political system with multiple choke points, biased towards inertia. Whereas in a parliamentary system the ruling majority can pretty much do what it likes, here one has the president, House, and Senate (not to mention the courts), each potentially run by a different party, and with lots of outside players and divergent views that can impede policy innovation even when all are at least nominally controlled by the same party.

A particularly keen example of Z in the case studies is the Nixon Administration's apparent interest, during the Trickster's first term, in enacting a VAT that would replace state and local property taxes in funding public education. This had a lot of underlying causes, including political and constitutional challenges to divergent levels of local funding, and the era's highly controversial disputes over busing. But its enactment would have required some sort of a deal between the Administration and the Democratic leadership in the House and Senate. Plus, it was apparently effectively vetoed early on by state and local governments' opposition, reflecting that by this time (as opposed to 25 years earlier) they had significant state and local sales taxes that they viewed as being threatened by a national VAT.

2. "BIASED" FISCAL DESIGN: The published paper argues that the US fiscal system is designed as if it had been intended to make taxes as visible and salient as possible, and benefits as invisible as possible. Hence, voters are predisposed to hate taxes and to believe that they don't purchase one anything.

Key words here are "as if ... intended." The claim is not one of intentionality but of end result. It's based on the facts that:

(a) on the tax side, the federal income tax is highly visible and salient, with April 15 filing, unaided by the likes of Ready Return. VATs, by contrast, are collected piecemeal and arguably less salient.

(b) on the social policy side, benefits are frequently delivered via tax expenditures and through private-public partnerships that make the government's role in benefit provision (e.g., for healthcare and housing subsidies) relatively invisible. 

I agree that our tax and "spending" institutions generally have this character. But an exception worth noting is the employer contribution to payroll taxes, which could hardly be less visible to workers than it is.

Also, tax expenditures' role on visibility and salience is a bit complicated. Yes, they hide the "spending" a bit. But they also hide the "tax" that funds the "spending" a bit. Thus, suppose we are comparing the the home mortgage interest deduction to a system in which the government first collected the forgone revenue through the tax system, then paid out explicit cash subsidies to existing law's beneficiaries from the deduction. This would cause, not just "spending," but also "taxes" to be optically higher than in the (by hypothesis) substantively identical system that we actually have.

The paper notes the following comparison between US and peer countries' taxes as a percentage of GDP. US taxes are typically at about 25.5% of national GDP, as compared to 33% in the UK, 38% in Germany, and 45% in France.

But our tax expenditures are 5.8% of GDP. Adding them to the 25.5%, we'd now be at 31.3%, bringing us significantly closer to the other 3, although we'd still rank below them. True, their percentages would rise as well if their tax expenditures (admittedly a fraught category to define) were added to collected taxes. But, if they use tax expenditures less than we do, which I believe to be the case, we'd still be closer after making the adjustment than before.

3. VATs and overall progressivity: Suppose one wants to make the US fiscal system more progressive. While enacting a VAT would do so, if the revenues therefrom were used to fund enhanced social spending (e.g., for education and healthcare) that sufficiently helped lower-income individuals, one could make the overall system more progressive still by using progressive taxes to fund the same thing.

Just to illustrate this, I've seen estimates suggesting that a 10%, fairly broad-based VAT would raise about $3 trillion over 10 years. By way of comparison:

--The Warren and Sanders wealth taxes - if allowed by the Supreme Court, which would require a change in the Court's membership - would raise $4 trillion over 10 years according to the proponents, and $2 trillion over 10 years according to the Tax Foundation.

--According to a 2019 article by Lily Batchelder and David Kamin, one could raise $4.5 to $5 trillion over 10 years through such tax changes, directed at the top 1 percent, as the following: higher individual and corporate rates, higher capital gains rate, realization at death, and higher rates plus lower exemption amounts under estate and gift taxes.

So it's not just about the revenue. That said, there are 2 main types of arguments for using a VAT in lieu of (or in addition to) the above alternatives. The first are arguments about efficiency and economic growth, while the latter are arguments about political feasibility.

I myself, if made the temporary fiscal tsar with some hope that my choices would persist, would add a VAT to the mix, for reasons of both (relative) efficiency and long-term political economy. But I would also revisit the existing and other proposed taxes in order to ensure that overall progressivity (giving due weight to concerns about efficiency and growth) was at the level, or achieved the set of tradeoffs, that I considered best. But, since no fiscal tsar job appears to be on offer for me at present, I don't see the need fully to decide and specify exactly what I would hypothetically do.


Lopo Martinez said...

Thank you for your insightful and comprehensive analysis on the absence of a Value-Added Tax (VAT) in the United States. Your discussion on how white supremacy, anti-state tradition, and a political system fraught with multiple choke points influence fiscal policies was particularly enlightening. It brilliantly highlighted the intricate interconnection between history, culture, and economics in shaping fiscal frameworks.

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