Value added tax: Senate weighs a tax reform Reagan once shunned

As president, Ronald Reagan, was 'not enthused' by the idea of a value added tax (VAT) in America. But at a Senate hearing this week, tax reform experts pushed for it.

Here's one thing on which Republicans and Democrats generally agree: Reforming the US tax code is needed and could give a major boost to America's fiscal and economic health.

But the political challenge – how to settle the details of reform – was visible Wednesday in a hearing on tax reform held by the Senate Budget Committee.

A focal point of the discussion was whether the US should impose a value-added tax (VAT), which would be similar to a federal sales tax. Other advanced economies lean heavily on such taxes as a way to efficiently collect revenue in a way that's compatible with economic growth.

It's an idea that has long been controversial, especially with Republicans. Ronald Reagan, in the spotlight this week because of the 100th anniversary of his birth, declared in 1985 that he was "just not enthused" by the idea.

One concern, then and now: A VAT could become a backdoor tax hike that might be out of view to most Americans.

Fast forward a quarter-century. Republicans at Wednesday's hearing weren't ruling out a VAT, but they weren't declaring themselves enthused, either. It remains a tough sell politicially for a variety of reasons. (Note, though, that President Reagan himself didn't say "never" back in 1985.)

Tax policy experts at the hearing, including a prominent conservative, said the idea should be a centerpiece of tax reform.

"All roads are going to lead to a VAT," said Lawrence Lindsey, a former top economic adviser to President George W. Bush. "If we want to be competitive, that's where we're going to end up."

Here's the chain of logic.

Both sides say the current tax code is a complex mess that harms US job growth, while other nations are using better-designed tax systems to lure corporate investment.

Tax reform could help the economy, and by making tax collection more efficient it also has the potential to reduce the persistent federal budget deficit. Politically, too, tax reform appears easier for both parties to strike a deal on than, say, health care reform.

A makeover of the tax code could occur simply by streamlining existing rules for personal income and corporate taxes. The VAT would add a further twist: Proponents say it could help to roll back incentives for corporations to add jobs and factories outside the US rather than inside.

"It really is our central economic issue," Mr. Lindsey said during the discussion with senators.

No one argues that a VAT alone will solve US competitiveness problems. But Lindsey said that such a tax, levied on all business receipts, could be "border-adjusted" so that it didn't tax exported goods. That way US exports wouldn't be taxed twice – once in the US and once by another nation's VAT.

Other changes – such as aligning corporate tax rates closer to rates in other nations – could also help level the field, witnesses at the hearing said.

Why did Reagan say in 1985 that the VAT idea didn't excite him, even though he was embarking on a major bipartisan tax-reform effort?

"A value-added tax actually gives a government a chance to blindfold the people and grow in stature and size," he said at a news conference. "That tax can quietly be increased, and all the people know is that the price went up and they don't know whether the price went up because somebody got a raise or whether the company wanted to increase profits or whether it was government."

He also argued that the federal government would be intruding on the terrain of states, since many states rely heavily on sales taxes for their revenue. But his main argument was that the VAT would be more or less hidden, compared with income taxes.

"Taxes should hurt in the sense that people should be able to see them and know what they're paying," Reagan said.

Some Republicans at Wednesday's hearing voiced similar themes.

Sen. Patrick Toomey (R) of Pennsylvania worried that a VAT, paired alongside an income tax, would make it easier for politicians to raise taxes. Rates for both taxes would start relatively low, so increases might not feel so bad to the public.

Sen. Rob Portman (R) of Ohio said he simply doubted the VAT "has political viability here in the short term."

Where Democrats are open to the idea of adding a VAT alongside a simplified income tax, Lindsey proposed that a VAT-type tax be implemented as a substitute for other taxes. "Adding yet another layer of complexity on top of what we already have would be among the worst ideas we could come up with," he said in his prepared testimony.

Another middle-ground approach, raised by some Democrats at the hearing, would add a VAT while eliminating income taxes for most Americans, and retaining the income tax on high earners. Such a plan has been outlined by Michael Graetz of Columbia University Law School.

Both liberal and conservative tax experts say that, with or without the VAT, it's vital that Congress move toward greater fiscal stability. On the current course, the nation is set for high annual deficits and an ever-rising national debt.

"The elephant in the room is the unbalanced fiscal situation that we have," Donald Marron, a visiting professor at Georgetown University, told the senators.

[Editor's note: The original version of this article incorrectly stated that the hearing on tax reform held by the Senate Budget Committee was held on Tuesday. It was actually held on Wednesday.]