Add Value To Your Buck

It's almost that time of year again, tax season! OK, maybe I'm exaggerating on how exciting this is. The US tax code is longer than War and Peace, but just like the classic book, almost no one can understand it, and almost no one today has read it. But someone has to read the code in order to figure out how much money people owe their government. If only there was a simpler way…

Debating tax policy is almost as bad as actually paying them, but here I go. The last time any serious tax reform occurred was during the Reagan administration. The Tax Reform Act of 1986 reduced individual and corporate taxes almost by half, and indexed those standards for inflation. The number of tax brackets were also reduced. But the Act also included the Alternative Minimum Tax (AMT) which only complicated the code more. The more complicated the code became, the more loopholes were there for people to take advantage of. While less money was coming in, the government was spending more, which increased the national debt. The code has become so complicated, and hard to enforce, only 47% of American's who file for federal taxes actually pay them.

President Obama has said he wants to reform the tax code to make it easier for Americans. But what's the best way to do this? There are a lot of ideas out there. Some say there should be a flat tax where everyone pays the same amount. But that's not progressive. It can also hurt those who do not have a lot of money, while people who earn more won't be paying their fair share. Another idea is to eliminate loopholes and certain credits. This could work, but doesn't go at the heart of the problem, which seems to be the way we calculate how much American's need to pay.

One idea that works for forty other countries (mostly in Europe) is the Value Added Tax (VAT). Instead of pushing a sales tax onto the consumer, items are taxed at a percentage as the product is put together. So if the VAT was 10% it would work like this:

- The manufacturer pays $1.00 for the raw materials, certifying it is not a final consumer.

- The manufacturer charges the retailer $1.20, checking that the retailer is not a consumer, leaving the same gross margin of $0.20.

- The retailer charges the consumer $1.50 + ($1.50 x 10%) = $1.65 and pays the government $0.15, leaving the gross margin of $0.30.

The government gets paid each step of the way, and it is clear how much everyone owes so it is easy to enforce. Overall this reduces the costs to the consumer because they don't have to pay so much at the end. The French implemented a VAT in 1954 and today it counts for half of the government's income.

 

But there are opponents. People argue implementing a VAT can cause large amounts of fraud such as false claims. There have been instances where the individual or business argues that they did not know they had to pay a tax on a certain item. Then of course there is the old fashion "hidden sale" where the consumer is charged something that is completely made up.

 

Despite those concerns, studies show that if a 5% VAT was implemented, and covered 80% of goods people consume, it could generate roughly $260 billion. The Virginia Tax Review estimates that a VAT of 25% could pay for health care reform, exempt millions of American families from income taxes and still raise the revenues necessary to cut into the budget deficit.

 

One of the reasons American's are less inclined to pay taxes now is because we became a individualistic society. When FDR was President, there was a "we are in this together" philosophy. But that has gone away. The book Bowling Alone explains it pretty well. But when you are paying taxes, you are paying for the freedoms that people in the Middle East and North Africa are fighting for. Whether you are rich or poor, everyone benefits one way or another, and those who don't pay their taxes are cheating their fellow citizens.

Just because something is European doesn't make it scary. Paying taxes is important. It goes to Veteran Hospitals, public parks, schools, and keeps our food and water clean. But paying for these services doesn't have to be a burden. Instituting a VAT could bring in more money for areas that all Americans use, and everyone could get a bigger bang for their buck.