Why France has VAT and America doesn’t

by Henry on August 7, 2007

Bruce Bartlett is advocating the introduction of Value Added Tax to America. This is a perennial proposal on the right, but it doesn’t appear to ever gain much political traction. The obvious reason why is that VAT is unpopular because it’s a regressive tax (the more people earn, the less they pay). However, this doesn’t explain why European countries which one would expect to be more attracted to progressive taxation systems have VAT, often at quite high levels.

Former CT guest blogger (and current GWU colleague and friend of mine) Kimberly Morgan has written a nice historical paper (Word file here )with Monica Prasad looking at how the US came “to have a tax code that is on many levels more hostile to capital accumulation than its peers” while France “which in some opinions has “never really been won over to capitalism” ” found itself relying on taxes that hit workers and consumers unusually hard. Simplifying drastically, she and Prasad argue that it can be explained by timing. Industrial capitalism arrived in the US before a real national state came into being, while the state preceded capitalism in France. The weak state in the US, and the willingness of business to ride roughshod over consumers, “led to an intense public interest in disciplining capital, which underpinned a movement toward income taxation that would punish capital and the wealthy.” In France, in contrast, well-founded fears of state intrusion led French citizens to fear direct taxation, and tax advocates to work against “fiscal inquisition” and the further expansion of the state into private life. This left French left-wingers ambivalent about the virtues of income taxes, so that a state crippled by war expenses had to turn to a sales tax to raise money. If this is right (and they provide a lot of historical evidence), some of the verities of left and right about France and the US should be turned on their head (this is one of the reasons why it’s a fun paper, for values of fun that include ‘detailed historical institutionalist arguments about causation.’)

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1

Factory 08.07.07 at 8:40 am

Erm, how does Australia fit in with this theory?
(for those that don’t know Australia introduced a 10% GST (basically a VAT) in 2000).
(actually NZ added one in 1980 too)

2

Richard J 08.07.07 at 9:42 am

Or for that matter, that France has a 3% net wealth tax and a rather stringent inheritance tax?

3

Yaron 08.07.07 at 10:05 am

Personally I never realized why VAT is really considered regressive (And please be careful with statements like ‘The more people earn, the less they pay’ or someone may not realize you mean relative to income and not in absolutes).

Usually VAT is placed on everything with the same rate, so while people with higher income may buy less food relative to their income (Which is also not clear-cut, they just buy more expensive food items), they will buy more cars, electronics, houses, etc, all of which they would pay the same VAT percentage on.

And if the overall amount of income that goes into consumption is still lower in high incomes, it’s because the rest mainly goes into savings, no?
The main purpose of savings is, I believe (and so all my economic lecturers claimed), to be able to consume more later. Since there is no VAT discount on goods purchased by savings money compared to salary money, the VAT would get the savings eventually as well.
Unless, of course, the money will just stay invested in savings. But while that is going on the person who saves the money can’t really do anything with it (i.e. consume and pay VAT) so it’s not like they really have more accessible property they don’t pay the VAT taxes on.

The only really regressive aspect is VAT wavers on imports, but that is usually kept to pretty low amounts of money before VAT is required, and I really doubt that is what bothers people.

4

reason 08.07.07 at 10:37 am

I think this is an important contribution to the “regressive” taxes argument:
http://worthwhile.typepad.com/worthwhile_canadian_initi/2007/06/why_focus_on_pr.html#trackback

Another point often forgotten is that VAT taxes imports but not exports and so ceterus paribus raises the value of the currency.

5

Peter 08.07.07 at 1:38 pm

I personally welcome VAT system, it is make to pay the tax correctly without any false accounts. Its also beneficial for high earners…
home contents insurance derbyshire

6

Pete 08.07.07 at 2:04 pm

VAT doesn’t usually apply to property, which has a big effect on disposable income.

7

Ted 08.07.07 at 2:07 pm

What other values of fun are there?

8

tveb 08.07.07 at 2:23 pm

Industrial capitalism arrived in the US before a real national state came into being, while the state preceded capitalism in France. The weak state in the US, and the willingness of business to ride roughshod over consumers, “led to an intense public interest in disciplining capital, which underpinned a movement toward income taxation that would punish capital and the wealthy.”

Except that other than the the property tax (which existed way before the founding of the U.S.; in fact that was partly how the seven years’ war was funded) the “direct taxation” system in the U.S. was consolidated after the development of considerable (national) state capacity[indeed, direct taxes in some ways presume an “intrusive state”]. (I guess the definition of “intrusion” or “strong state” is crucial here; there is also ample scope for circular arguments once you bring these definitions in) Other than that the argument seems plausible since the progressives did campaign hard for such a tax.
Also I would be careful with statements such as “the Weak U.S. state”, etc. Weak vis-a-vis whom? Maybe vis-a-vis business,but not weak at all from the perspective of labor leaders and strikers who felt the power of the state very frequently (labor history in the U.S. is pretty violent, starting from the early 1840s).

9

Cranky Observer 08.07.07 at 2:25 pm

Politicians love VAT because it is impossible for anyone other than a PhD in Accounting to figure out and thus allows them to tweak levers and dials to change revenues and reward/punish in ways that are impossible for voters to understand or even see.

Cranky

10

Yaron 08.07.07 at 6:16 pm

Cranky, what exactly is there to figure out in VAT, or to have too many “levers and dials” for?
VAT is, usually, just a “You pay 15% tax for everything you buy, and if you use what you bought to sell something else then you can get those 15% back” sort of thing (15% was an example, actual values vary). It’s possible to have different VAT rates for different types of goods, but it’s not always done, and I think even where it is done it’s not all that complex (e.g. lower VAT on food or other essentials)

11

Richard J 08.07.07 at 6:55 pm

It gets complicated when you consider issues of composite suppliers, partial exemption, the purchase of large capital items where the percentage of exempt supplies varies over the lifetime of the lease, the issue of opting to tax on buildings, and my personal new favourite, that the French tax authorities require to self-account for construction works (which can immediately be reclaimed on the same return, leading to no net payment, bar a 5% penalty for cocking up).

12

DAS 08.07.07 at 8:21 pm

Industrial capitalism arrived in the US before a real national state came into being

Is that true, though? Seems to me that the two worked hand in hand.

Proto-industrialist merchants wanting to be free to pursue economic strategies other than those conveniently deemed by the British to be to our “comparative advantage” were the key people who fought to establish our country in the first place.

The compromise by which corporations were allowed in this country was that they be regulated by the government.

The industrializing Northeast actually wanted a strong, tax-happy federal government (e.g. to impose protective tarrifs), which was opposed strongly by the agrarian South (ever hear of a little unpleasantness called the Civil War?). It was from this cauldron that the modern, national state came …

13

John F. Opie 08.07.07 at 9:15 pm

Hi –

I’m always amazed that there are people who think that VAT isn’t necessarily regressive.

Let’s take two families.

First family is 4 people, 2 adults, 2 kids. Father and mother both work, he as construction worker and she in retail at the local supermarket, cashier. Blue collar

Gross income: $36 000/year, $3 000 per month.

Second family: same situation, but white collar workers: father is accountant, mother is secretary.

Gross income: $60 000/year, $5 000 per month. They live next door to family 1.

Let’s ignore income tax for right now, as this is external to the discussion here.

Postulate a VAT of 20% for everything except food, which is 0%. Rent is also free of VAT.

Anything consumed besides food and dwelling has 20% added at every stage of value added in production (principle of VAT).

Let’s say that food costs take up $600/month, leaving $2400. Of that $2400, $1200 goes for rent. That leaves $1200 for everything else.

Of that $1200, both families spend $1000 on VAT goods. That’s $800 for the goods, and $200 for the VAT.

That leaves first family with $200 and second family with $1200.

Tax burden for first family is $200/$3000 or 5%; second family has a tax burden of $200/$5000 or 2.5%.

Lower-income is taxed at a higher rate than higher income.

That is regressive, by any way or sense of the definition of the word.

I have friends who have low incomes, and it is appalling what they are taxed: they also cannot avoid it. It is for many lower-income folks literally the difference between being in debt or being able to save money.

But the real reason that you have VAT is that it is very, very lucrative for the government, who also gains massive insights into who is doing what in the economy: they can cross-reference that to other tax reports and check to see if anyone is fudging the numbers.

Criminals love VAT as well: all you need is a bit of criminal energy and a couple of shell companies. I won’t go into details, but suffice to say that this has been one of the greater scams in Europe over the last several decades, and it is highly lucrative and rarely punished, but costs the EU taxpayers billions a year.

It’s a system that allows too much abuse by those with criminal intent, as well as providing politicians with too large a revenue stream. I find the US approach better: add the tax ex post facto, and people start to realize their tax burden. Include it in the price, and people ignore it and never realize how much is taken (sure, you can figure it out: no one ever does).

14

Sebastian Holsclaw 08.08.07 at 2:33 am

“Include it in the price, and people ignore it and never realize how much is taken (sure, you can figure it out: no one ever does).”

For many here I suspect that is a feature, not a bug.

15

Jon 08.08.07 at 5:13 am

I think we don’t see VAT in the US because most who look think it’s not working so well in the UK. It’s a terrible burden to figure the wrinkles of, especially for small business. If web firms had to pay VAT here, it’d probably triple some companies’ administrative overheads.

Another problem is that it discourages high-value-added products, which is where alot (most?) of the good money and jobs are.

16

Yaron 08.08.07 at 11:06 am

John F. Opie, are you seriously claiming that:

A. A family with almost double income will spend the same amount on food every month, buying the same basic products the family with less income does?

B. A family with almost double income will not buy anything more than the family with lower income does each month? No extra purchases of luxury goods, or nice to have but not essential things?

C. The leftover money both families have will never go into buying anything, so VAT will not be paid with it eventually? And that this money that will never be used to consume actually gives the higher income family anything beyond what the lower income one has?

D. If it is used for consumption sometime, well, what happens next month, when the high income family will buy a new HDTV set (or whatever) with their saved 2400$, giving them savings of 0$ and an extra 480$ of paid VAT, while the lower income family will have savings of 400$ and have paid 480$ less VAT over the two month period? That’s a progressive tax right there, isn’t it? High income family has paid a lot more VAT.

17

Yaron 08.08.07 at 12:33 pm

Err… My D point actually wasn’t a part of the first three, and is a separate issue built on them.

18

reason 08.08.07 at 2:14 pm

Excercise follow the link I gave in #5. One tax isn’t the whole tax/expenditure system.

19

terence 08.08.07 at 9:09 pm

I’m just curious – what’s the practical difference between the sales taxes that most US states have and VATs (or GST as it is called here in New Zealand)*

__________________________

*By the way, in New Zealand GST is levied on all goods, including basic food items.

20

John F. Opie 08.08.07 at 10:43 pm

Yaron –

No, I’m not saying that higher income folks don’t consume more, this was a Gedankenexperiment.

My point is that taxing consumption is necessarily regressive, as those with low incomes pay a significantly higher rate of taxes for basic necessities. I have friends here in Germany who earn a fraction of what I do, but our lifestyles aren’t all that different: I prefer a simpler lifestyle and don’t indulge, preferring instead to invest my surpluses.

Let me take the example of someone we’ll call H. She works in health care as a nurse, doing house calls for the elderly. Her gross is around €3400, take home pay is around €2400. She pays €800 for her apartment, leaving €1600. She has two teenage daughters and between the three of them they spend around €1500/month, leaving €100 for savings.

VAT of 20% on that €1500 is €300 in taxes, €300/€3400 is around 8.8%.

Let’s take my friend K. He’s a programmer and earns €6000/month. He’s married and his wife doesn’t work, one kid. He lives two apartments above H, pays the same rent, and is a frugal fellow. Spends €1700 for the three of them, saves the rest. VAT on €1700 is €340, €340/€6000 = 5.7% taxation.

If there were no VAT, my friend H would be able to save €400 and not €100. My friend K would save even more. H could consume more (and probably would, while K probably wouldn’t, since his level of consumption is already higher.

Sure, K is paying more VAT than H. But his rate of taxation is lower, and for higher wages earners to be taxed at a lower rate than low wage earners is the very definition of being regressive.

You can try the scenario where consumption increases at the same rate, but that’s not the real world. Higher income does not necessarily bring significantly higher expenditures, as people’s life styles don’t necessarily change when their income levels do. I know that mine haven’t, and I live well under my means. Your mileage may vary.

21

Yaron 08.09.07 at 10:00 am

John,

First, specifically for your example, K is frugal, and you too describe yourself like that. So yes, I agree that frugal people pay less immediate taxes on consumption than non-frugal people.

K could have saved a little bit more and paid the same immediate VAT as H. Or you could have added a person N who earns a little bit less than K (say 5800 a month?), but is not frugal and spends 3000 on living well by his means. Presto, VAT is a progressive tax!

Which is to say, I don’t think specific examples and cases are good reflection on how a tax affects people in general. You can find real world examples that go either way.

And there’s still a large point of what is it that you do with your savings. There is no VAT exemptions for when the payment is done out of saved money rather than from same-month income.

At some month K is likely to dip into his savings and buy something. A new car? A new house instead of the apartment he has? He’s going to pay VAT on it. So, new car for 10,000 pounds, VAT comes to 2,000 pounds. 2000/6000 is around 33%.
If both H and K pay the same rate of income tax, he takes about 4200 home every month. After spending 1700 he saves about 2500. So it takes him four month to afford the car.
After four months he has no money saved, and paid in VAT a total of 340*4+2000=3360.
After those same four months H still saves money (400 saved), and paid a total of 300*4=1200 in VAT.
As percentages of total salary over four months, K paid 3360/24000, about 14%. H paid 1200/13600, about the same 8.8% of course.
A progressive tax if I ever saw one.

if H also used her savings to buy something, for 400, she’d still only have paid about 9.4% VAT for the same period.

Well, income tax counts, of course. Since you consider VAT as percentage of gross income rather than net income.
But income tax is all that counts, since the VAT applies to all consumptions, and eventually people consume everything, including savings.

If you put your money into savings, and never ever ever do anything with it besides keep saving it, then it’s not realistic to consider you as better off than someone who consumes the same as you each month but doesn’t save anything…

22

uptown 08.09.07 at 7:03 pm

A major problem with implementing a VAT in the USA is that many states/counties/cities already sales tax as their major revenue source. In Seattle we’re paying 8.9%.

23

John F. Opie 08.09.07 at 7:06 pm

Yaron –

You’re begging the question: the question is not “do people who consume more pay more VAT?”

The question is whether, ceteris paribus, whether VAT is regressive: differing income and same consumption, it is regressive. Differing income and differing consumption, it depends.

And if you include income tax, it gets vastly worse, not better, as lower incomes are taxed in Germany as well: it’s a known problem in the German tax system that past a certain pitiful amount, the tax burden jumps from basically 0% to around 15%, making entry-level jobs hard to justify taking instead of living off of Hartz IV. Someone earning like my friend H is making only 1-2 €/hour more than someone on the dole, meaning that she’d actually be better off not working at all.

The point is that people in low income conditions spend all they earn, basically: those with higher incomes don’t. If things were progressive, then those with higher incomes would pay more VAT, not proportionately less: those with higher incomes who can afford to save and must not necessarily consume all that they earn tend – depending on the circumstances – to pay less VAT as a proportion of their income over time.

Put it this way: if you were to move the VAT from 20% to 25%, the effect on high-incomes is there, but minimal, while the effect on low-income cohorts is devastating, since they already consume all that they earn and cannot afford their lifestyle anymore. And that is real-world: it means doing without because the VAT has been raised, while those better off can simply shrug it off as an annoyance.

Sorry, VAT is and remains a regressive tax.

24

Harald Korneliussen 08.10.07 at 10:27 am

Off topic here, but…

John F. Opie, what’s with the “gedankenexperiment”? It’s a word I think I’ve never seen before, but two times on English sites today. It must be in the wind.

What happened to “thought experiment”?

25

John F. Opie 08.10.07 at 11:20 am

Hi –

Sorry, my bad: I live in Germany and my daily language is German, and I’d forgotten that “thought experiment” was in use.

26

Keith M Ellis 08.10.07 at 4:43 pm

I’ve probably seen the word gedankenexperiment for almost as long as I’ve been literate. That’s not to say that my experience is normative. But its opposite isn’t, either.

27

Yaron 08.12.07 at 1:20 pm

John, my point is that we can’t really change the income and keep consumption. That’s not a realistic scenario, so nobody in the “real world” should care about it enough to let it affect politics.

Income that is not consumed goes into savings (or paying back for loans, but for this case it’s like saving backwards in time). The purpose of savings is to spread/move consumption. So it will be consumed, and VAT will be paid on it.

The VAT is the same whether the consumption was made directly, or after the money spent some time in savings.

Only taking into account the VAT paid from direct income, ignoring all purchases from savings, will indeed cause VAT to look regressive. But it ignores a large percentage of VAT payments. The people who saved money to later buy other (more expensive?) things *will* pay VAT on them.

Ignoring that is not really “ceteris paribus”, because in the long run people consume all the income, and VAT is considered to be instated for the long run. So by raising income, AND holding consumption to the save level for the sake of comparison, we’re not changing one thing, we’re changing at least two.

The level of consumption is not a pre-condition separate from income, it’s dependent on the income. We can’t hold it the same. Because by the same token we may as well say that when increasing income we’ll also hold the total amount of taxes paid to be the same. Thereby demonstrating that VAT has no regressive or progressive effects whatsoever, but that VAT will cause all higher income people to be guilty of heavy tax evasion.

That example is a bit extreme, but what if maybe instead of holding consumption we’ll hold savings when increasing income? Ceteris paribus, right? So savings should remain the same? Meaning that consumption increases for all the extra income, and the higher income person now pays relatively more VAT, and VAT is obviously progressive…
After all, holding savings isn’t any more far-fetched than holding income.

I do agree that the effect is much worse on the people whose income is low enough that they need to consume all of it on necessities. But that is not directly related to the progressive/regressive/neutral issue.

Even a very progressive tax, that still does not subsidize (or exempt) people in those income ranges, will have a worse affect on them in that regard, allowing them to consume less necessities. Even if they only have to reduce 1% of essentials, and high income people will need to cut 60% of their luxury items, you can make a statement that the low income people were more hurt at some basic level.
And they would be. But not because of any regressiveness of the tax.

Oh, as for “Gedankenexperiment”, it’s a term I’m familiar with as well. I think it’s long ago passed from being German to being a more global term. Feel free to use it outside of Germany.

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