The VAT Issue: Will A VAT Increase Size Of Government
Since the current level of budget deficits in the United States is in the long run unsustainable, the discussion has begun of how to close the deficit. Imposing a federal VAT is one possible way to close it. I will in a number of posts (this being the first one) analyze the effects of a VAT.
The key counter-argument against it among advocates of limited government is that it will prove to be a "money machine" for the government that will expand the size of government. Is this argument true?
In short: Yes.
One reason for this is that a VAT is "efficient" in the sense that it will be effective in raising revenue. The fact that retailers can deduct VAT paid by its suppliers reduces the incentive for tax evasion compared to sales taxes. Another reason is that it is more politically easy to have several taxes (income taxes, payroll taxes and consumption taxes like the VAT) each having moderate rates than a single tax with a high rate, as each tax seems less burdensome even if the total burden is the same. A third reason is that "hidden taxes" like payroll taxes and consumption taxes are perceived as less real than direct taxes like the income tax.
On an anecdotal note, I have personally in discussions heard many Swedes say that they pay only 30% in taxes. 30% was the income tax rate applied at the time for them, meaning that they thought that they didn't pay any payroll taxes or consumption taxes.
Casey Mulligan however argue that the hidden nature don't matter, using a scatter plot which seemingly show no relationship between public pension payments and the amount of payroll taxes which are hidden. But his comparison is highly problematic for a number of reasons, not least the fact that this is linked to a defined benefit, which is probably more politically popular than general funding for government, which is what VAT would be about.
Tino Sanandaji has a more relevant comparison, namely between the proportion of all taxes that are visible and the total tax burden. He finds that there is a positive relationship. The relationship isn't perfect, but since there are always other factors involved, no causal relationships have a "perfect" empirical relationship between causal factor and aggregate phenomenon it contributes to.
In a previous post, Sanandaji found a link between the level of VAT and the level of total taxation.
In conclusion, based on the theoretical and empirical evidence, accepting a VAT will all other things being equal contribute to an expansion of the size of government, though the effect might not be dramatic.