Rand Paul, Daniel Mitchell, and a VAT?

Daniel Mitchell, a libertarian economist and Senior Fellow at the CATO Institute, offered an overall positive review of [mc_name name=’Sen. Rand Paul (R-KY)’ chamber=’senate’ mcid=’P000603′ ]’s tax plan that was released today. He had three minor quibbles and one major concern with the proposal. It his his evaluation of [mc_name name=’Sen. Rand Paul (R-KY)’ chamber=’senate’ mcid=’P000603′ ]’s 14.5% business activity tax that is the interesting point for discussion — Mitchell asserts is a Value-Added Tax (VAT) for all intents and purposes.

Paul’s argues that he “would also apply this uniform 14.5% business-activity tax on all companies…. This tax would be levied on revenues minus allowable expenses, such as the purchase of parts, computers and office equipment. All capital purchases would be immediately expensed, ending complicated depreciation schedules.”

As Mitchell points out, the high corporate tax rate (35%) would be reduced down to 14.5% which is obviously a great thing. His bone of contention is the “business-activity tax doesn’t allow a deduction for wages and salaries” and therefore, “he is turning the corporate income tax into a value-added tax (VAT).” In theory, he argues, a VAT would not be a terrible thing because “is a consumption-based tax which does far less damage to the economy, on a per-dollar-collected basis, than the corporate income tax.”

However, the VAT’s place in other economies have proven to be, as Mitchell suggests, “a money machine for big government”, and therefore Mitchell cautions against its implementation in the United States.

Mitchell contends,

“The VAT helped finance the giant expansion of the welfare state in Europe. And the VAT is now being used to enable ever-bigger government in Japan. Heck, even the IMF has provided evidence (albeit inadvertently) that the VAT is a money machine. All of which helps to explain why it would be a big mistake to give politicians this new source of revenue.

Indeed, this is why I was critical of Herman Cain’s 9-9-9 plan four years ago. It’s why I’ve been leery of Congressman [mc_name name=’Rep. Paul Ryan (R-WI)’ chamber=’house’ mcid=’R000570′ ]’s otherwise very admirable Roadmap plan. And it’s one of the reasons why I feared Mitt Romney’s policies would have facilitated a larger burden of government.

These politicians may have had their hearts in the right place and wanted to use the VAT to finance pro-growth tax reforms. But I can’t stop worrying about what happens when politicians with bad motives get control. Particularly when there are safer ways of achieving the same objectives.”

Mitchell gives an alternative suggestion for reforming the corporate part of the tax code. He calls for “an incremental reform”, consisting of the following:

–Lower the corporate tax rate
–Replace depreciation with expensing
–Replace worldwide taxation with territorial taxation

His suggestion is that if there is enough support within Congress to potentially reform the corporate income tax (and replace it with a VAT), there should also be support for an alternative reform done incrementally, which would be far better in the long run than introducing a VAT for good.

So are Mitchell’s concerns about Paul’s “business activity tax” valid? Is it essentially a VAT? Pretty much. The VAT gets added to products along the way in the process of production and distribution, and is ultimately passed on to the consumer in the form of the final price.

One could certainly argue that the VAT is not a positive solution for reasons such as the fact that European economies which have the VAT are also in shambles. Also, though many of the VATs started out small, most VATs average nearly 20%. That would likely happen here too — while we still continue to collect an income tax. What’s more, it also tends to disproportionately affect small businesses because they often can’t pass along the cost increases associated with the VAT, and compliance will be burdensome and expensive.

Overall, though, Mitchell was pleased with [mc_name name=’Sen. Rand Paul (R-KY)’ chamber=’senate’ mcid=’P000603′ ]’s plan, which is to be expected from a fellow libertarian economist. His points about the business activity tax are fair, but Paul’s roadmap is overall a decent one.