The Simmering VAT

ONE of the hottest economic debates this election year crackles round a measure that President Nixon has been conspicuously flirting with but has not yet openly embraced: the value-added tax. A kind of national sales tax that is imposed on most goods and services, VAT is a big revenue raiser in Europe. West Germany, for example, collects 25% of its government's money from it. By adopting VAT, the U.S. could ease its crushing problem of raising funds for urgent social needs from a revenue base that has been steadily diminished by income tax cuts.

For the moment, President Nixon has not formally proposed VAT because he is aware that any new tax would meet hard opposition from Congress and from voters, who are already up in arms over the tax load. Treasury Secretary John Connally has said that the Administration has no plans to recommend any new taxes this year. Yet VAT has been under serious consideration for months, and White House aides have been floating the idea in what amounts to a test-marketing program among Congressmen and state and local officials. The possibility that a form of VAT will be imposed at some future date has raised a clutch of fundamental questions about the whole creaking tax system in the U.S.

Bucket Brigade. One idea being weighed in Washington is that VAT revenues ultimately would go to states to help pay for public schooling costs, and thus lighten the load on home owners, who pay for education out of their heavy--and increasingly unpopular--property taxes. In sum, Nixon could promise during his election campaign to reduce property taxes and then make up for this loss by proposing VAT after the elections. The Administration calculates that in order to reduce or stabilize the residential property tax by eliminating that part of it devoted to schools, it must raise about $12 billion to $13 billion. White House staffers have discussed a plan to raise about $18 billion a year, which would require a value-added tax of approximately 3% on most goods and services.

Basically, the VAT system collects a percentage of the price that is added to a product at each stage of production and marketing. It also enables businessmen to pass the entire cost of the tax along, bucket-brigade fashion, until it gets to the consumer.

A theoretical example:

A lumber mill produces a load of wood with a market price of $25; this price represents practically all the "value" that the mill has added to the raw timber by buying and converting it to lumber. On a VAT of 3% the mill pays the Government 75-c-. This cost, separately invoiced, is tacked to the price of the lumber, which is then sold to a cabinetmaker for $25.75. The manufacturer transforms the lumber into a cabinet, increasing its market value from $25 to $75. On the $50 value added, the cabinetmaker pays another 3%, or $1.50. When selling the cabinet to a wholesaler, he will add to the price his own tax cost, plus the 75-c- VAT that he paid the mill. The wholesaler will pass on his own tax costs along to the retailer in the same way. Ultimately the 3% tax is absorbed by the consumer, so that a cabinet with a normal retail price of $100 would cost $103 (see chart).

Softening the Blow. Critics of VAT, notably liberal Democrats and labor leaders, argue that it would be an unfair tax that would put an undue burden on the poor and lower middle class. Senator Edmund Muskie has characterized any national sales tax for the purpose of reducing property levies as "a tax that will make you pay more every day so you can pay a little less at the end of the year."

Some economists see the possible use of VAT in the U.S. as part of a longer-term shift away from progressive taxes on income (which hit the rich hardest) and toward a regressive tax system. Sales, excise and even Social Security payroll taxes are regressive because rich and poor alike tend to pay the same. Tax Expert Joseph Pechman, a member of TIME'S Board of Economists, argues that instead of adopting VAT, it would be fairer and more effective to increase income tax rates and close off loopholes.

To soften VAT's harshly regressive features, Administration officials have talked about giving rebates to the poor and lower-income groups, who must spend a larger percentage of their incomes on essentials like food and shelter than those in higher-income brackets. Opponents argue that in practice rebates would do little to help the lowest-income people; most of them would not bother to file for the money. Moreover, the rebate would not fully compensate the poor for the increase in their living costs caused by VAT. Opponents also contend that VAT would be inflationary in more ways than one. For instance, because VAT would push up prices on everything from electric light bulbs to power saws, a certain amount of additional inflation would seep into operating costs and be reflected in price increases above those caused by VAT itself. In addition, in calculating prices, most sellers would tend to round the figures up instead of down, giving living costs another upward nudge. In The Netherlands, where VAT was started in 1970, prices rose by an average of 9% in three months.

Advocates of VAT note that it would enable the Administration to raise money without adding to corporate or personal income taxes. VAT is also almost impossible to avoid and inexpensively easy to collect. Moreover, VAT would not burden exports because, unlike direct taxes, it can be rebated under the rules of the General Agreement on Tariffs and Trade.

Beyond any economic advantages, VAT has strong political allure for President Nixon. For one thing, the cost of VAT is hidden in the price. Asked why increasing the income tax was rejected, one Government tax expert replied: "It shows." Businessmen, who form a part of the President's natural constituency, generally would favor VAT as a substitute for increases in corporate income taxes.

Despite VAT's critics, the idea of using it to pare property taxes would probably be welcomed by millions of home-owning voters. If the President adopted that notion as part of his future programs, the Democrats could find it difficult to attack without offering some alternative equally attractive to the home-owning middle class. Democratic House Ways and Means Committee Chairman Wilbur Mills, the most powerful Congressman in tax matters, has always opposed the idea of VAT. But even his resistance is waning. Says Mills: "If Nixon couples it to the area of school property taxes, I'd have to look at it again."

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