Why Cruz’s tax plan could expand government

The clash began this month, when Rubio took aim at the business portion of Cruz’s tax plan. Cruz’s proposed “business flat tax,” Rubio said, is really a value-added tax, an “anti-free market idea” that would stealthily raise tax bills.

Cruz has denied that his proposal for the 16 percent business flat tax is a value-added tax, but it shares the key feature of a VAT, namely that it taxes products at each stage of production, rather than all at once at the point of sale. Rand Paul, another GOP hopeful, has embraced a similar idea.

Tax experts mostly agree that a value-added tax is an efficient way to raise revenue, as it taxes consumption rather than earnings or savings and applies to a broad base. The question for conservatives is whether Rubio is right that implementing a VAT will lead to more taxation and spending.

Many prominent conservatives have long warned it would. President Ronald Reagan said in 1985 that a value-added tax “actually gives a government a chance to blindfold the people and grow in stature and size.” He was referring to the fact that, unlike the income tax, workers don’t see the VAT come out of their paychecks, but instead pay higher prices and receive lower wages.

The other concern among conservatives is that the value-added tax gives Congress a new tool for raising taxes, one that can later be used by raising rates without voters realizing the full impact.

“That’s precisely why people like me are so terrified by it,” said Daniel Mitchell, a tax expert at the libertarian Cato Institute and prolific opponent of the VAT. “It’s not that I don’t trust Ted Cruz or Rand Paul … but I’m terrified of what President Chelsea Clinton will do if there’s a VAT.”

A piece of evidence often cited by low-tax proponents is that most European countries implemented VATs in the 1960s and now all have much larger governments than the U.S. does.

France, for instance, sports a 20 percent VAT, in addition to its high-income and corporate tax rates. Germany has a 19 percent VAT, and the United Kingdom 20 percent.

There’s a chicken-or-egg element to the line of reasoning that those VATs allowed their governments to grow. It’s possible that Europeans demanded larger safety nets and more government programs, and that governments responded by raising taxes through VATs.

“Without the higher taxes, none of it would be sustainable,” Mitchell said. Many European countries are on the wrong side of the “Laffer Curve” with their income and corporate taxes, he said, meaning that further rate increases would fail to raise more taxes — instead, people would work less or companies would produce less. Only the VAT allows governments to take as much money from the public as is needed to support an expansive welfare state.

It’s worth noting that Arthur Laffer, namesake of the Laffer Curve and former Reagan adviser, helped Cruz and Paul design their tax plans.

And the data on what has happened in Europe since the introduction of the value-added tax are tricky to interpret.

“The data’s a little fuzzier than the straightforward narrative that’s been swirling around recently,” said Kyle Pomerleau, a tax expert at the Tax Foundation, a research group that has analyzed the GOP candidates’ tax reform plans.

One of the few studies on the question, published in the National Tax Journal in 2006, found some evidence that governments with VATs raise more revenue, setting all else equal. But the authors also found that governments generally use the value-added tax to replace other forms of taxation that are less efficient. Overall, there was weak evidence that VATs caused a small increase in the size of government.

Pomerleau provided statistics to the Washington Examiner to illustrate the complexity. In particular, VATs in Europe have replaced other, less efficient taxes. Among developed nations, as indicated by the Organization for Economic Cooperation and Development, tax revenue from all consumption taxes has hovered around 10 percent of gross domestic product since the 1960s. Meanwhile, revenues from VATs, which are a subset of consumption taxes, have climbed from 0.7 percent of GDP to 6.6 percent, indicating that VATs have replaced other forms of consumption taxes, such as those on sales and gross receipts.

Over the same time, payroll taxes have risen, from 4 percent of GDP to 9 percent of GDP, indicating that the prevalence of value-added taxes is not driving growth, but rather that governments are responding to voter preference for more spending by raising taxes in general.

There are also several counterexamples to the idea that VATs increase the size of government among the 150-plus countries that have them.

For example, with total tax revenue at all levels of government equivalent to 19.5 percent of economic output, Mexico has less taxation than the U.S., which collects 26 percent, even though Mexico has a 16 percent VAT. Chile also has a 19 percent VAT but total tax revenues of 19.8 percent of GDP.

Canada also sports a federal-province VAT system that varies in rate depending on the province. Canada does raise more revenue from its citizens than the U.S. does, about 30 percent of GDP. That’s still less than the roughly 34 percent average for developed countries, however, and under Conservative Prime Minister Stephen Harper, the country lowered the federal rate.

For U.S. conservatives, however, Canada’s still-new experiment with a VAT, which began in the 1980s, is bound to result in bigger government, even if it hasn’t yet. That fear is part of the reason that George W. Bush’s 2005 President’s Advisory Panel on Federal Tax Reform stayed away from endorsing a VAT.

Part of the fear, too, said Mitchell, is that the plans from Cruz and Paul wouldn’t survive congressional sausage-making. Although they propose eliminating the corporate tax code and payroll tax system, Mitchell noted, it’s unlikely that Congress would go along entirely, leaving in place different tax-raisers that could be boosted in the future.

“No plan lasts beyond the first punch,” he said, paraphrasing the boxer Mike Tyson.