US Ted Cruz’s “VAT”
As Ted Cruz emerges as one of the leaders in the Republican Presidential Nomination race, his radical tax proposals are coming under scrutiny. These seek to unblock the log jam around US tax reform which has made little progress since the last major changes in the 1980’s.
Simplifying US tax
The Texan Senator’s tax package looks to pivot tax away from income towards consumption since some believe this is better for investment and savings. It includes scrapping: corporate income tax; estate tax; gift tax and employer payroll taxes. In their place, he would in set income tax at a flat 10%, and introduce a new tax on companies at 16% (rivals argue it is 19% when grossed up). Cruz claims his ‘flat tax for economic growth’ would be levied on company turnover less costs to suppliers, employees and charges on capital (e.g. interest).
Cruz’s aim is to simplify one of the world’s most complex tax regimes, with a myriad of rules, exceptions and loopholes.
A VAT wolf in sheep’s clothing?
Many of Cruz’s critics have labelled his tax as a VAT regime. The fear in the Republican party is that whilst the tax is on companies, it would passed onto consumers, like VAT which is charged on individuals as is tax neutral for business.
The Democratic party have long suspected that VAT falls disproportionately upon the poorest in the population who cannot avoid paying when levied on essentials. Although supporters of VAT claim this can be alleviated through the use of nil/reduced VAT rates, and targeted welfare support which is more cost-effective at helping the poor.
Others have attacked his tax as potentially enabling companies to raise prices above the 16% or 19% level since, unlike VAT, companies will not have to disclose to the consumer what element of the price is tax. The introduction of VAT in many countries has historically led to big jumps in inflation as retailers have exploited the opportunity to hike prices by more than the in-coming VAT rate. There are also questions about the amount of funds the tax reform would raise, and if there is a major shortfall.
Since Cruz’s tax is a direct tax on companies, it probably cannot be correctly termed a VAT levy. VAT is an indirect tax charged on the final consumer.
Why VAT is popular
Over 140 countries now operate a VAT regime. Some of the reasons for its popularity with governments include:
- It is easy to collect since companies act as unpaid tax collectors
- It is hard to avoid since consumption is taxed in real time, and complex corporate structures cannot shift taxable amounts to other territories
- It funds cuts in corporate income tax which can attract fluid global corporations which create employment opportunities
- Exports are VAT free, so are artificially boosted since they are subsidized by VAT-bearing domestic consumption