It might be hard to believe, but once you get past the political theater of the current presidential campaign, the remaining candidates have actually managed to disclose some level of detail on what their tax plans would look like if they were elected. Unfortunately for Senator Ted Cruz (R-TX), who dropped out of the race this week, he won't get to enact one portion of his plan that had been generating a great deal of intrigue among tax professionals and academics who study tax.
Before bowing out, Cruz had introduced his tax plan as a "simple flat tax," which he says will help create 4.9 million new jobs and help him abolish the IRS as we know it. Despite his best efforts to pitch this concept as a brand new tax model, the Cruz plan was actually a value-added tax (VAT), which is very common in virtually every country in the world, with the notable exception of the U.S.
As its name would suggest, value-added tax is consumption-based tax that is applied at each point in the production and sale of goods whenever value is added. So if you were manufacturing a car, each step of the supply chain is taxed whenever value is added, such as when a steel company sells material for the frame, rubber is sold to produce tires, etc. Expenses at each leg of the chain are used to offset the tax.
Most of the world uses this type of tax. In fact, the United States is the only country that belongs to the Organization for Economic Cooperation and Development (OECD) that does not have one. Cruz's tax plans called to change all that, though without specifically naming it a VAT. My colleague Joe Harpaz recently described the business implications of this portion of Cruz's plan.
"Cruz is calling his business transfer tax concept a 'business flat tax,' but it is actually more complex than that. Some commentators have referred it as a value-added tax in disguise because it is a broad tax on the supply chain, rather than a tax on corporate profits. Cruz explains it as 'gross receipts from sales of goods and services, less purchases from other businesses, including capital investment,' which, in tax geek circles, is known as a tax-inclusive subtraction-method value-added tax."
I recently spoke with Michael Graetz, an Alumni Professor of Tax Law at Columbia Law School and a leading expert on national and international tax law. He has written many books on federal taxation, including a leading law school text, as well as more than 60 articles on a wide range of tax, international taxation, health policy, and social insurance issues. He concurred with Harpaz and said Cruz's plan clearly includes a VAT, even if he doesn't refer to it by that name.
"It's a value-added tax. All the experts know it's a value-added tax," Graetz said. "Cruz probably knows it's a value-added tax, though he'd be the last one to call it one."
So why did Cruz try so hard to distance himself from the term? Graetz explains that while a VAT certainly isn't as lethal a third rail as, say, social security, there's certainly lore about it being a candidate killer in American politics.
"President Nixon actually thought about adding a value-added tax shortly after the European countries had adopted them. He was in a meeting, and Dale Bumpers who was governor of Arkansas, stood up and said, 'Sales taxes belong to the states, they're the state's sources of revenue, and the federal government shouldn't get involved.' Nixon backed down fearing he would lose favor of the governors, who had much more sway back then," Graetz told me.
He continued to say that, back in the 1980s, a Democrat named Al Ullman (D-OR), who was chairman of Ways and Means Committee, talked about adding a VAT, and shortly after that he lost his election. He lost because he wasn't spending any time of his district, but the legend became that he lost it on the VAT, so that ultimately made politicians even more squeamish about publically embracing a VAT.
Still, Graetz doesn't believe a VAT is something to shy away from. While he disagrees with almost all of the tenets of Cruz's plan (such as instituting a flat individual income tax rate of 10 percent, eliminating payroll taxes, and replacing the current corporate tax structure with a 16 percent rate, all while calling for the abolition of the IRS), he doesn't believe the inclusion of a VAT is the problem. In fact, he adds there are tremendous benefits to the tax when done properly.
"The benefits range from tax-free savings that spur economic growth to lower waste in the form of tax compliance cost," Graetz added. "Not to mention that it's far less easy to evade. You can't evade it by moving capital."
That's right, a VAT could actually make a dent in the corporate tax inversion problem, as it may reasonably allow the U.S. to lower the corporate tax rate without depleting the country's tax coffers.
"Take a corporation that's now operating abroad and selling abroad; any company that's producing consumer goods," Graetz said. "If they're producing them here, they're not taxed at all in the U.S., and they wouldn't be taxed on any sales from their sales abroad. It would tax imports, but there's be no reason not to be a U.S. company. There'd be no reason for corporates to move their headquarters abroad."
Ending inversions may be reason enough to give VAT a try in the continental United States (it's worth noting Puerto Rico recently instituted a VAT of their own), but now that Cruz is officially out of the race, his chances of bringing it to fruition have gone by the wayside. Maybe a different Presidential hopeful will take up the ghost. Or, perhaps the VAT will continue its legacy as a kind of Black Widow of tax policies.