It’s a banality among progressives in the United States to observe that we collect too little in taxes, spend too little on government programs, and consequently enjoy the least-generous welfare state, lowest life expectancy, and worst government services among our peer countries. And this is, as far as it goes, true: there’s no obvious reason a country with the per capita income of Switzerland should have the life expectancy of Costa Rica.
The problem, we are assured, is that while developed social democracies raise 30%, 40%, or 50% of GDP using broad-based value-added taxes, the United States is hobbled by its antiquated income tax system. If we want a European welfare state, we need a European tax state, right?
What makes someone rich?
In Soviet Russia, the most beloved humorists were a pair of journalists, universally referred to as Ilf and Petrov, and their most beloved character was Ostap Bender, a con artist. In “The Little Golden Fleece,” the second Ostap Bender novel, their hero hears a rumor of a Soviet citizen who has accumulated one million rubles, and he decides to find and rob the man. Without ruining too much of the plot, the hero succeeds, only to realize, to his horror, that there’s nothing you can actually do with a million Soviet rubles. Every hotel room is reserved for party functions, every restaurant is reserved for factory employees, every car is reserved for high-ranking officials. He has a million rubles and he can’t spend a single one of them.
This is a useful frame of reference for thinking about the ideologues of the VAT: a person is not made rich by how much they earn, nor by how much they save, invest, or own. A person is made rich by how much they consume. Just like Ostap Bender, a person who earns a million dollars per year but who only spends $20,000 of it isn’t really any better off than a person who earns $20,000 per year and spends all of it.
Unfortunately for the ideologues, Americans have never believed this.
Americans believe that what makes you rich is money
At the federal level in the United States, we mostly do not tax consumption. There are exceptions, and I don’t want to trivialize them. Tariffs are a form of taxation on the the consumption of imported goods. We have federal excise taxes on gasoline, tobacco, and alcohol, which are obviously included in the prices consumers pay.
But the overwhelming majority of federal tax revenue is not raised by taxes on consumption. Instead, it’s raised by taxes on profit. That means, unlike in the social democracies of Western Europe, our taxes are based on how much you earn, not how much you spend.
At the corporate level, this calculation can be quite complicated, but the underlying principle is that taxes should be paid on “what’s left” after deducting all your expenses.
At the individual level, for most workers the calculation is a lot simpler, but the fundamental principle is the same: you pay taxes based on how much you earn.
This is because Americans understand, in a way that is fundamentally different from the people of many other developed countries, that the thing that makes you rich is having money. Warren Buffett is not rich because he eats caviar every night in a jacuzzi full of champagne while being serenaded by the original cast of “Hamilton;” he’s rich because he owns assets worth $100 billion.
The backdoor VAT is swallowing the tax code
Given that Americans do not actually believe in the idea of financing the government with nationwide consumption taxes, you might assume the idea is as theoretical as a North American cricket league. But this would be to underestimate the resiliency of a bad idea.
What we have instead is what I have started to call the “backdoor VAT:” a flattening of the income tax code, combined with deductions for an ever-expanding array of expenditures.
The flattening of the income tax is no mystery: the Republican Smash-and-Grab Tax Act of 2017 lowered the corporate income tax to 21%, raised the standard deduction, widened personal income tax brackets and lowered the top rates on the highest incomes.
But less noticed is the way that tax-advantaged accounts have come to carve out more and more income for permanent tax exemption.
In countries financed through VAT’s, lots of sectors are naturally excluded from the tax: when you’re treated for free at a NHS clinic in the United Kingdom, they don’t add VAT to your (nonexistent) bill. When you pay tuition at the University of Lausanne in Switzerland you don’t see a separate VAT charge.
Tax-advantaged accounts in the United States function identically: they are a way of asserting that certain expenses “shouldn’t count” as part of your income. If you’re saving for education in a 529 account, that’s not “real” income, so you should get a deduction, and your capital gains should be tax-free. If you’re saving for retirement, that’s not “real” income, so you shouldn’t pay taxes on your savings now or ever. If you’re saving for medical expenses, it wouldn’t be fair to tax you on that income, since you’re not spending it on something frivolous, after all. Even money you spend on childcare isn’t “real” income, since you’re not spending it on yourself; help yourself to a deduction.
There’s nothing wrong with VAT’s, but they’re wrong for us
At this point in the argument, you typically hear that what “really” matters is the overall progressivity of the entire structure of the state, including both taxes and expenditures. A flat consumption tax, which is by definition regressive (since low-income people spend a higher percentage of their income than high-income people), that finances a progressive welfare state can easily wind up being more progressive than a progressive income tax that finances a stingy welfare state.
This is correct: the overall progressivity of the state is what “really” matters. But making the federal income tax less progressive mechanically reduces the overall progressivity of the state. It’s of course possible to make up that difference through an even more progressive spending agenda: that’s the model pursued by our European peers, and God bless them.
But to say the only way to raise enough money to provide universal health care, tuition-free higher education, or a carbon-free energy system is to allow the wealthy to keep even more of their money is not just to miss the point, it’s downright un-American.
A progressive income tax and a progressive welfare state aren’t mutually exclusive, they’re two great tastes that taste great together.