As Andrew Yang takes his place among the top 10 Democratic presidential candidates during a debate in Houston this week, the entrepreneur’s central campaign proposal — and the new tax he wants to use to pay for it — could soon come under increased scrutiny.
Yang plans to give every American adult $1,000 a month in universal basic income, as a way to offset job loss from automation. The first-time presidential candidate proposes paying for the monthly distributions, in large part, by implementing a new 10 percent value-added tax (VAT) on goods and services.
What is a VAT tax?
A VAT is similar to a sales tax or other consumption tax. It’s a percentage of the price that gets added on to the goods and services you buy at the store or online. But the way the tax is collected is different.
In a sales tax, the tax is collected only when a customer buys a product, “whereas, under a value-added tax, the tax is actually collected in stages along the production process,” Kyle Pomerlau, chief economist and vice president of economic analysis at the nonpartisan Tax Foundation, told the PBS NewsHour.
Here’s how it works: To make a T-shirt, a clothing company would buy fabric from a supplier for $5, for example. The supplier charges the clothing company the 10 percent value-added tax, or 50 cents, for a total of $5.50. The supplier then sends that 50 cents to the federal government.
Once the T-shirt is made, a clothing company sells it to a department store for $10, plus $1 in VAT, for a total of $11. The clothing company then gets a rebate from the federal government for 50 cents because it already paid 50 cents to the fabric supplier.
A customer then comes into the department store and buys the shirt for $20. The department store charges the customer the 10 percent VAT, or $2, for a grand total of $22. The department store will then get a rebate of $1 from the federal government because it paid the other $1 to the clothing company in VAT.
Notice that the total of the federal VAT of 10 percent on the final sale of the T-shirt has been collected along the way. The federal government collected its $2 from the $20 purchase (50 cents from the fabric supplier, 50 cents from the clothing company and $1 from the department store).
Under Yang’s plan, 10 percent would be the standard VAT rate, but some goods would be taxed at higher or lower rates: luxury items, such as yachts, would face a higher tax rate, while everyday items, such as groceries, would be exempt from VAT or taxed at a lower rate.
In the European Union, VAT also covers digital services, such as providing access to the internet, online gaming and web hosting services. It is unclear at this time whether Yang’s VAT proposal would cover those services, but Yang has cited VAT as a way for Google, Amazon and other big tech companies to pay more of their “fair share” in taxes.
Who uses a VAT and why?
A total of 168 countries use a VAT as of November 2018, according to the Organization for Economic Cooperation and Development (OECD). The U.S. is the only OECD country that does not. All of the EU countries implement different VAT rates, but they have to be at least 15 percent. At the same time, some of those goods and services, such as food, water and medicine, can be subject to a reduced VAT rate of at least 5 percent.
VATs were established in Europe in the middle of the 20th century because they could be administered to raise revenue easily “without distorting investment decisions or saving decisions,” Lilian Faulhaber, a law professor at Georgetown University, said.
While VAT creates an added cost to spending, some economists say because the tax is typically on most goods and services, it is hard to avoid and has less of an effect on consumer behavior than other taxes.
VATs are effective at raising revenues. In 2016, OECD countries earned, on average, more than 30 percent of their total tax revenues through consumption taxes, including VATs. The EU also reports that VAT is a “major source of tax revenue,” although the 28-member bloc reported collecting 137.5 billion euros ($151.7 billion) less in taxes than expected in 2017, likely due to VAT fraud and tax avoidance.
A 2018 report by the Congressional Budget Office estimated that implementing a 5 percent VAT on most goods and services in the U.S. would raise $3 trillion in revenue from 2020 to 2028.
Some critics worry a VAT would make it too easy to raise revenue and encourage lawmakers to expand the size of the government and increase spending.
Yang’s plan for a VAT “takes us right away to European levels of government spending,” David R. Henderson, an emeritus professor of economics at the Naval Postgraduate School and a research fellow at the conservative Hoover Institution, told the NewsHour. “A VAT to fund UBI (universal basic income) then gets rid of our degrees of freedom to deal with the deficit.”
The left also criticizes VAT. Progressive economists call it a regressive tax — one that costs lower-income people more than the wealthy. While everyone is taxed at the same 10-percent rate under Yang’s proposed VAT, low-income earners will spend a higher percentage of their income paying the tax.
Dorothy Brown, a law professor at Emory University School of Law who has written extensively on the effects of the federal tax system on race and class, said Yang’s plan, at this point, raises questions more than answers.
“If I’m low-income and I’m getting this extra $12,000 a year, how much of that am I going to pay out in VAT?” she asked. “Does it apply to the types of goods that you see low income taxpayers more likely to purchase?”
And, to the extent that communities of color are disproportionately poor compared to white communities, a VAT may hurt communities of color more.
“The devil’s in the details,” Brown said. “A VAT on all goods and services is basically taking money out of the pockets of the people you’re trying to put the money in.”
Yang writes in his book, “The War on Normal People,” that a VAT would “generate income from the people and businesses that benefit from society the most.”
A VAT “makes it much harder for large companies, which are experts at reducing their taxes, to benefit from the American infrastructure and citizenry without paying into it,” Yang writes.
Yang argues that while a VAT would mean “slightly higher prices,” advances in technology mean prices for most items will come down because the cost to make them will be cheaper.
Do the numbers add up?
Pomerlau ran the numbers on VAT and Yang’s universal basic income proposal in July. He found that Yang’s current proposal — which would be funded by VAT, as well as by lifting the cap on maximum earnings subject to social security taxes, creating a financial transactions tax, imposing a carbon tax and changing the tax rates on capital gains and carried interest — would not add up.
He estimated the tax increases Yang is proposing would raise $1.3 trillion total, of which more than $950 billion would come from a 10 percent VAT.
That would not be enough to pay for the $2.8 trillion that Yang’s proposed universal basic income would cost each year, according to the analysis.