The Case for Flat Consumption Taxes
The BTT is back in the news.
A BTT, or business transfer tax, is a flat-rate consumption tax collected at the business level. Both Sen. Ted Cruz and Sen. Rand Paul have included one in their presidential platforms.
Supporters call it a business activity tax or business flat tax. Critics call it a value-added tax (VAT). They view this as undesirable because they think a VAT would make tax hikes easier to implement in the future. Unlike income taxes or sales taxes, consumption taxes collected at the business level, like all business-level taxes, are not immediately obvious to the people who ultimately pay them, in this case primarily the businesses' customers and owners. Both the Cruz and Paul plans repeal employer payroll taxes and corporate taxes, which raise the same concerns.
The BTT is, indeed, economically equivalent both to a VAT and to other consumption taxes such as the flat tax and the national sales tax (often called the FairTax). They all tax the same tax base, and they all tax capital and labor equally. But if the BTT is a VAT, it's unlike any VAT ever seen. Administratively, it functions much more like the corporate income tax or the flat tax. And in general, flat-rate consumption taxes — whether they're called “VATs” or not — are dramatically superior to our current system of taxation.
European VATs (and the Canadian and Australian versions) are administered somewhat like a sales tax: on a transaction-by-transaction basis. Businesses must pay the VAT on all of their sales, but they get a credit for the value-added tax paid on the inputs used to produce the goods and services they sell. The credit avoids cascading taxation, where a tax is imposed on a tax again and again before the product reaches the consumer. By contrast, under the BTT, businesses would simply pay a tax on their gross revenues, minus what they paid to other businesses for their inputs, when they filed their quarterly and annual tax returns.
The BTT is different in one important respect from the flat consumption tax that free-market advocates have championed for decades. In 1983, economists Alvin Rabushka and Robert Hall developed the Hall-Rabushka flat tax, later promoted by then majority leader Dick Armey and by Steve Forbes. Under Hall-Rabushka, businesses deduct wages on their tax returns; then wages, and only wages, are taxed on individuals' personal tax returns. In other words, the old flat tax taxes capital at the business level and labor income at the individual level. Under a BTT, by contrast, wages are not a deductible business expense. A BTT therefore taxes both wages and capital at the business level.
Replacing the current income tax with a flat-rate consumption tax would simplify the tax system considerably. It could also increase the size of the national economy by about 15 percent over a decade. That growth results from eliminating the double taxation of savings and investment, dramatically reducing marginal tax rates, and dropping the plethora of existing special preferences, deductions, credits, and exclusions. These reforms would boost employment, real incomes, and tax receipts. Higher employment and higher incomes will substantially reduce state and federal spending on income-maintenance programs.
These positive economic effects have inspired a number of BTT proposals over the last two decades. They include the 1995 USA Tax plan of former Sen. Pete Domenici, R.-N.M.; the 2005 BEST Tax proposal by former senator Jim DeMint, R-S.C.; and the plan from House Speaker Paul Ryan's 2010 Roadmap for America's Future.
Ultimately, it's largely unimportant whether you call the BTT a VAT or some other name. At the end of the day, a BTT, a flat tax, and a sales tax are all flat-rate consumption taxes. As a replacement for the income tax, they would all have a dramatic, positive impact on economic growth and the real incomes of the American people.
Any of them would constitute a huge improvement over the current tax system. And any one of them deserves very serious consideration.
David R. Burton is senior fellow in the Heritage Foundation's Thomas A. Roe Institute for Economic Policy Studies.