George Gibbs Center for Economic Prosperity

2010 December – Federal VAT Would Be Bad for Flor⁠i⁠da

By: The James Madison Institute / 2010

Federal VAT Would Be Bad for Florida
By Dr. Randall Holcombe
As printed in the St. Petersburg Times, December 29, 2010
One idea circulating through the Capitol is the implementation of a national value-added tax, or VAT. This truly harmful tax would have a significant negative impact on all states, but the pain would be even greater for places like Florida. With the federal debt now topping $14 trillion – almost 100 percent of the country’s economic output – Washington is searching the couch cushions for spare change and new sources of revenue to make it easier to balance the federal books. • One idea circulating through the Capitol is the implementation of a national value-added tax, or VAT. This truly harmful tax would have a significant negative impact on all states, but the pain would be even greater for places like Florida.A VAT works much like a sales tax, except instead of levying a tax when a good is sold to its final user, a tax is collected on the “value added” at every stage of the production process. In theory, a VAT would have the same economic effect as a national sales tax, except that it would be more expensive and complex to administer.One problem with a VAT is that it competes with the same sales tax base that states rely on for much of their revenue. As a result, states will take in less revenue through their sales taxes.Indeed, Florida would be one of the states hardest hit by a national VAT. As one of just a handful of states that do not levy personal income taxes, Florida relies on sales tax revenue for about 60 percent of total revenue – almost double the national average. Only Tennessee and Washington rely more heavily on sales tax revenue than Florida.Because taxes discourage consumers from spending money by raising the costs of products, even at a modest rate a VAT would reduce consumption and hence sales tax collections in Florida. Consumers and businesses alike would immediately lose out. This is the same logic by which public health advocates, for instance, have called for sharply higher cigarette taxes in the previous decade: taxing a product reduces its consumption.The longer-term effects would be even more pernicious. Because the federal government would set the VAT rate and Florida would still set its sales tax rate, we would likely see a struggle between Washington and Tallahassee to move rates higher and higher to make up for decreasing revenue wrought by the other government’s taxes.The result would be an arms race as the federal VAT and state sales tax rates climb in an attempt to boost persistently falling revenue – falling precisely because of rising tax rates. As a result, Floridians would end up seeing higher overall taxes, lower state revenue, and less purchasing power for consumers.Within about 20 years of its introduction, the effect of a federal VAT on revenue would be largely to shift revenue from states – particularly states like Florida that rely on the sales tax for a majority of revenue – to the federal government.A VAT would chiefly serve to give Washington revenue that otherwise would have gone to Tallahassee. It would serve to make Florida even more dependent on the federal government for revenue and decrease the state’s independence in policymaking.Moreover, a VAT would slow economic growth, both in Florida and nationwide. Compounded over two decades, even a seemingly small tax would reduce economic output by about 2.6 percent, decreasing national income by almost a trillion dollars. That is an enormous amount of lost economic productivity for a tax that will generate only a trivial amount of additional revenue.Proponents of a national VAT suggest that enacting such a tax is virtually the only thing Washington can do to fix our increasingly spendthrift federal budget. This is false. Spending cuts, tax reform, and fixing entitlements like Medicare and Social Security are critical. Inventing new ways to tax consumers is the last thing we should consider, particularly in the midst of a weak recovery.A decade ago, at the end of the Clinton administration, federal expenditures were 18.4 percent of economic output. Today they are around 25 percent. Evidence indicating government spending has made us better off today than we were back then is hard to find.The economic evidence we do have, however, suggests that the effects of a federal VAT on Florida would be sharply decreased revenue, increased fiscal dependence on Washington and slower economic growth. It would raise little revenue and mostly shift funds from the statehouse to Congress. In other words, a VAT is simply too costly forFlorida. Randall G. Holcombe is the author of “The Value Added Tax: Too Costly for the United States,” published by the Mercatus Center at George Mason University. He is also a professor of economics at Florida State University and senior fellow at the James Madison Institute in Tallahassee.