Friday, April 23, 2010

Value Added Tax

      It’s not often that I agree with George Will, but his column in Monday’s paper was an exception. It was headed, “If VAT, ditch the income tax.” So what is the VAT (Value Added Tax)?
      VAT is a form of sales tax – but the tax is collected as value is added through production instead of on the end product. The result is the same. Here is an example:*

      Suppose the end product is an agricultural product, and the VAT is 10%.

1) The farmer sells it to the packer for .50 per pound plus 10%, or .55. He remits the .05 to the government. He must show the VAT (.05) as a separate amount to his customer.

2) The packer sells it to the wholesaler for .90 per pound plus 10%, or .99. He remits the .09 minus the .05 paid previously, (net .04) to the government. His gross profit is .99 - .04 - .55 = .40, which is the same as if he had bought it for .50 and sold it for .90. He must show the cumulative VAT (.09) as a separate amount to his customer.

3) The wholesaler sells it to the retailer for 1.20 per pound plus 10%, or 1.32. He remits the .12 minus the .09 paid previously, (net .03) to the government. His gross profit is 1.32 - .03 - .99 = .30, which is the same as if he had bought it for .90 and sold it for 1.20. He must show the cumulative VAT (.12) as a separate amount to his customer.

4) The retailer sells it to the end user for 1.50 per pound plus 10%, or 1.65. He remits the .15 minus the .12 paid previously, (net .03) to the government. His gross profit is 1.65 - .03 – 1.32 = .30, which is the same as if he had bought it for 1.20 and sold it for 1.50.
      The total VAT paid was .15 (.05+.04+.03+.03 = .15), the same amount as a 10% sales tax (10% x 1.50), but the government has collected the VAT at each step along the way. To the end user it appears no different from a sales tax.
      The VAT system sounds complicated, but as long as it applies to all products, it is not nearly as complicated as the income tax system. Because every member in the supply chain pays tax at the same rate, enforcement is simplified. One of the difficulties of enforcing a sales tax is the status, taxable or nontaxable, of the participants. When rates vary between products or income groups or whatever other exceptions may be carved out, the VAT enforcement becomes somewhat more complex.
      Critics contend that the VAT falls unfairly on the poor because it represents a larger portion of their income than it does for the well-to-do. But so does a sales tax. And as for passing it on, under the income tax system all taxes paid by suppliers, manufacturers, etc. are also passed along in the increased price of the product.
      I don’t believe we should fix something that is not broken, but the income tax system, spelled out in 39,000+ pages of code, is definitely broken. So as long as exceptions and exemptions are not allowed, the VAT should be on the table for discussion. But I agree with Mr. Will, discuss it as a replacement for the income tax, not as an addition to it. How likely is that?

*I am ignoring possible distortions of supply and demand in order to simplify this example.
******
      Shortly after a sperm penetrates an ovum, their nuclear materials fuse to form the required chromosomes of a somatic cell. The fertilized ovum has become a zygote. Depending upon the particular species, the first of billions of cell divisions occurs a few hours later, and within days a fetus is formed. Gathering all nutritional requirements from the host-mother, the fetus develops until the climactic moment of birth.
      There is no satisfactory reason why a sperm should penetrate an ovum, or why a fertilized ovum should metamorphose into a zygote, or why a zygote should start dividing, or why nutritional elements should not remain in the mother’s blood stream, or why any of this should occur. It just does. Again some invisible creative activity drives the transformation.
      Introduction – The Spirit Runs Through It

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