Research desk responds: What could we swap a VAT or carbon tax with?

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(at the federal level) trade a VAT and a carbon tax for the payroll tax and the income tax: revenue picture looks like what?

Nothing good. Eric Toder and Joseph Rosenberg at the Tax Policy Center estimate (pdf) that a 5 percent value-added tax (VAT) would bring in $258.6 billion a year in tax revenue if applied to a broad base of goods and $160.9 billion if applied to a narrower base (excluding housing and food costs, for example) or applied to a broad base with a rebate to pay for necessities. Meanwhile, Gilbert Metcalf at the Brookings Institute figures (pdf) that a $15 per ton carbon tax, assuming a 14 percent reduction in greenhouse gas emissions, would bring in about $82.5 billion a year, with greater revenue if the emissions reductions are more modest. That adds up to a high end figure of $341.1 billion, a far cry from the more than $1.7 trillion (pdf) that personal income, Social Security and Medicare taxes brought in during fiscal year 2009.

That said, Toder and Rosenberg as well as Metcalf looked into using a VAT or carbon tax, respectively, to cut, rather than eliminate, payroll taxes. Toder and Rosenberg estimated that a broad-based VAT would allow the employer contribution to Social Security to drop from 6.2 percent to only 0.3 percent (the employee contribution would stay constant); a narrow-based or rebated VAT would drop the rate down to 2.5 percent. They also found that this would make the federal tax system in general more progressive. Here’s how effective tax rates on earned income (capital gains, dividends, etc. are excluded) changes with the introduction of a VAT and a reduction in payroll tax rates:

As you can see, rates for lower-income filers in the 15 percent bracket and middle-income filers in the 25 percent bracket fall, while rates on rich filers in the 35 percent bracket go up. Metcalf took a different tack, estimating that a carbon tax would be revenue neutral if the first $3,660 of income were exempted from payroll taxes, which would be implemented by creating a tax credit refunding the first $560 a filer pays in payroll taxes. The net effect of this and a carbon tax is regressive:

While the situation for the top two income deciles does not change, large drops in after-tax household income in the poorest two deciles fund modest increases in income among middle-class households. Thus, a carbon tax swap like this, in addition to its emissions reduction effects, would implement a mild redistribution of wealth from the poor to the middle class.

Posted on July 17, 2010 · in USA

Tagged as: America carbon • Carbon Tax • VAT