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Tax Reform and the VAT

When President Reagan was elected into office in 1980, he believed that high taxes were the main deterrent to prosperity. Upon entering office the following January, the Economic Recovery Tax Act of 1981 was instated, substantially reduced personal business taxes. It lowered the marginal rates in all brackets and capped the highest marginal tax wealthy individuals pay at 50%. Businesses got relief as well through the accelerated depreciation section of the act, which allows companies to expedite the depreciation of their plants and equipment by taking larger depreciation charges right away. Accelerated depreciation saved corporations billions of dollars in taxes because these charges were treated like a cost that is deducted from a firm's income before taxes are paid. Another section of the act introduced the investment tax credit (ITC), which allowed a company to purchase tools and equipment and subsequently receive a tax credit based on the amount spent.

In 5 years time, people started feeling that the tax code favored the rich and powerful. Many millionaires and corporations avoided paying taxes. In 1986, Congress passed a tax reform act that ended the traditionally progressive individual income tax brackets. The law also added a 5% surcharge but it was later changed. The law also made it difficult for the very rich to avoid taxes altogether. The alternative income tax, which is the personal income rate that applies whenever the amount of taxes paid falls below a designated level, was strengthened. People had to pay a minimum tax of 20% regardless of other circumstances or loopholes in the tax code. Finally, the reform act called for the removal of the ITC and a revision of the accelerated depreciation schedules.

By the 1990's, government spending was growing faster than revenues, and the government had to make up the difference by borrowing. The Omnibus Budget Reconciliation Act of 1993 was driven by the need for the government to balance its budget. It combined future spending cuts with tax hikes and affected government revenue in several ways. The law added the two top marginal tax brackets, which affected the richest 1.2% of taxpayers. It also removed the $135,000 cap on Medicare taxes. The alternative minimum tax, which targets the wealthiest 250,000 taxpayers, was also strengthened, making tax avoidance difficult for the extremely wealthy. Another provision prevented single individuals with taxable incomes in excess of $100,000 and couples with incomes in excess of $160,000 from claiming some deductions that would lower their taxes. Estate taxes were increased on properties valued at more than $2.5 million. Finally, the federal excise tax on gasoline was raised by 4.3 cents per gallon to 18.4 cents. This act, however, contained some tax cuts. Credits worth $21 billion were given to lower-income working families with children, and about $4.6 billion for low-income housing were granted. Businesses even received some tax cuts to offset the higher corporate tax rates, and approximately $5 billion of credits for research and experimentation were approved.

The Value Added Tax (VAT)

The value-added tax (VAT) is a tax imposed on business at all levels of production, and based on the increase in value, provided by each level. Because all stages of a value-added tax are ultimately passed on to the consumer via higher prices, it has been described as a hidden sales tax. The VAT has several advantages. First of all, it is hard to avoid because the tax collector imposes it on the total amount of sales excluding the cost of inputs. Secondly, the incidence of the tax is widely spread, which makes it difficult of a singe firm to shift the burden of the tax to one group or another. Third, the tax is not readily apparent to the consumer, because it has been included in the price before the purchase is made. Fourth, the VAT is easy to collect because businesses would make their VAT payments along side their tax payments to the government. Finally, the smallest of VAT's can raise a tremendous amount of revenue. However, there are also disadvantages to the VAT. The fact that the customer can't tell what the tax is, prevents them from being as vigilant about higher taxes, and can make them feel like they're being taken advantage of. Another disadvantage is that the VAT would compete directly with the state sales tax. The VAT is a federal sales tax to already-existing state taxes. Therefore, in order to increase spending, a state may have to forego their own tax in order to increase the selling of their goods.


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