Value Added Tax

By Ash Bhatt

Creating a fair and equitable tax system for California

It's time to rethink the way we tax businesses and how that tax burden is distributed among Californians. Currently, we impose the following taxes on corporations: income taxes, unemployment insurance premiums, employment training fee, disability insurance premiums, and workers' compensation insurance premiums, along with numerous fees and sales taxes incurred in the course of business. These taxes impact individual businesses and economic growth at large in many and unforeseeable ways. Because they are also imposed on products, materials and labor at various stages of the production process, they distort prices and lead to disincentives for many kinds of labor-intensive and manufacturing businesses in the state. Finally, they are intricate. The brute complexity of taxation in California discourages business growth.

We need to be clear: Taxes are only one of many factors that businesses consider when they locate offices and operations to a new location or when they expand existing operations. California has many other advantages, including a highly educated workforce, a vital cultural life, great natural beauty, excellent technological infrastructure, and several high-density business centers, each of which may be more important to businesses when they consider relocating or expanding. At the same time, this is offset in particular by the high cost of housing and the high taxes that businesses and their employees do not have to pay in other states. Also, the financial health of the state has not been stable in recent years. And this makes businesses wary of the future here. We need to capitalize on our strengths and seek ways to limit the liabilities of our weaknesses.

One way to do this is to make taxes cleaner, clearer, and fairer. I propose that we reduce business income tax and replace both the state sales tax and workers compensation insurance with a valued added tax (VAT). This is a far more advanced form of taxation than we use and one that other countries have been using for a long time. Even here at home, Michigan has used the VAT since 1975 and has found that revenues are considerably more stable than under the complex regime of income and sales taxation that we impose here in California.

VAT works on the principle that when raw material passes through various manufacturing stages and manufactured product passes through various distribution stages, tax should be levied on the `value added' at each stage and not on the gross sales price. This ensures that same commodity does not get taxed again and again and there is no cascading effect that raises the price of those goods that need to go through many stages over those that have few production stages. In simple terms, VAT taxes the difference between the selling price and purchase price. Companies are credited for the tax they have already paid for the goods and services they have used in earlier stages. The tax burden is passed on when goods are sold and the process continues till goods are finally consumed. Hence, VAT is termed as `consumption type' tax.

There are many advantages to this system. Six stand out:

1. It evens out the playing field. There is no distortion of prices for those goods and services that pass through many stages of production--that is, we don't tax the parts of the commodity many times, instead of the value of the final product is what gets taxed.
2. The tax is more equitable. Businesses and consumers both bear the burden of the tax along the way instead of having sales taxes, payroll taxes, and income taxes discourage job production and punish high revenue businesses along the way.
3. The tax has proven to provide a more stable stream of revenue for the state than have income and sales taxes. And this can help the economic health of the state over the long term.
4. It encourages investment in the state. Products purchased for capital investment can be easily exempted from the tax through credits or refunds.
5. It gives California businesses a competitive advantage and helps job growth. When businesses export products made in the state, the tax is refunded. This means that taxes on goods made here are not passed on to consumers who don't live here. This means businesses have an incentive to operate in California, hire Californians to work for them here, and produce for export.
6. The VAT tax rate is lower. Because all goods and services are taxed along the route of production rather than only selected products and services that are subject to business income and sales taxes, the VAT rate can be lower than the sales tax and the income tax. Again, this distorts the market less and is more equitable both to businesses along the path of production and to consumers who buy the goods.

I propose that we work over the long run to eliminate business income taxes, the state sales tax, many state fees, and the workers' compensation insurance premiums and replace them with a single value added tax.

The advantages laid out here are clear. Moreover, with workers' compensation costs either driving businesses out of the state or discouraging job growth, this reform would spread the burden of these costs to all Californians and give politicians the political will to develop new methods of dealing with workers injured on the job. State government and our municipalities are passing on their own suffering to Californians as well. We must be able to plan for the future and protect our people from the booms and busts of the business cycle. The VAT will help do both. Good government, public services and a good business climate are not incompatible. With the right tax structure, they actually complement one another.