19 January 2010

Towards A Colorado VAT?

Colorado is in a long term revenue bind, because the legislature has not had a free hand to balance spending cuts and new revenues as a result of TABOR, and one way to address the issues would be to have voters approve a proposal to replace our current retail sales tax with a value added tax.

Retail Sales Taxes In A Nutshell

An American style sales tax is a tax imposed on retail sales of non-exempt goods. Usually, housing, grocery store food, gasoline and drugs are exempt, on the theory that they are necessity. Services are exempt because they aren't goods. Wholesale purchases and purchase by businesses that are used to create goods are exempt because they aren't retail sales.

There is also an exemption for sales from sellers with no presence in the state (but not from "use taxes" on in state buyers), usually involve internet sales or mail order sales, that arises from constitutional tax jurisdiction principles, rather than tax policy.

Retail sales taxes geographically fix the ultimate tax burden and revenues at the place of the final retail sale of the goods, exemption all wholesale suppliers of goods and services from tax.

From a collection perspective, retail sales taxes make irrelevant non-reporting by customers and wholesale goods and service providers, leaving the state with a relatively small universe of potential taxpayers to collect from, many of whom must advertise widely and reveal themselves to the general public (including tax collectors) in order to operate. But, an unreported sale deprives the state from all revenue associated with that sale.

Value Added Taxes In A Nutshell

In contrast, in a value added tax, common in Europe, both goods and services are taxed at both the wholesale and retail level, there are fewer exemptions, and the value added taxes already paid by suppliers and service providers of someone who then sells goods is a credit against the taxes due on the gross amount.

Value added taxes are typically included in the final sales price where they are used, while retail sales taxes in the United States are typically imposed on top of a final sales price. But, value added taxes are not "invisible" to anyone but a retail consumer, because wholesale buyers must receive proof of payment of value added taxes from the the sellers of goods and services in order to claim those taxes paid as a credit against their own value added tax obligations.

Value added taxes collect more revenue than sales taxes at comparable rates, because they have a broader tax base. Value added taxes can also be easier to enforce as a practical matter, because unpaid taxes at an early stage of production are recouped at later stages of production, while paid taxes at early stages of production reduce potential revenue losses if a final retail sale is not reported and taxed.

Value added taxes geographically spread the tax burden and revenues from the tax across all of the places in the chain of production relative to the value they add to the final purchase price. So, for example, if a good is completely assembled in Colorado, but sold in Wyoming, the wholesale price would be taxed in Colorado, while the additional margin made at retail would be taxed in Wyoming.

Goods produced in a value added tax state and sold in a retail sales tax state are, conceptually, double taxed. Goods produced in a retail sales tax state and sold in a value added tax state are, conceptually, under taxed.

Sales Taxes In Colorado

In Colorado, retail sales taxes are a key component of both state and local tax revenues. At the state level, Colorado has both an income tax and a retail sales tax. At the local level, most Colorado local government have both a property tax and a retail sales tax.

Several of Governor Ritter'sproposed suspensions of sales tax exemptions in the state budget to be adopted this year, moves Colorado in the direction of a value added tax, by bringing non-retail sales and arguable services into the sales tax net, while also expanding the retail goods tax base. The taxes on wholesale purchase include suspensions of exemptions for:

"[P]urchases of energy used in manufacturing.";
"[C]artons, napkins, condiments, plasticware and other items used to serve food at restaurants.";
"[P]rinted materials used in direct-mail advertising."; and
"[A]nimal vaccines, hormones, animal drugs, bull semen and other compounds used in agriculture."

Meanwhile, "expanding the definition of what type of software is taxable, including software purchased online," pushes the boundary between goods and services.

The end of the exemption for "candy and soft drinks" represents a move to tighten the fit between necessities exemptions and true necessities. (The flip side of that debate has been an off and on campaign to exempt diapers from sales taxes, which is at a disadvantage in a tight budget year.)

Local governments, particularly in mountain areas, have narrowed the "necessities" exemption even further by imposing real estate transfer taxes, which amount to retail sales taxes on real estate including housing. In part, this makes sense in the context of necessity doctrine because most real estate in these areas are second homes, rather than primary residences (which workers often have to lease because they can't afford to buy).

A pledge to more strongly enforce uncollected sales taxes on internet sales also, of course, doesn't change the tax base.

What Would A Value Added Tax Mean For Colorado?

A 2009 journal article on Canadian experience, where this was done, provides empirical evidence regarding what would happen if Colorado made this change.

Over a decade ago, several Canadian provinces replaced their retail sales taxes with value-added taxes. . . . [T]he reform led to significant increases in machinery and equipment investment, at least in the short run.

This is consistent with the non-obvious fact that a value added tax is economically similar to an income tax with an exemption for investment income.

Of course, a complete switch from a retail sales tax to a value added tax is sufficiently radical that it would be a surprise to see in the state. But, one can view that theory of taxation as a pull on tax policy makers on an axis from one proven workable tax (the retail sales tax) to another (the VAT) that can explain what is going on in individual legislative and budget proposals for sales tax amendments.

Colorado could, for example, in an impure version of a value added tax, expand its tax base to cover some services and wholesale purchases, raise more revenue, and yet actually decrease the tax rate paid on any particular transaction, while minimizing the problems associated with having a different kind of tax than its sister states.

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