Europe's VAT Lessons - Rates start low and increase, while income tax rates stay high

Europe's VAT Lessons. WSJ Editorial
Rates start low and increase, while income tax rates stay high.
WSJ, Apr 15, 2010

As Americans rush to complete their annual tax returns today, there is still some consolation in knowing that it could be worse: Like Europeans, we could pay both income taxes and a value-added tax, or VAT. And maybe we soon will. Paul Volcker, Nancy Pelosi, John Podesta and other allies of the Obama Administration have already floated the idea of an American VAT, so we thought you might like to know how it has worked in Europe.

A VAT is essentially a national sales tax that is assessed at each stage of production, with the bill passed along to consumers at the cash register. In Europe the average rate is a little under 20%. (See the nearby chart.) In the U.S., a federal VAT would presumably be levied on top of state and local sales taxes that range as high as 10%. Some nations also exempt food, medicine and certain other goods from the tax.

VATs were sold in Europe as a way to tax consumption, which in principle does less economic harm than taxing income, savings or investment. This sounds good, but in practice the VAT has rarely replaced the income tax, or even resulted in a lower income-tax rate. The top individual income tax rate remains very high in Europe despite the VAT, with an average on the continent of about 46%.

Europe's individual income tax rates have fallen since the 1980s, following the U.S. lead in the Reagan era, and European corporate tax rates have come down even more sharply. But the drive of this decline has been global tax competition, not the offsetting burden of the VAT.
In the U.S., VAT proponents aren't calling for a repeal of the 16th Amendment that allowed the income tax—and, in fact, they want income tax rates to rise. The White House has promised to let the top individual rate increase in January to 39.6% from 35% as the Bush tax cuts expire, while the dividend rate will go to 39.6% from 15% and the capital gains rate to 20% next year and 23.8% in 2013 under the health bill, from 15% today. Even with these higher rates, or because of them, revenues won't come close to paying for the Obama Administration's new spending—which is why it is also eyeing a VAT.

One trait of European VATs is that while their rates often start low, they rarely stay that way. Of the 10 major OECD nations with VATs or national sales taxes, only Canada has lowered its rate. Denmark has gone to 25% from 9%, Germany to 19% from 10%, and Italy to 20% from 12%. The nonpartisan Tax Foundation recently calculated that to balance the U.S. federal budget with a VAT would require a rate of at least 18%.

Proponents also argue that a VAT would result in less federal government borrowing. But that, too, has rarely been true in Europe. From the 1980s through 2005, deficits were by and large higher in Europe than in the U.S. By 2005, debt averaged 50% of GDP in Europe, according to OECD data, compared to under 40% in the U.S.

It is precisely this revenue-generating ability that makes the VAT so appealing to liberal intellectuals and politicians. Even liberals understand that at some point high income tax rates stop yielding much more revenue as the rich change their behavior or exploit loopholes. The middle-class is where the real money is, and the only way to get more of it with the least political pain is through a broad-based consumption tax such as a VAT.

And one more point: In Europe, this heavier spending and tax burden has also meant lower levels of income growth and job creation. From 1982 to 2007, the U.S. created 45 million new jobs, compared to fewer than 10 million in Europe, and U.S. economic growth was more than one-third faster over the last two decades, according to the Bureau of Labor Statistics.

In 2008, the average resident of West Virginia, one of the poorest American states, had an income $2,000 a year higher than the average resident of the European Union, according to economist Mark Perry of the University of Michigan, Flint. The price of a much higher tax burden to finance a cradle-to-grave entitlement state in Europe has been a lower standard of living. VAT supporters should explain why the same won't be true in America.

China and the US, Two Energy Giants: A Contrast In Approach

Two Energy Giants: A contrast in approach

IER, Apr 22, 2010

China’s economy is growing with dizzying speed, and the government is fueling the growth with plentiful energy. In fact, China’s electrification program and its ability to secure future oil supplies are second to none. By contrast, the U.S. economy is growing more slowly and its energy strategy is limiting that growth. The United States has slowed its electrification, adding only select forms of generating capacity, and has taken steps to reduce its flexibility in securing safe oil supplies.

China Setting Records: China Oil Demand, Coal Production and Vehicle Sales Up in 2010

During January, February, and March of this year, China was again setting records with huge year-over-year increases in oil demand.  In February, China’s oil demand rose 19.4 percent over a year earlier, the second fastest rise on record. According to Reuters, China is the world’s second largest oil user (second to the United States) and consumed 8.65 million barrels of oil per day in February, an increase of 9.4 percent or 604,000 barrels per day over January’s consumption.[i] Oil imports were up 13.8 percent in March over February, reaching 4.95 million barrels per day, according to preliminary data from China’s General Administration of Customs.[ii] In part, these large oil increases are fueling China’s passenger car fleet. New passenger car sales rose 55 percent in February from a year earlier, following a 116 percent increase in January, most likely aided by the extension of government incentives to boost purchases of smaller vehicles and spur rural demand for cars.  [iii]

China has spent nearly $200 billion on oil deals during the past few years, joining with more than 19 countries —including Russia, Turkmenistan, Kuwait, Yemen, Libya, Angola, Venezuela and Brazil— and paying for exploration, production, infrastructure construction, as well as “loans for energy” deals.[iv] Recently, China’s Sinopec International Petroleum Exploration and Production Company agreed to buy, for $4.65 billion, the 9 percent interest that ConocoPhillips holds in Syncrude,[v] a Canadian business involved in the production of oil sands (an asphalt-like heavy oil).[vi] Approval from the Canadian and Chinese governments is expected in the third quarter of this year.

Along with China’s Canadian oil pursuits, long thought to be a safe and secure supply for U.S. oil demand, the state-owned China Development Bank has promised to lend $20 billion to Venezuela to build new power plants, highways, and other projects, which will be repaid with Venezuelan crude oil. Venezuela’s President Hugo Chavez has long complained about the United States’ standing as the largest buyer of Venezuelan oil, and so he is more than pleased to offer his country’s oil to China instead.[vii] Both the Canadian crude and the Venezuelan crude are heavy oils, and the United States owns most of the refineries that can process heavy crude oils. So, to prepare itself for future heavy oil supplies, China has approved plans for construction of such a refinery. As the United States loses neighboring oil supplies to China, one wonders how the U.S. will meet future oil demand, especially as the Obama Administration has been slow to open new offshore areas to oil development (claiming further study is needed) but speedy at advocating climate legislation and a low-carbon fuel standard, both policies aimed at reducing the demand for fossil fuels without providing comparable energy substitutes.



Oil resources are not the only target on China’s energy wish-list. It also plans to increase its consumption of natural gas; last year, its liquefied natural gas imports rose by two-thirds, to 5.53 million tons or 7.7 billion cubic meters.[viii] China also continues to consume large quantities of its primary fuel, coal, in its industrial and electric generation sectors. According to China’s National Bureau of Statistics, the country’s coal output grew more than 28 percent, to well over 751 million tons in the first quarter of 2010. A report by China’s National Coal Association estimates China’s total coal production capacity exceeds 3.6 billion tons.[ix] This is in sharp contrast to coal mining in the United States, where the Environmental Protection Agency (EPA) has issued a new policy aimed at curbing mountain top removal mining[x] and is scrutinizing surface coal mine permits.  EPA is revoking or blocking Clean Water Act permits for mountain top mining citing irreversible damage to the environment. Some of the permits were awarded years ago.[xi]

Seventy percent of China’s energy comes from coal,[xii] the most carbon-intensive fossil fuel. China already consumes more than twice the coal as  the United States, and by 2030, China is expected to consume 3.7 times as much coal.[xiii] As a result, China emits more carbon dioxide than any other country in the world including the United States, and by 2030, it is expected to release 82 percent more carbon dioxide emissions than the United States.[xiv]

China’s Race to Electrification; U.S. Stagnation

Between 2004 and 2008, China added 346 gigawatts of generating capacity, of which 272 gigawatts were conventional thermal power (mostly coal) and 66 gigawatts were hydroelectric power. This compares to a total installed US hydroelectric capacity of 77 gigawatts.  China is estimated to have added an additional 85 gigawatts in 2009, reaching a total of 874 gigawatts,[xv] about 15 percent less than the total capacity in the United States. Of the 85 gigawatts added in 2009, 51 gigawatts were conventional thermal, again mostly coal, 25 gigawatts were hydroelectric, and 9 gigawatts were wind power.[xvi] Many of China’s wind turbines were funded by the U.N.’s Clean Development Mechanism,   under which wealthy countries fund projects in developing countries and receive carbon credits so long as those projects would not have been accomplished otherwise.[xvii]

In contrast, the United States added only 47 gigawatts of generating capacity from 2004 to 2008 (14 percent of the capacity China added), of which 26 gigawatts were natural gas-fired units and 18 gigawatts were wind turbines. New coal-fired capacity additions are practically non-existent in the United States primarily owing to objections regarding emissions of carbon dioxide. Coal-fired projects in the United States have either been cancelled or delayed because of permitting problems, reviews and re-reviews by EPA and resulting financing problems. While the United States has more coal than any other country in the world, with over 200 years of reserves at current usage rates, coal’s share of new U.S. generating markets has been replaced by natural gas and renewable units that are  more politically in vogue.

China’s Economic Growth and Export Market

China’s economy, the second-largest in the world in terms of purchasing power, is currently about half the size of the U.S. gross domestic product. According to China’s central bank, the country’s economy grew at an annual rate of 10.7 percent in the fourth quarter of 2009,[xviii] a rate almost twice the U.S. rate of 5.6 percent for the same time period.[xix] And in the first quarter of 2010, China’s economy grew by 11.9 percent. Forecasters predict that China’s economy will exceed that of the United States in 10 to 15 years.[xx]

China became the world’s largest exporter last year, edging out Germany and the United States. Despite a decline in total world trade, China’s exports fell less than those of other big powers. A report by the World Trade Organization calculates that the total value of merchandise exports fell by 23 percent in 2009. Among the top ten exporters, Japan’s shipments were the worst affected, falling by 26 percent. Because China’s exports fell by only 16 percent, it is now the single largest exporter. The World Trade Organization expects trade to rebound by nearly 10 percent this year.[xxi]



Lessons to Be Learned

Many environmentalists and politicians seem to believe that China is winning the green energy race, but nothing could be further from reality.[xxii] China is in a race for energy—all forms of energy—to fuel its growing economy. The size and scope of its investments in conventional forms of energy dwarf their commitment to “green energy.” It is providing loans around the world to invest in future oil projects, and it cares not that the oil is less than the lightest and sweetest. Canadian oil sands and Venezuelan heavy crude are perfectly fine. China is building a coal-fired generating plant each and every week on average, and increasing its coal mining capacity to fuel them. This belies any stated concerns about increasing their carbon dioxide emissions, already the highest of any country in the world. China is building wind turbines too, but if wealthy countries are willing to pay—why not? It matters not at all that the transmission capacity is not yet there to operate almost a third of these wind turbines. And China’s large-scale hydroelectric projects are engineering feats par excellence, built regardless of environmental concerns.
China is ensuring energy supplies will be available to fuel its growing economy. The United States should take note.

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 References

[i] Reuters, China oil demand rise second fastest, inventories drag, March 22, 2010, http://in.reuters.com/article/oilRpt/idINTOE62L01Z20100322?sp=true [ii] Reuters, Oil falls as demand, inventories weigh, April 12, 2010, http://www.reuters.com/article/idUSTRE6142V820100412
[iii] Reuters, China oil demand rise second fastest, inventories drag, March 22, 2010, http://in.reuters.com/article/oilRpt/idINTOE62L01Z20100322?sp=true
[iv] Politico, To compete with China, U.S. must tap natural gas, April 13, 2010, http://www.politico.com/news/stories/0410/35689.html#ixzz0kyYru8gb
[v] Reuters, China bags oil sands stake, not finished yet, April 13, 2010, http://www.reuters.com/article/idUSTRE63C17X20100413 and www.conocophillips.com
[vi] Syncrude, http://www.syncrude.ca/users/folder.asp?FolderID=5753
[vii] The Wall Street Journal, China’s $20 Billion Bolsters Chavez, April 18, 2010, http://online.wsj.com/article/SB10001424052748703594404575191671972897694.html
[viii] Reuters, China bags oil sands stake, not finished yet, April 13, 2010, http://www.reuters.com/article/idUSTRE63C17X20100413
[ix] China Daily, China’s coal output up 28.1% in Q1, April 15, 2010, http://www.chinadaily.com.cn/bizchina/2010-04/15/content_9736151.htm
[x] Environmental protection Agency, New Releases, EPA issues comprehensive guidance to protect Appalachian communities from harmful environmental impacts of mountaintop mining, April 1, 2010, http://yosemite.epa.gov/opa/admpress.nsf/d0cf6618525a9efb85257359003fb69d/4145c96189a17239852576f8005867bd!OpenDocument
[xi] Associated Press, Arch Coal sues EPA over veto of W.Va. mine permit, April 2, 2010, http://news.yahoo.com/s/ap/20100402/ap_on_bi_ge/wv_epa_coal_lawsuit
[xii] Energy Information Administration, China, http://www.eia.doe.gov/emeu/cabs/China/Background.html
[xiii] Energy Information Administration, International Energy Outlook 2009, http://www.eia.doe.gov/oiaf/ieo/index.html
[xiv] Energy Information Administration, International Energy Outlook 2009, http://www.eia.doe.gov/oiaf/ieo/index.html
[xv] http://en.wikipedia.org/wiki/Energy_policy_of_China
[xvi] China’s power generation goes greener with total capacity up 10%, January 7, 2010, http://news.xinhuanet.com/english/2010-01/07/content_12771880.htm
[xvii] http://www.instituteforenergyresearch.org/2010/03/24/kyotos-clean-development-mechanism-is-it-producing-results-for-whom/
[xviii] Politico, To compete with China, U.S. must tap natural gas, April 13, 2010,  http://www.politico.com/news/stories/0410/35689.html#ixzz0kyYru8gb
[xix] http://bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm
[xx] Energy Information Administration, International Energy Outlook 2009, http://www.eia.doe.gov/oiaf/ieo/index.html
[xxi] China overtakes Germany to become the biggest exporter of all, March 31, 2010, http://www.economist.com/daily/news/displaystory.cfm?story_id=15836406&fsrc=nwl
[xxii] http://www.instituteforenergyresearch.org/2010/03/15/the-u-s-in-the-world-race-for-clean-electric-generating-capacity/