Text size

The 2012 Republican Platform calls for a complete overhaul of the federal tax system. No surprise there. But then it endorses a value-added tax or national sales tax as one possible solution to the nation's budget problems. This is shocking.

The VAT would be adopted only if it is accompanied by "the simultaneous repeal of the Sixteenth Amendment, which established the federal income tax," the platform states. A Republican-controlled Congress passed that amendment in 1909, and the states ratified it in 1913. The tax was aimed squarely at the ultra-wealthy, targeting the top 1% of wage earners.

Removal of the 99-year-old tax amendment is so unlikely that the platform plank seems facetious. As for the VAT, perhaps it was inserted in the document for yucks, too. A mere two years ago, "VAT" was an obscenity in GOP circles. The Republican National Committee, which produced the 2012 platform in 2010, vigorously attacked the value-added tax after Obama advisor Paul Volcker said that a VAT or a carbon tax might be needed to narrow the budget deficit. The RNC assumed that the Democrats would add the regressive VAT to existing taxes and consequently soak the middle class.

Arizona Republican Sen. John McCain introduced a rancorous resolution in April 2010 that condemned the proposed tax as one that would cripple families on fixed incomes and "further push back America's economic recovery." MostSenate Democrats -- worried about the coming 2010 midterm election -- sided with McCain. Only 13 senators voted against the resolution.

WHAT IS A VAT? It's a sales tax, used mainly by the Europeans, that layers taxes on a product at each stage of manufacture and distribution, from raw materialto final sale. The nonpartisan Tax Foundation offers this example: "Take a wooden table sold at retail and a 10% VAT rate. The lumber company sells the wood to the furniture maker for $50, paying $5 (10% of $50) to the government. The furniture maker sells the table to the retailer for $120, sending $7 ($120 - $50 = $70 X 10% = $7) to the government. The retailer sells the finished table to a customer for $150, sending $3 to the government ($150 - $120 = $30 X 10% = $3). The total tax paid is $15, or 10% of the final retail price."

The scheme is supposed to reduce consumption and encourage savings.

"Advocates say a VAT reduces evasion because it's harder for three entities to avoid paying a $15 tax than it is for one," says the Tax Foundation. According to data released by the IRS in January, based on 2006 data, the estimated gap between taxes actually owed and those paid is $385 billion. That's more than a third of the current $1.1 trillion budget deficit. But a VAT would have to be set so high -- 30% at the federal level, with state sales taxes then added on -- that Mitt Romney economic advisor R. Glenn Hubbard has termed it a "political nonstarter."

How, then, did the VAT end up in the Republican platform? The RNC hasn't gotten back to us on this salient point. In all likelihood, it was added to satisfy some nagging constituency, just as a plank calling for exploration of a fixed rate for the dollar -- without even describing what the buck would be fixed against -- is a paean to the effervescent Ron Paul wing of the party. Investors needn't worry. Chances of passage are slight to nonexistent.

HOWEVER, IF THE GOP UNSEATS President Obama and takes the Senate, investors should consider the positive ramifications of the platform's other tax planks, which are more bullish than a Labor Day barbecue. The pledges include maintenance of the Bush tax cuts while the tax code is being overhauled, and a 20% across-the-board reduction in marginal tax rates. All this would be implemented in a revenue-neutral manner -- meaning paid for by eliminating tax write-offs. A victorious GOP also would seek to eliminate taxes on dividends, interest, and capital gains for lower- and middle-income taxpayers. The idea is to provide these wage earners with an incentive to save, and perhaps even venture back into the stock and bond markets, where their absence has reduced liquidity. The GOP also promises to repeal the federal estate tax and the alternative minimum tax, both obstacles, in its view, to business formation and gung-ho capitalism.

Additionally, the Republican platform proposes a reduction of the corporate tax rate to make the U.S. a more attractive domicile; a permanent R&D tax credit; repeal of the corporate alternative minimum tax; and a switch to a territorial system of corporate taxation, so profits taxed abroad can enter the U.S. without additional levies. These changes would bolster corporate earnings and, theoretically, stock prices.

Of course, to implement any of this, the GOP must win in November. And even if it does triumph, Congress will be the arbiter of tax reform. So many of its members are the pet monkeys of special interests, eliminating tax preferences might be impossible. Even so, a new, less-than-perfect tax code that is simpler and flatter would be better for the country than the existing one.

Comments? E-mail: jim.mctague@barrons.com