From the June 2007 issue of Wealth Manager Web • Subscribe!

The European Way

Back in the 60s, residents of the United Kingdom may have had the value-added tax (VAT) to thank for the creation of the miniskirt. It seems that while children's clothing wasn't taxed, adult garments carried an 18 percent VAT. "It simply cost a lot less to buy a young girl's skirt," explains Thomas P. Ochsenschlager, CPA and vice president, Taxation, of the American Institute of Certified Public Accountants (AICPA). And it was a lot shorter.

But the VAT is not as simple as it was originally billed. "People say the VAT is simpler because there are no tax returns, no forms to fill out," Ochsenschlager says. The tax is already part of the purchase price of the goods. It's not as obvious as a sales tax; it's simply the price you pay to buy the item.

A French invention, the VAT was developed in 1954 by economist Maurice Laur?. "You don't see it; you are taxed only on the value added to the good, rather than the good itself," explains Louis Osmont, a partner at Mazars in New York, part of the French company Mazars Worldwide.

VAT is a consumption tax, as opposed to an income tax. But even French President Jacques Chirac sees it as regressive in that people with the lowest incomes spend a greater portion of their money to buy things--one reason that governments try to even out its sting by excluding such necessities as medicine and groceries. Can wine be excluded as a promoter of good health? France has certainly floated that.

"It's very much a political issue," Ochsenschlager notes, adding that the current concern in the U.S. over the unfairness of the Alternative Minimum Tax could provide an environment into which a VAT could be proposed. A VAT of 2 percent to 5 percent could supplement the loss in revenue that repeal of the AMT would cause. But this suggestion would be anathema to many groups: "The states, for starters would be very upset because they'd say the federal government was stepping on their toes. States decide whether or not to levy sales taxes, after all," Ochsenschlager says.

And after state and local governments, retailers would be complaining, since they would inherit much of the technical responsibility for collecting the VAT. Next in line to complain vigorously would probably be the AARP, which Ochsenschlager says, "would go berserk." That's because retirees, who'd already been taxed on their money, would now be taxed twice, "which is Draconian," he points out.

Also weighing in on the subject is Steve Forbes, editor-in-chief of Forbes magazine, onetime candidate for president and continued strong proponent of the flat tax. Forbes told Wealth Manager "[The VAT] has been proposed here and induced visceral responses. It's lethal and should be avoided." His reasons? Look at the countries that have it--in Europe, Japan, Canada, Australia and New Zealand for starters. Most not only have a very high percentage VAT to pay, but also have income taxes. "Look at Germany's recent hike of the VAT to almost 20 percent," says Forbes. He describes VAT as a "multi-layered sales tax in which each level of production adds to it via the good or service they perform. It's hidden in the price of the good and that's why it becomes easy to put in. The VAT then becomes hard to avoid."

Bart Fooden, CPA and partner of Bart Fooden & Associates in Woodbury, N.Y., echoes that the VAT was originally proposed in lieu of income taxes, but in reality is used to supplement them. He also cautions that it can easily balloon. "Canada has a federal VAT of 8 percent, but each province also has a VAT, so Ontario adds its 7 percent, and living there means a total 15 percent VAT. But it pays for such government services as the National Health system."

He and Mazurs' Osmont talk about the relationship between tourism and the VAT. In theory, when Americans visit a country that has VAT, they can get a refund of the tax on the goods they're bringing home. "But how many people are willing to wait in line for two hours to receive a $20 refund? In practice we pay the VAT but don't take any government services," says Fooden.

Could the VAT come here in lieu of the AMT? "The AMT needs adjustments, but I don't see it being eliminated. If the VAT came here, it wouldn't be such a jolt because we're already conditioned to paying sales taxes. But the VAT has been floated many times, and it's never been accepted," he adds.

It's still the number one tax that Europe counts on for revenue, reminds Osmont. "It is such a huge revenue-maker that it would be hard to eliminate." He also thinks that its regressive aspects--that it's a lot more difficult to avoid and is more costly for the poor--are reasons why the U.S. hasn't adopted it.

Osmont's relationship with the VAT comes from personal experience. "Once I came to live here I wondered why in the world do European cars cost more money in France than here? To get here, European cars come over the sea and pay customs' costs, and yet a BMW costs more in France than in the U.S. Why? It's the VAT!"

Janice Fioravante wrote about online income tax filing in March.

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