OECD Recommends VAT for U.S., 09/22/10

The OECD has just published its 2010 Economic Survey of the U.S., and calls the “long-term fiscal trends unsustainable.”  Of course, this is no surprise, but the world is watching and worrying about what remedial medicine we may, or may not, take.

The U.S. tax system is criticized for its subsidy of housing via the mortgage deduction from personal income taxes.  Also singled out is the tax preference given to employer-provided health insurance premiums, which encourages over-consumption of medical services.

OECD recommends the implementation of a value added tax to address the need for additional revenue.  Otherwise, they conclude, increases in personal income taxes will likely be needed to reduce the deficits. (Currently, the federal government spends three dollars for every two dollars in tax receipts, and, since draconian cuts to social security and medicare will be politically impossible, some revenue enhancement will be needed.)

Unlike our Corporate Income Tax, which is included in the price of exports, the VAT is neutral and “…does not increase the cost of exported products and therefore does not hamper international competitiveness.”  (Because the VAT is border-adjustable under GATT rules, exports do not carry the burden of our government covered by the VAT.  This would be an argument for replacing additional taxes with a VAT, not just the CIT.)

As advocated by others (Toder, Rosenberg, Boskin, Sen. Hollings, Aaron, Sawhill), a replacement of the CIT with a revenue-neutral VAT, i.e., without raising taxes at the present time, would be stimulative of itself.  When the economy returns to a firm footing, the VAT will be in place to close the deficit — rather than look to income taxes.

Another efficiency referred to by OECD is the potential to harmonize the VAT with state sales taxes, affording a single, joint administrative agency (federal and state). Because a VAT is a consumption tax and considered regressive, OECD suggests that, in fairness, the EITC could be expanded to offset the additional cost for the lower income deciles.

The Bowles-Simpson Deficit Reduction Commission is to report in December.  We need to restructure for commercial success.  Will the Commission have the courage to recommend the VAT as tax reform for structural change?