Deficit Commission: Dodo or Phoenix?, 12/03/10

One can only imagine the inner working meetings of the Simpson-Bowles commission. Perhaps the inside story of the commission deliberations will become the subject of a new book. Our complex tax code has so many tax preferences representing as many or more political constituencies, that achieving a consensus on what budgets to cut and which taxes to increase was predictably impossible. Remember Sen. Russell Long’s ditty: “Don’t tax you, don’t tax me, tax the fellow behind the tree.”? One person’s deduction is another person’s loophole. If oxen must be gored, politicians will tremble./p>

Alan Simpson has found his metaphor in the Dodo bird. A clear path to fiscal responsibility must be outlined or the global currency markets will take the dollar down, and when it happens it will be fast and crippling. But, the fix dare not be short-term, as we all fear a double-dip contraction.

Politicians may not admit it, but they’re all Keynesians, now. Republicans want the tax cuts continued for everyone. Democrats want extension of unemployment benefits. And, while both sides posture that this deficit spending must be paid for, neither side will pay for these expenditures with tax increases. Both sides are de facto favoring short-term stimulus.

Keynes warned about the complacency of economists who feared the risk of short-term stimulus and believed that free markets would work things out in the long run: “In the long run, we’re all dead.” Dodo birds?

I admire the Domenici-Rivlin proposal because it includes the short-term stimulus of a payroll tax holiday backed up by a medium-term increase in revenues via a VAT tax. But, my dream was not of Dodo birds, but of the Phoenix, as metaphor for a revitalized America through sweeping tax reform

The economy is seriously crippled. Paul Kennedy clarified in “The Rise and Fall of Great Powers,” that a country must have a strong economy to support the projection of military power internationally. We are bleeding borrowed capital for our military campaigns. Our economy has been hollowed out, riddled by policies derived from the false perspective that expanded world trade based on comparative advantage was not a zero sum game, and that all economies would grow together. The truth is the American labor force has been decimated by these policies.

We now have a virtual rentier society, where the upper class gets richer collecting its dividends and capital gains from the spreads achieved by outsourcing production and jobs for the middle class. How many CEO’s have already retired with their stock options inflated by their having outsourced manufacturing? How many more hold their employees captive to a lower wage with the threat of shipping their jobs to India or China?

America needs a fresh start. The ideal tax system would replace all revenue sources with a VAT tax coupled balanced by a flat income tax with a high deduction threshold, the concept recently revived by Gov. Mitch Daniels. No tax preferences. No lobbying for loopholes. There are three variables to adjust to achieve an equitable balance.

The VAT would be protectionist in the short-term, since the U.S. would be the last of our trading partners to have implemented one, i.e., cheaper exports and more expensive imports. VAT is the tax for the era of globalization, i.e., the border-adjustable tax, subtracted from exports and added to imports without prejudice. Again, all our trading partners use a VAT as a component of their tax revenues to our competitive disadvantage. There would be no retaliation.

Bold leadership is needed from the President. It would have been useful had the Simpson-Bowles commission asked OMB to run the numbers on the distribution of the tax burden of this revolutionary sweeping tax reform.