WSJ Interview, Mitt Romney, “On Taxes, ‘Modeling,’ and the Vision Thing,” 12/24/11

Merry Christmas!  Mitt Romney, in an interview, today, with The Wall Street Journal expresses his open-mindedness toward a VAT, if the “modeling” proves to be pro-growth, and implemented with a vision of fairness and not class-warfare.

Here is the portion of the interview relating to tax reform:

” What about his reform principles? Mr. Romney talks only in general terms. “Moving to a consumption-based system is something which is very attractive to me philosophically, but I’ve not been able to sufficiently model it out to jump on board a consumption-based tax. A flat tax, a true flat tax is also attractive to me. What I like—I mean, I like the simplification of a flat tax. I also like removing the distortion in our tax code for certain classes of investment. And the advantage of a flat tax is getting rid of some of those distortions.”

Since Mr. Romney mentioned a consumption tax, would he rule out a value-added tax?

He says he doesn’t “like the idea” of layering a VAT onto the current income tax system. But he adds that, philosophically speaking, a VAT might work as a replacement for some part of the tax code, “particularly at the corporate level,” as Paul Ryan proposed several years ago. What he doesn’t do is rule a VAT out.

Amid such generalities, it’s hard not to conclude that the candidate is trying to avoid offering any details that might become a political target. And he all but admits as much. “I happen to also recognize,” he says, “that if you go out with a tax proposal which conforms to your philosophy but it hasn’t been thoroughly analyzed, vetted, put through models and calculated in detail, that you’re gonna get hit by the demagogues in the general election.”

That also seems to explain his refusal to propose cuts in individual tax rates, except for people who make less than $200,000, which not coincidentally is also Mr. Obama’s threshold for defining “the rich.”

“The president will characterize anyone running for office, and me in particular, as just in there to lower taxes for rich people, and that is not my intent,” Mr. Romney says. “My intent is to simplify our tax code and create growth, and so I will also look to see whether the top one-half of 1% or one-thousandth of 1% or top 1% are still paying roughly the same share of the total tax burden that they have today. I’m not looking to lower the share paid for by the top, the top earners like myself.”

But doesn’t that merely concede Mr. Obama’s philosophical argument? “No,” Mr. Romney responds, clipping his sentences. “I’m just saying that I’m not looking to change the deal. I’m not looking to go after high-income individuals like myself. I’m not looking to differentially favor. I’m looking to provide a system which continues to recognize that people of higher income pay a larger portion of the tax burden and I’m not looking, I’m not running for office trying to find a way to lower the tax burden paid for by the very high, very highest income individuals. What I’m solving for is growth.” ”

http://online.wsj.com/article/SB10001424052970204464404577114591784420950.html

Toder, Eric, et.al., “Using a VAT for Deficit Reduction,” Urban-Brookings Tax Policy Center, November, 2011

This analysis by Urban Brookings Tax Policy Center was undertaken to explore the comparative influences of raising taxes – in the event that becomes necessary – via an increase in the Personal Income Tax or by the addition of a Value Added Tax:

“At some (unknown) point of the debt-to-GDP level, purchasers of U.S. debt could decide that they face a significant risk of loss through inflationary policies or outright default, and accordingly demand much higher interest rates to hold U.S. government debt as compensation for that risk.  This spike in interest rates would require even higher spending, resulting in more debt and possibly sparking a crisis.

 Policy makers could choose to increase revenues as part of a plan to help avert a fiscal crisis.  This paper examines two options to increase revenues.  The first option is to adopt a value-added tax (VAT).”…

 …“A VAT is a tax on households’ consumption of goods and services, equivalent to a retail sales tax, with the same broad base and same rate, but with a different administrative structure.  Unlike a retail sales tax, which is collected only at the final retail level on sales, a VAT is collected incrementally at each stage of the production and distribution of goods and services. More than 130 other nations around the world have a VAT, including every country in the Organization for Economic Co-operation and Development (OECD) except the United States.  The VAT examined in this paper is an add-on tax (i.e., it raises revenue, rather than replacing funds from an existing federal tax).  This prototype VAT has a broad base and includes a rebate to mitigate the distributional effects of the tax on lower-income households.

 The other option examined in the paper would reduce the deficit by the same amount as the VAT, but in a very different way: by increasing all individual income tax rates, including those that apply to capital gains and dividends.”

 The authors recognize that there are many variables that can influence the results of a VAT implementation:

 “Although a VAT would cause fewer economic distortions than an income tax, the overall effect on economic distortions from raising any given amount of revenue from a VAT could be larger or smaller than from raising the same revenue from the income tax.  Only careful and detailed empirical analysis can indicate the likely size of economic distortions, which depend critically on the specific choices made about tax bases and rates, the timing of implementation, and administrative mechanisms, and the responsiveness of households and businesses to those choices.”

 http://www.urban.org/UploadedPDF/1001567-Pew-VAT-for-Deficit-Reduction.pdf

Howard Gleckman’s blog for Tax Policy Center reviews the above paper:

“Pick Your Poison: VAT or Higher Income Tax Rates”

Howard Gleckman | Posted on December 5, 2011, 8:51 pm

“With congressional deficit reduction efforts largely collapsed, the question remains: What are we going to do about the nation’s long-term budget mess? Since any realistic deficit reduction plan will require significant new revenues, is a Value-Added Tax a sensible way for government to raise those extra dollars?

In an effort to find out, the Pew Charitable Trusts asked my Tax Policy Center colleagues Eric Toder, Jim Nunns, and Joe Rosenberg to set up something of a cage match: In the blue trunks, a broad-based VAT (think 9-9-9 only much less complicated). In the white trunks, the income tax.  And they asked a basic question: What are the pros and cons of using a VAT to cut the deficit compared to an across-the-board hike in income tax rates.

Of course, real deficit reduction would surely involve substantial spending reductions and, in the real world, Congress might raise some new revenues by cutting tax subsidies not just raising rates. But to keep things relatively simple, Eric, Jim, and Joe looked at just two options: raising rates in the existing income tax system or adding a prototype VAT to what we’ve got.

They found that, even with one form of rebate, this version of a VAT would impose a larger tax burden on low- and moderate-income households than an across-the-board income tax rate increase. And it would significantly increase compliance and administrative costs, especially at the beginning.

However, a VAT would result in a smaller increase in marginal tax rates on labor than an income tax rate hike. And it would intrude on fewer economic decisions, especially related to savings and investment.

The goal of the exercise was to reduce the ratio of debt to Gross Domestic Product (a standard way of measuring red ink) to 60 percent. They looked at doing this by 2020, 2025,  and 2035. The debt/GDP ratio is about 69 percent today and the Congressional Budget Office predicts it will rise to 187 percent by 2035 if the government keeps doing what it has been doing (maintaining the 2001/2003/2010 tax rates, continuing to protect middle-income families from the Alternative Minimum Tax, etc.).

To hit the 60 percent target by 2020, average after-tax incomes would have to be cut by 8.7 percent under the VAT or 9.3 percent with tax rate hikes, relative to incomes under today’s tax rules. Income for the lowest-earning 20 percent of households would be cut by 1.8 percent under the VAT but only 0.5 percent if Congress raised income tax rates. Middle-income households would see  their after-tax income fall by 7.9 percent under the VAT but just 5.5 percent from higher rates. By contrast, the rich would be better off with the VAT. After-tax incomes of the top 1 percent would shrink by 9.6 percent compared to 17.2 percent with a rate hike.

Regular people can probably stop here, but if you are a serious tax wonk, here are some details on this prototype VAT and the income tax alternative.  This VAT has a very broad base (no exemptions for food and clothing, for example). However, it does not tax Medicare and Medicaid payments, spending by non-profits, or state and local sales taxes (yes, Virginia, some VATs do) . Combined, it would tax about 60 percent of all consumption and about 40 percent of GDP.

The VAT would partially protect low-income households with two rebates—one for workers and a second for Social Security recipients and others who get government cash transfers. Assuming current tax policy does not change, they estimate it would take a VAT rate of 22.9 percent in 2015 to meet the debt target in 2020. Because the glide path would be longer, the 2015 rate would only have to be 16.7 percent if the goal is to hit 60 percent by 2035.

To hit the 2020 target though an across-the-board income tax rate increase, rates in 2015 would rise from today’s 10-15-25-28-33-35 to 17.1-25.6-42.6-47.7-56.3-59.7 (yup, that’s a top income tax rate of almost 60 percent). As with the VAT, income tax rates would also be lower if the aim was to reach the 60 percent goal in 2025 or 2035. Rates on capital gains and dividends would also have to rise—to a top rate of 29.4 percent in 2015 if Congress wanted to meet its deficit target by 2020.

Not surprisingly, Eric, Jim, and Joe found flaws in both options. Without entitlement cuts hitting this ambitious debt target forces painful tax hikes either way. And, of course, a differently designed VAT would have yielded a different outcome. But in its cage match with a big income tax rate increase, the VAT at least gets a draw.”

 

 

 

White, James R., Director, Strategic Issues, GAO, “Value-Added Taxes: Potential Lessons for the United States from Other Countries’ Experiences,” Testimony Before the Committee on Ways and Means, July 26, 2011

“…Some available data from our study countries indicate a VAT may be less expensive and easier to administer than an income tax. In 2006, the tax administration agency in the United Kingdom measured administrative costs for the VAT to be approximately half a percent of revenue collected compared to over one and a quarter percent for the income tax. Officials at the New Zealand Inland Revenue Department also told us that administering their VAT was easier than administering some of their other taxes. For example, only 3 percent of VAT returns submitted to New Zealand’s revenue agency are found to have errors, compared to approximately 25 percent for income tax returns. ..”

“…One overriding lesson about VAT design is that, like our income tax system, adding tax preferences to the system may satisfy economic, distributional, or other policy goals but at a cost. Tax preferences—in the form of exemptions, zero rates, or reduced rates—often reduce revenue, add complexity, and increase compliance risks. To mitigate the increased risk, countries have imposed additional record-keeping and reporting requirements on businesses, delayed refunds, and done more auditing of businesses. The end result is an increase in compliance burden for businesses and administrative costs for the government…”

http://waysandmeans.house.gov/UploadedFiles/White_Testimony.pdf

 

Carroll, Robert, Ernst & Young, LLC’s Center for Tax Policy, “Considerations for a Value-Added Tax in the United States,” Testimony before the Ways and Means Committee, July 26, 2011

“…If VAT revenue were used to lower the corporate tax rate (i.e., with a partial replacement VAT), the effects of the lower corporate tax rate could benefit many firms. Firms with substantial foreign operations might see their competitive position improve relative to foreign firms, as the U.S. corporate rate becomes more closely aligned with the international norm.

The effects of a VAT on economic performance depend on how the revenue from the VAT is used. A VAT that replaces or reduces the worst features of the income tax could increase economic growth, while the effects of an add-on VAT can be more varied depending on the alternative policies for reducing the deficit.

Many economists have long held that the income tax imposes a drag on the economy by taxing the return to saving and investment. This ―tax penalty‖ on saving and investment could manifest itself in many ways; for example, businesses might provide less equipment to workers or use older technologies and be slower to incorporate new technologies, thereby decreasing worker productivity and their real wages and, ultimately, lowering living standards.

Greater reliance on value-added taxes, or other consumption-type taxes, to fund government can help improve economic performance because consumption taxes do not tax the return to saving and investment. By not taxing the return to saving and investment, these taxes reduce the cost of capital and lead to greater investment. Greater investment means more capital formation, and, ultimately, higher labor productivity and living standards than otherwise.

Some estimates suggest that the economic gains from replacing all or a portion of the income tax with a consumption-type tax, such as a VAT, could be significant. One study found that complete replacement of the individual and corporate income tax could increase the size of the economy in the long-run by between 6 percent and 10 percent.

Another study found that replacement of the corporate income tax with a VAT could increase long-run output by 2.0 percent to 2.5 percent…”

“…The United States relies more heavily on income taxes as compared to consumption-type taxes to raise revenue than other major developed nations, even when taking into account state sales taxes in the United States.

One factor that may trigger increased interest in a VAT in the United States is the difficulty of raising substantially more revenue through the current income tax system. Higher tax rates may be problematic because they have been found to be damaging to the economy. A recent OECD study suggests that income taxes are among the least conducive types of taxes to economic growth, which may partly explain the growth of consumption-type taxes abroad.

Among the nearly 150 countries that have implemented VATs, the VATs account for nearly one-fifth of total government revenue. The United States is the only major developed nation without a VAT.  (T)he average VAT rate among member nations of the OECD in 2011 was 18.5 percent. Japan has the lowest VAT rate (5 percent), while several countries have combined federal/sub-national rates approaching 40 percent (e.g., Austria, Norway, Sweden).”

http://waysandmeans.house.gov/UploadedFiles/Carroll_Testimony.pdf

Altshuler, Rosanne, Department of Economics, Rutgers University, Testimony Before the Committee on Ways and Means, Hearing on Tax Reform and Consumption-Based Tax Systems, July 26, 2011

…“A VAT is a type of consumption tax that is similar to a retail sales tax but is collected in smaller increments throughout the production process. This form of consumption tax is part of the tax systems of nearly 150 countries worldwide. All OECD member countries except the United States have VATs. In 2007, revenues generated by the VAT represented almost 19 percent of the total tax revenues of OECD countries and about 20 percent of the total tax revenues of European OECD countries.

Adding a VAT to the U.S. federal tax system could help address the medium and long-term revenue shortfalls forecast for the United States. The VAT is particularly effective in raising substantial amounts of revenue in a relatively efficient manner and has proven to be an administrable tax.

If the U.S. were to adopt a VAT, it could rely on the experience and best practices of other countries in setting up and administering the tax. In addition to these attributes, the VAT has a number of other advantages. First, a portion of the revenues from a VAT could be used to finance reductions in statutory income tax rates. Two tax systems (a VAT and an income tax) with low tax rates may be superior from an efficiency and administration perspective to an income tax system with higher statutory rates. Second, given the size of projected future budget deficits, adding a VAT to our current system to generate revenues for deficit reduction alone would likely have positive effects on economic growth. Third, a pre-announced and phased in VAT might stimulate the economy by encouraging consumption in anticipation of the imposition of the tax.

Finally, while the states are likely to protest, a properly designed VAT may actually help force them to redesign or improve their retail sales taxes.”…

“…The VAT on its own cannot solve the country’s fiscal problems. And introducing a VAT has its own problems.  If we adopted the VAT, we would have to institute some form of rebate to offset its regressivity and make every effort to adopt the broadest possible base. We would need to increase IRS resources for administration and be attentive to a range of compliance issues. But we must recognize that near and long-term fiscal pressures will require that we raise more revenue from our tax system. The VAT is an efficient revenue raiser that is likely to be significantly less damaging to economic growth than increasing personal and corporate statutory rates. After considering the range of issues associated with adopting a VAT, I conclude that the United States may be best served by combining a base-broadening reform of the current income tax system with the introduction of a VAT.”

 http://waysandmeans.house.gov/UploadedFiles/Altshuler_Testimony.pdf

 

 

Graetz, Michael J., Professor of Law, Columbia Law School, Statement At a Hearing of the House Ways and Means Committee on Tax Reform and Consumption-Based Tax Systems, July 26, 2011

“…It is the central contention of my book, and the centerpiece of my proposal, that the fundamental reform required to create an internationally competitive, administratively efficient, and viable long-term solution to our funding requirements is to make a different choice.  We should eliminate the income tax for the overwhelming majority of Americans and replace it with a broad-based tax on sales of goods and services. We should return the income tax to its original, manageable purpose: the collection of a simpler tax on high-income earners who tend to have multiple income sources. And we should dramatically lower our corporate income tax rate. In order to do that, we need to tax consumption, sales of goods and services.”…

“…For those unfamiliar with my Competitive Tax plan, it has four key pieces:

• First, enact a value added tax – a broad based tax on sales of goods and services now used by more than 150 countries worldwide.  We are the only OECD country that does not have a VAT or, as it is sometimes called, a goods and services tax.

 • Second, use the revenues produced by that consumption tax to finance an income tax exemption of $100,000 of family income and to lower substantially the individual income tax rate on income above that amount.

 • Third, lower the corporate income tax rate to 15%, or at most 20%.

 • Fourth, replace the earned income tax credit and provide low and middle income families with tax relief from the VAT burden through payroll tax offsets and debit cards….”

 “…Opponents of value-added taxes often complain that they are regressive, and if such a sales tax were to fully replace our income tax, as proponents of the so-called Fairtax urge, tax burdens would indeed be shifted down the income scale.  So I designed my Competitive Tax Plan in a manner generally to change neither the progressivity of the tax system nor the amount of revenue produced under current law.  This allows my proposal to be evaluated by comparing it directly to the current system, and it follows the important precedent of both distributional and revenue neutrality that facilitated enactment of the 1986 Tax Reform Act, our last major tax reform…”

“…A great advantage of my Competitive Tax plan is that, by introducing a border-adjustable value added tax on sales of goods and services and thereby decreasing our nation’s need to rely so heavily on the income tax to finance our government’s spending, we can have a tax system that is fair and yet substantially more favorable to economic growth than our current system…”

 http://waysandmeans.house.gov/UploadedFiles/Graetz_Testimony.pdf