Sen. Orrin Hatch (Again) Miscasts VAT

On August 2, Sen. Hatch, in a speech on the Senate Floor, used the opportunity to again warn against a “European-style” Value Added Tax.

Notably, in the last Domenici-Rivlin testimony before the SFC, Sen. Hatch – for emphasis – rhetorically asked Sen. Domenici and Alice Rivlin if their revised proposal dropped the Deficit Reduction Sales Tax (VAT).  Alice Rivlin responded affirmatively, but made the point that both she and Sen. Domenici “still like” the DRST, but there was “no appetite” in Congress for a VAT.

Sen. Hatch and others who oppose a VAT smear it as a “European-style” tax, and only characterize it as an “add-on” tax, which it need not be!

Opponents in Congress ignore the potential opportunity for a revenue-neutral replacement of the Corporate Income Tax by a VAT to stimulate domestic growth and improve our trade balance.

The U.S. is at a competitive disadvantage in global trade for not employing a Value Added Tax.  All our trading partners use a VAT to eliminate the burden of taxation from the price/value comparison of goods crossing borders, since the VAT is subtracted from exports and added to imports.  Even China imposes a 17% VAT on everything we sell to them, and subtracts 17% from exports.  It’s not a socialist concept.  It’s just smart business.

In contrast, the U.S. clings to its high 35% CIT rate which is successfully avoided by parking profits abroad and through successful lobbying for loopholes.  The CIT is so unsuccessful that its share of government revenue has dropped from 32% in 1952 to 7.9% in 2011.  Today, that 24% drop in share would project to $674 billion in revenue.  In fact, government receipts have dropped to the point where corporations now spend $740 for avoidance (accountants, tax attorneys, lobbyists) for every $1,000 the government collects.

To replace the CIT, revenue-neutral, would take a VAT of 4.5%.  Imagine the effect on domestic job creation, if imports cost 4.5% more and exports cost 4.5% less. Imagine the effect of zero CIT on the billions of U.S. profits retained in lower CIT countries to avoid U.S. taxes?  Imagine the investment by foreign businesses, which would want to avoid their own country’s CIT?

Nothing government could do would have the significant positive effect on growth as replacing the CIT by a revenue-neutral VAT.

Prejudicial rhetoric without discussion of the merits of a revenue-neutral VAT to replace the CIT is against the country’s best interest.

Domenici-Rivlin Ditch DRST (VAT), testimony before Senate Finance Committee, 06/19/12

Sen. Pete Domenici and Dr. Alice Rivlin appeared before the Senate Finance Committee in open session to discuss their plan for sweeping tax reform.  They emphasized the overarching point that additional revenue is needed to reduce the deficit.  After all prudent cuts are made to Medicare, and after means-testing Social Security, there will still be a need for additional revenue to meet the obligations of a growing retired population.

Senator Hatch asked for confirmation that the revised D-R plan as now presented would replace their original element of a Deficit Reduction Sales Tax, a VAT, with an increased Corporate Income Tax (CIT).  Dr. Rivlin confirmed in response, but added that they “both still like” the idea of the DRST, however there was “no appetite” in Congress for a VAT.

The fact that no one in the Senate has the courage to back a Value Added Tax is at once understandable and regrettable.  Introducing a VAT…even dedicated to deficit reduction…would create yet another new tax in addition to the CIT.  Senators would have a hard time convincing their constituents that this medicine would be in their best interest.  It just would not be politically viable.

The way to sell a VAT rests with outright replacement of the CIT, which is a broken cog in our tax system.

In the process of avoiding taxation, corporations employ accountants, tax attorneys, and lobbyists to find and create loopholes that will minimize their costs.  These specialists are hugely successful, particularly for the large multi-national corporations.  As a result, the CIT is riddled with many exceptions —for agricultural subsidies, off-shore profits, American cruise lines, literally hundreds upon hundreds.

The result is a complicated maze that only a team of specialists can navigate. And, who knows what’s right? Neither individuals nor corporations know for sure whether their taxes paid are more or less than they could or should be.  As Will Rogers said, “The income tax has made more liars out of the American people than golf has.” Ultimately, this crazy quilt of code has undermined trust in government.

The CIT has long been criticized for being too high and uncompetitive.  This is why our multi-nationals tend to park profits in countries with lower tax rates. Some multi-national corporations push the limits by incorporating overseas profit centers that are no more than a mailbox in a foreign land. Such legal non-compliance may be an ethical and moral question, but it makes for good after-tax profits.

The fundamental purpose of our tax system should be to efficiently collect revenue in a way that is equitable and minimally inhibits economic growth and domestic employment.  William Simon, who served as Secretary of the Treasury in the Nixon and Ford administrations, said disparaging of our tax code: “The nation should have a tax system that looks like someone designed it on purpose.”

Look at how unsuccessful the CIT really is.  Collections peaked as a percentage of federal tax receipts in 1952 at 32.1%.  Receipts averaged 21.3% of total revenues in the 1960’s, 16.1% in the 1970’s, 9.6% in the 1980’s, 10.5% in the 1990’s, 10.4% in the 2000’s.  In 2010, the CIT contributed 8.9% and in 2011 only 7.9%.

A 2011 study by Citizens for Tax Justice revealed that the 280 most profitable corporations sheltered nearly half their profits from federal income taxes in the prior three years; their average effective tax rate was 18.5% over the three years, about half the statutory 35% rate; 78 of these companies paid zero federal income tax in one or more of those years.

Corporations are so successful at gaming the CIT, that taxes paid have fallen to the point where their compliance expenses including accountants, lawyers and lobbyists cost these corporations $740 for every $1000 the government collects.

If federal receipts from corporations have declined from one-third of federal revenues and now amount to less than 10%, why continue a tax system that is so easily thwarted and inefficient?

Why not replace the CIT with a smarter tax, a VAT to better compete in world trade and to assure compliance?

VAT is already accepted and proven.  This tax system was specifically created for world trade and is employed by all our trading partners and over 150 countries.  It is a consumption tax levied at each stage of production and in total is equivalent to a retail sales tax.

What makes the VAT important for trade is its border adjustability, meaning it is subtracted from exports and added to imports.  This feature removes the variable of the burden of government from the cost comparison of goods in international trade.

For example, when a car is shipped from Germany to China, the 19% German VAT is deducted from the price of the vehicle, and the 17% VAT in China is added to the price of the car when it is imported there. But, when a U.S. car ships overseas, there is no such deduction for the cost government (the CIT), and a VAT tax is added to the price by the importing country.  Here in the U.S., there is no VAT added to imports.  Without our own VAT, there is a large price wedge against U.S. products at home and abroad.

Our largest trading partners add the following VAT cost to goods they import from us.  The range is from 5% VAT in Canada and Japan to over 17% on average from the others: Canada 5%, China 17%, France 19.6%, Germany 19%, Italy 20%, Japan 5%, Korea 10%, Mexico 16%, Spain 16%, United Kingdom 17.5%.

These countries have a CIT in addition to a VAT.  But, that does not make sense for the U.S.  Why just add another tax onto the CIT, which we already know is a broken system?  How would replacing the CIT by a VAT affect us?

  • We would very likely see a strong economic growth spurt and more jobs.
  • U.S. goods would be more competitive with imports here, since imports would be equally taxed by the VAT.
  • U.S. exports would be more competitive, as the VAT, unlike the CIT, would be subtracted from exports.
  • There would be no double-taxation of dividends.  Because corporate profits would not be taxed, only dividends would be taxed to individuals when they receive them.
  • U.S. multi-nationals…which now park profits in lower-taxed countries…would bring their capital back to the U.S. for investment. The U.S. with NO corporate income tax would be the best country for recognizing your profits.  Foreign corporations would likewise shift profits to the U.S. for investment.

 If VAT is so good, why don’t we have it?  Again, VAT would be a new tax, and politicians fear proposing taxes, even if it is good medicine.  Tax is a four-letter word to politicians.  But, we don’t have to follow other countries and make our VAT an “add-on” tax.  Our VAT can be a dollar-for-dollar replacement for other taxes.  We can replace all corporate tax revenues by an 8% VAT, including rebates to protect individual tax filers with low income.  Companies would save substantially on their compliance expenses, and that savings could go to stockholders or consumers in the form of lower prices. Companies would no longer have the CIT to dodge, so they would no longer need a bevy of expensive lobbyists to push for loopholes (unless we made the mistake of permitting exceptions to the VAT, which would be like letting the camel’s nose under the tent).

Want to see the idea considered of replacing the CIT by a VAT?  Contact your representatives in the House and Senate. Tell them you would like the U.S. to get a fair shake in international trade.  Tell them replacing the Corporate Income Tax by a Value Added Tax will make the U.S. more competitive and create jobs.  Tell them you will not vote against them for proposing a revenue-neutral VAT to replace the Corporate Income Tax.

Chances are, some of our representatives really get the concept and would support a VAT, but they need to know you will support them.

VAT Gaining Momentum?, 12/21/10

CNNMoney.com surveyed 23 economists about where the economy is headed and how tax reform might be used to stimulate growth and to address America’s debt crisis. Nearly half the economists surveyed believe “overhauling the current system would be the best tax policy going forward,” including lower tax rates combined with ending certain tax preferences. “Several of the economists favor implementing both tax reform and a VAT. ‘Actually, we need a combination,’ wrote David Wyss, chief economist with Standard & Poor’s. ‘The fiscal outlook is disastrous, and unless draconian cuts in Medicare and Social Security are made, taxes will have to rise.'”

On “60 Minutes,” Federal Reserve Chairman Ben Bernanke remarked that “The tax code is very inefficient. Both the personal tax code and the corporate tax code. By closing loopholes and lowering rates, you could increase the efficiency of the tax code and create more incentives for people to invest.”

The Domenici-Rivlin plan from the Bipartisan Policy Center calls for a VAT offset in the first year by a payroll tax cut. Gov. Mitch Daniels of Indiana has suggested sweeping overhaul with a VAT paired with a flat tax on income with a high deductible. And, President Obama has indicated he would like to see the tax system reformed before the end of the two-year extension of the tax cuts.

Stimulus Comparison: Extended Bush Tax Cuts vs. Domenici-Rivlin Plan, 12/08/10

The exact numbers in the compromise extention of the Bush tax cuts are not yet available, but CNNMoney is reporting early Treasury estimates place it at $458 billion over two years. The overall compromise adjustment including the 2% Social Security cut, business tax breaks, and estate tax deductions should total between $700 to $800 billion in tax relief. Deficit hawks are reportedly OK with the implied increase in short-term debt so long as it is tied to a long-term deficit reduction plan.

Is this a plus or a minus for the economy? Previously, I have observed that both sides are Keynesians, now. For Congress, a decision not to extend the Bush tax cuts would come with the political risk of blame for a potential double-dip recession, i.e., extending an existing tax cut is not a true stimulus, but eclipsing the tax cut could hinder economic growth. We need more stimulus because we fear further contraction.

For stimulus size comparison, in 2011, Domenici-Rivlin projected the value of a payroll tax holiday to be $481 billion. The D-R plan would commence in 2012 with a payroll tax holiday stimulus paired with a Deficit Reduction Sales Tax (DRST), a VAT. In 2012, the D-R plan would net around $375 billion stimulus from the payroll tax holiday after the DRST (which would raise $105 billion), but D-R had contemplated that the Bush tax cuts would expire. So, the Bush tax cut compromise, if it comes about, would result in two to three times the first year stimulus of D-R.

Will that be enough stimulus to revive the economy? If throwing money at the economy is enough, then yes. If we need direction in spending that money, which I feel we do (on alternative energy), then we need an industrial policy as described in my last post.

(Gov. Daniels) Herman Kahn on Tax Reform & VAT, 11/27/10

It was smart marketing for Domenici/Rivlin to label their VAT a DRST (deficit reduction sales tax), and as a result there has not been much outcry about the VAT component.

Contrast that response with the well-publicized criticism that followed Indiana Gov. Mitch Daniels’ endorsement of sweeping tax reform including a VAT. Gov. Daniels, on the occasion of accepting the Hudson Institute’s Herman Kahn Award, Gov. Daniels had quoteed from Kahn’s 1982 book, “The Coming Boom.” Herman Kahn was co-founder and Director of the Hudson Institute, a conservative think-tank, so it is somewhat curious that the critical response to Gov. Daniels’ endorsement of Kahn’s tax reform proposal came almost entirely from conservatives.

Of course, the makeup of our economy has changed in the eighteen years since Kahn’s book was published, but the principle should still apply. It would be instructive to have OMB run the numbers based on different percentages and proportions.

NRF Distorts Domenici-Rivlin Sales Tax, 11/18/10

The National Retail Federation has it in for consumption taxes and wrongly opposes the Domenici-Rivlin plan, “Restoring America’s Future” from the Bipartisan Policy Center. NRF fears the short-term losses that might occur from an increase in prices. Fair enough. But, the Ernst & Young study they funded looks only to the effect of an ADD-ON value added tax, and that is not what the Domenici-Rivlin deficit reduction package is all about. (E&Y cannot be faulted; they were given the assignment to look only at an add-on VAT and not a VAT substitute for other taxes.)

First and foremost, D-R is intended to get the economy on a firm footing for growth, and they do this with an initial stimulus for jobs that puts money in the hands of consumers. NRF should really like that. The Deficit Reduction Sales Tax proposed in D-R is 3% in the first year, and rises to 6.5% thereafter, but it is offset in the first year by a payroll tax holiday for both employers and employees (combined 12.4%). Employers will have a reduced burden for employment, and that should help stimulate jobs. Employees will have extra cash in their pockets which when spent will be an off-budget stimulus to the economy. will be a boost to the economy and retail sales.

NRF is simply wrong-headed on this. The payroll tax cut and increase in consumer income in the Domenici-Rivlin plan will be good for retail business, jobs, and the economy.