Saluting Chairman Ryan

At last, a leader has presented a courageous plan to address the virtually crippled state of the economy.  With his proposal, “The Path to Prosperity, Restoring America’s Promise,” Republican House Budget Committee Chairman Paul Ryan has interjected the needed stimulus for substantive debate to resolve the endless budget deficits and the threatening debt crisis.   Politicians whose knee-jerk reaction is to immediately demagogue the Ryan plan would better serve the country by introducing modifications to this plan or their own alternatives.

Rep. Ryan has stepped out beyond the narrow budget discussions of his Committee to cover all the bases to achieve an “Efficient, Effective and Responsible Government.”   He has emphasized the importance of growing the economy through lower rates of taxation at both the individual and corporate level: “A broader base with lower rates is central to a fair, efficient and sustainable tax code, and the economic growth spurred by such a reform is a precondition to fixing the nation’s fiscal mess.”

If this sounds familiar, Rep. Ryan notably worked as speechwriter for the late Congressman Jack Kemp.  You can almost hear Kemp’s voice in the rallying cries that: “A government that allows economic destinies to be determine by political considerations rather than merit cannot lead the world in productivity and growth,” and “The biggest driver of revenue to the federal government isn’t higher rates – it’s economic growth.  Growth is the key to fiscal sustainability – and low rates are the key to growth.”

The Ryan Plan calls for repealing last year’s healthcare law and replacing, for those under 55, blank-check Medicare payments with a “premium-support” limited voucher system in an insurance exchange.  This subsidy would also be means-tested.  It does beg the question as to why not include all Medicare recipients in this Plan, and not just those who will arrive at eligibility in about a decade?

As to the tax system, reform suggestions are limited to lowering rates, broadening the base by eliminating loopholes and preferences, and cutting the number of brackets.   But introducing sweeping tax reform concepts such as suggested by Gov. Mitch Daniels would have distracted from this sensible start to substantive debate about balancing the budget and debt reduction.  The discussion of radical reform to the revenue side will have to wait.  Paul Ryan deserves much credit.

Simon Johnson, “Does the U.S. Really Have a Fiscal Crisis,” Economix Blog, The New York Times, 02/25/11

“…(O)ur tax system is completely antiquated. For the same level of tax revenue relative to G.D.P., we could greatly reduce the distortions (e.g., disincentives to work) just by modernizing. The right and the left agree that we should tax consumption more and income less, but neither is willing to make any kind of meaningful move toward a value-added tax (VAT).

The right seems afraid that this tax will be too effective and power an expansion of government. The left thinks a VAT is inevitably regressive (imposing more burden on poorer people), despite all the evidence that the impact of VAT depends on how it is designed — because you can choose what gets zero taxes (e.g., baby clothes) and high taxes (e.g., yachts).

The only room for bipartisan consensus here seems to be what we got in December 2010 — a big tax cut. Cutting taxes is nice, but only if it is consistent with keeping the budget on a sustainable path.

How does the Republican initiative to cut spending fit in with these budget issues? Not very much is the generous answer. The Republicans’ proposed cuts at the federal level are for discretionary nonmilitary spending, but this is small as a percentage of the budget (and therefore of the economy).

But the problem here is bipartisan — as it was with the tax cut last year. None of the leadership on either side is willing to talk openly about how our biggest banks caused great fiscal damage. No one is willing to explain why our health care costs continue to rise. And no top politicians currently champion real tax reform.”

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.

Thompson, Derek, “The Best Plan Yet? A Summary of the New Bipartisan Deficit Reduction Scheme,”, 11/17/10

“…(S)ix times the size of the Making Work Pay tax cut in the president’s 2009 Recovery Act, this would give employers and employees each a 6.2 percent tax cut on all wages up to $107,000. Employers would have thousands of dollars to spend on new equipment and workers, and employees would have a couple thousand dollars to spend on food and furniture.

So far, the White House has resisted this option for a few reasons: (1) it costs a lot of money; (2) without capping the payroll tax cut, a lot of this money will end up in wealthy people’s pockets and they might not spend it quickly; and (3) it’s unclear how well a one-year tax cut will stimulate growth if people know that taxes will rise significantly two years later. Still, this is a bold and worthy idea — the CBO esimates it could create up to 7 million jobs in 2011 — that would draw both liberal and conservative support.”

Domenici-Rivlin, “Restoring America’s Future,” The Debt Reduction Task Force,, 11/17/10

“Phase-in a Debt Reduction Sales Tax (DRST)

The tax reforms described above greatly simplify the income tax system, and make it fairer and more economically efficient. The combination of reduced tax expenditures and lower individual and corporate rates, however, leaves federal revenue roughly unchanged through 2020 and does not raise enough revenue to reduce the debt sufficiently in the long term, as population aging and rising healthcare costs drive up the cost of entitlements. Building on the base of a greatly improved income tax, with strengthened provisions that support low- and moderate-wage working families and retirees, the nation can add an additional source of revenue to reduce the debt without sacrificing fairness or economic growth.

The Task Force proposes a new broad-based tax on goods and services, the Debt Reduction Sales Tax (or DRST), that will phase in over two years to a rate of 6.5 percent (3 percent in 2012, and 6.5 percent from 2013 onward). A national sales tax has many advantages compared to increases in income tax rates. It does not tax the return to saving and investment, so it will not provide a disincentive for long-run wealth accumulation or for the capital accumulation needed to generate economic growth. Unlike an increase in the corporate income tax rate, the sales tax does not provide an incentive to shift investment overseas. Because a sales tax is based on domestic consumption instead of production (see below), preferences for some goods and services, unlike income tax preferences, will not affect the relative costs of producing different goods and services in the United States, and therefore does not place some industries at a competitive disadvantage. The proposed DRST will be consistent with international norms and easy to coordinate with the tax systems of other countries, while allowing the United States to set whatever specific exemptions it deems appropriate.

The DRST will be designed roughly like the national sales taxes in effect in over 150 countries around the world, including all of our major trading partners. Businesses pay tax on all of their sales, but receive credits for taxes that their suppliers pay when they purchase materials and capital goods from other firms. Final consumers in the United States, however, will not be able to claim credits on their purchases. The resulting total tax will be the same as for a tax collected from retailers only, but collecting the tax in stages from all businesses has two very large advantages over the form of retail sales tax used by most states in the country.

First, collecting it in stages facilitates tax compliance because businesses that try to operate outside the system will lose their ability to claim credits for purchases from other firms. By contrast, under a retail sales tax, if the retailer fails to pay the tax, the tax that should have been imposed on the entire value of the goods and services he or she sells is lost to the government.

Second, collecting the tax in stages reduces the “cascading” that occurs with a retail sales tax, under which sellers have difficulty distinguishing between sales to other businesses and sales to final consumers. Under most current state retail sales taxes, an estimated 40 percent of receipts come from business-to-business sales; consequently, some goods and services bear several levels of tax, first when sold to a business and then when resold to the final consumer. In contrast, under a multi-stage tax, there is no need to separate sales to different purchasers; all sales are taxable, but business purchasers can wipe out the tax liability from the prior sale by claiming a credit for the tax that the supplier pays.

Following international practice, the DRST will exempt exports (allowing exporters to claim credits on purchases, but pay no tax on sales) and tax imports (requiring importers to pay tax on sales, but allowing them no credit on purchases). Contrary to some assertions, these rules do not amount to either an export subsidy or an import tax (and they are allowed under international trade agreements). These “border adjustments” merely ensure that the tax base is domestic consumption only. Goods and services produced for domestic use bear the same tax burden whether produced in the United States or overseas. Goods and services produced for foreign consumers bear no U.S. sales tax, whether exported from the United States or produced overseas.

The tax will fall on a very broad base that includes most goods and services. However, government services, services produced by charitable organizations, educational activities, the imputed value of financial services (services that financial institutions finance by paying reduced interest to depositors instead of charging them explicit fees – like free checking) and government subsidies to health care (Medicare and Medicaid expenses, for example) will be exempt from the tax. Housing rents will be untaxed, but sales of new homes and rental properties will be taxable. All other consumer goods and services, including privately funded healthcare costs, food and beverages, clothing, legal and accounting services, and many other items not typically captured by state retail sales taxes, will be included in the tax base. Overall, about 75 percent of personal consumption expenditures will be subject to tax.

Using a broad base to tax consumption follows the practice of countries that have recently adopted national sales taxes (Australia, Canada, and New Zealand), compared with those that enacted such a tax earlier (the United Kingdom, France, and other European countries), whose tax bases are typically riddled with exemptions. A broad base allows lower rates to raise the same revenue as a narrow-base tax with higher rates. The broad base also creates many fewer compliance problems, because it avoids many issues that exemptions raise in determining which items are taxable and which are not. Exemptions for items that are considered necessities (food and clothing) – intended to make the tax less regressive – have little effect on the distribution of the tax burden because higher-income people generally consume the same broad classes of products and services, just higher-quality and more-expensive versions. Thus, exemptions are typically ineffective. A better way to make a sales tax less regressive is to give taxpayers a broad-based rebate, either as a lump-sum grant or an earnings subsidy – as the Task Force plan does.

The main objections raised to a national sales tax of this type are that it is regressive; it interferes with a revenue source that has historically been used exclusively by the states; and it would be a hidden tax that would facilitate excessive growth in government spending. However, these problems are either overstated or surmountable:

• Regressive Burden of the Tax: Merely substituting a sales tax for our current income tax would make the tax system less progressive, raising tax burdens on low- and middle-income families and lowering tax burdens on high-income families. But a more-modest sales tax can be one component of a tax system that is, on balance, even more progressive than today’s, just as the regressive payroll tax is part of our currently progressive federal tax system. The Task Force plan offsets the burden of the DRST on lower-income families through enhanced tax benefits in the form of new refundable credits for children and for the first $20,300 of each worker’s earnings.

• Competition with the States: States may object to a new multi-stage federal sales tax on the ground that it interferes with a tax base that has to date been reserved for them. But state retail sales tax bases have been eroding over time, as untaxed services account for a growing share of economic activity, and more and more products sold on the Internet have escaped state sales tax collections. States will benefit from piggy-backing their taxes on top of a broad-based federal sales tax. State tax authorities will benefit from access to IRS data from sales tax returns, just as they now rely on the IRS to help them enforce state income taxes. The recent experience with Canada’s goods and services tax suggests that sales taxes of sub-national governments can co-exist with a national multi-stage sales tax within a federal system.

• A Sales Tax as a “Money Machine”: A sales tax need not be hidden; the law can require that the amount of tax be itemized on sales receipts, as is now the practice in Canadian provinces and in many U.S. states. It would be no easier for Congress to raise the DRST than to raise income tax rates. Moreover, the 6.5 percent level of the DRST will be sufficient to keep the public debt stabilized below 60 percent of GDP for the foreseeable future.”