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.

Thompson, Derek, “The Best Plan Yet? A Summary of the New Bipartisan Deficit Reduction Scheme,” TheAtlantic.com, 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.”
http://www.theatlantic.com/business/archive/2010/11/the-best-plan-yet-a-summary-of-the-new-bipartisan-deficit-reduction-scheme/66695/

Domenici-Rivlin, “Restoring America’s Future,” The Debt Reduction Task Force, BipartisanPolicy.org, 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.”

http://www.bipartisanpolicy.org/projects/debt-initiative/about

Domenici-Rivlin: Payroll Tax Holiday to Reduce Debt

Today, the Bipartisan Policy Center released its tax proposal to reduce the deficit and debt and put the country on a competitive footing for growth. This report, chaired by Pete Domenici and Alice Rivlin comes on the heels of the Simpson-Bowles recommendation of last week. A month ago, Gov. Mitch Daniels floated the concept of simplified sweeping tax reform with a VAT balanced by a flat income tax with a high deductible threshold. Could it be we are finally about to have the serious debate on tax policy that the country needs?
Last February, Rivlin testified to the Senate Budget Committee that: “…(O)ur tax system is extremely inefficient and complex. Part of the gap should be closed by reforming the federal tax system so that it produces more revenue with less drag on economic growth.”

Yesterday, ABC (Reuters) reported at the Wall Street Journal CEO Council conference in Washington that Rivlin hinted at the proposal being released today: “”We need a broad-based consumption tax. That is not politically popular, but at some point we are going to have to do it.”

In their joint Op/Ed in The Washington Post, today, Rivlin-Domenici propose: “To ensure a more robust recovery, we propose a one-year “payroll tax holiday” for 2011, suspending Social Security payroll taxes for employers and employees.” The proposal cuts corporate and individual tax rates and adds a 6.5 percent “debt-reduction sales tax.”

“…Restraining the debt can give us a leaner, more-effective government, a more efficient health system and a far simpler tax system more favorable to economic growth. Moreover, we can put the budget on a sustainable path without threatening the fragile recovery.”

This is a smart tax approach…reducing tax rates will cushion the introduction of the sales tax and the elimination of tax expenditures. The reduction in the employee portion of the payroll tax would more than offset the sales tax, and should make the new tax base marketable to the public and therefore politically viable.  President Obama would be well advised to back it.