Toder, Eric, Jim Nunns and Joseph Rosenberg, “Implications of Different Bases for a VAT,” Tax Policy Institute, 02/12

“The federal budget outlook is unsustainable over the long run.  The latest (June 2011) projections by the Congressional Budget Office (CBO)1 show the ratio of publicly-held debt held to GDP, which was 40 percent at the end of 2008, rising from 69 percent in 2011 to 187 percent in 2035 under their Alternative Fiscal Scenario, which assumes that current federal spending and revenue policies will largely continue.  Even under CBO’s Extended-Baseline Scenario, which assumes that all of the 2001-2003 tax cuts expire at the end of 2012, the AMT will no longer be patched, and that Medicare and other health-related spending will be held to modest growth rates, debt held by the public is projected to rise to 84 percent of GDP by 2035.  Rising debt levels increase the chance of a fiscal crisis, a sudden spike in the interest rate the federal government must pay on its debt that would necessitate large adjustments to spending, revenues, or both.  More gradual adjustments could be better designed and less damaging to long-run growth and social welfare.

Two prestigious groups, the President’s National Commission on Fiscal Responsibility and Reform and the Bipartisan Policy Center’s Debt Reduction Task Force, both recommended a sweeping set of changes in taxes and spending policies to address future deficits and eventually reduce the ratio of publicly held debt to GDP below its current level.2  The Debt Reduction Task Force recommendations included adopting a “debt reduction sales tax” structured as a value-added tax (VAT).  A VAT is a broad-based tax on household consumption that is collected incrementally by businesses at each stage of their production and distribution of goods and services.  VATs are an important source of revenue for nearly all countries, and among major countries, the United States is alone in not imposing a VAT.

VATs around the world typically exclude certain consumption items from the VAT base for policy or administrative reasons.  This paper describes the policy and administrative reasons for exclusions from the VAT base and the design of a rebate as a substitute for base exclusions to address distributional objectives.  The paper then analyzes the effect of possible exclusions from a U.S. VAT base or a rebate on the VAT rate necessary to achieve a specific deficit reduction target and on the distribution of the tax burden.   Two options for the base of a VAT are analyzed: a broad base, which would allow the lowest rate necessary to meet the specific target for deficit reduction, and a narrower base that is designed to address the distributional effects of a VAT by omitting items that are disproportionately consumed by lower-income households.  A higher rate would be required on this narrower base to meet the deficit reduction target.  A third VAT option that takes a different approach to addressing the distributional effects of a VAT also is analyzed.  This option uses the broad base of the first option but provides a rebate to households, so it would also require a higher rate than the first option to meet the deficit reduction target.”

 http://www.urban.org/uploadedpdf/412501-Implications-of-Different-Bases-for-a-VAT.pdf

Selling a Tax Increase, What Would Reagan Do?

President Obama could end the Congressional budget stalemate by going to the people directly, as President Reagan did in his first term.  At that time, President Reagan needed to break a deadlock on his tax reform proposal.  The solution was to go on prime-time TV and appeal to the public to send postcards in support to their Congressional representatives.  Granted, a tax cut is an easy sell, and a tax increase a hard one, but the idea is to provide needed cover to Republicans (and some Democrats) to compromise on raising taxes.

Technology favors this approach today, as much easier emails would replace postcards, and the volume of response would surely be higher than Reagan’s successful appeal.  A website would be created to offer direct links to the email addresses of Congress by zip code with pre-formatted messages, e.g., “I support the return to Clinton-level taxes on January 1, 2013. I am willing to pay my fair share to reduce our deficit and debt.”  A web blast could complement a TV appeal.

Polls also favor this approach.  A review of 2011 polls on taxes compiled by Bruce Bartlett reveals that Americans will support President Obama’s call for increased taxes:

(Bruce Bartlett’s blog: CapitalGainsandGames.com)

“Americans Support Higher Taxes. Really.,” June 29, 2011

Contrary to Republican dogma, polls show that the American people strongly support higher taxes to reduce the deficit and improve income inequality. Following are 19 different polls since the first of the year that say so.

A June 9 Washington Post/ABC News poll found that 61 percent of people believe higher taxes will be necessary to reduce the deficit.

A June 7 Pew poll found strong support for tax increases to reduce the deficit; 67 percent of people favor raising the wage cap for Social Security taxes, 66 percent raising income tax rates on those making more than $250,000, and 62 percent favor limiting tax deductions for large corporations. A plurality of people would also limit the mortgage interest deduction.

A May 26 Lake Research poll of Colorado voters found that they support higher taxes on the rich to shore-up Social Security’s finances by a 44 percent to 25 percent margin.

A May 13 Bloomberg poll found that only one third of people believe it is possible to substantially reduce the budget deficit without higher taxes; two thirds do not.

A May 12 Ipsos/Reuters poll found that three-fifths of people would support higher taxes to reduce the deficit.

A May 4 Quinnipiac poll found that people favor raising taxes on those making more than $250,000 to reduce the deficit by a 69 percent to 28 percent margin.

An April 29 Gallup poll found that only 20 percent of people believe the budget deficit should be reduced only by cutting spending; 76 percent say that higher taxes must play a role.

An April 25 USC/Los Angeles Times poll of Californians found that by about a 2-to-1 margin voters favor raising taxes to deal with the state’s budget problems over cutting spending alone.

An April 22 New York Times/CBS News poll found that 72 percent of people favor raising taxes on the rich to reduce the deficit. It also found that 66 percent of people believe tax increases will be necessary to reduce the deficit versus 19 percent who believe spending cuts alone are sufficient.

An April 20 Washington Post/ABC News poll found that by a 2-to-1 margin people favor a combination of higher taxes and spending cuts over spending cuts alone to reduce the deficit. It also found that 72 percent of people favor raising taxes on the rich to reduce the deficit and it is far and away the most popular deficit reduction measure.

An April 20 Public Religion Research Institute poll found that by a 2-to-1 margin, people believe that the wealthy should pay more taxes than the poor or middle class. Also, 62 percent of people believe that growing inequality of wealth is a serious problem.

An April 18 McClatchy-Marist poll found that voters support higher taxes on the rich to reduce the deficit by a 2-to-1 margin, including 45 percent of self-identified Tea Party members.

An April 18 Gallup poll found that 67 percent of people do not believe that corporations pay their fair share of taxes, and 59 percent believe that the rich do not pay their fair share.

On April 1, Tulchin Research released a poll showing that voters in California overwhelmingly support higher taxes on the rich to deal with the state’s budgetary problems.

A March 15 ABC News/Washington Post poll found that only 31 percent of voters support the Republican policy of only cutting spending to reduce the deficit; 64 percent believe higher taxes will also be necessary.

A March 2 NBC News/Wall Street Journal poll found that 81 percent of people would support a surtax on millionaires to help reduce the budget deficit, and 68 percent would support eliminating the Bush tax cuts for those earning more than $250,000.

A February 15 CBS News poll found that only 49 percent of people believe that reducing the deficit will require cuts in programs that benefit them; 41 percent do not. Also, only 37 percent of people believe that reducing the deficit will require higher taxes on them; 59 percent do not.

A January 20 CBS News/New York Times poll found that close to two-thirds of people would rather raise taxes than cut benefits for Social Security or Medicare in order to stabilize their finances. The poll also found that if taxes must be raised, 33 percent would favor a national sales tax, 32 percent would support restricting the mortgage interest deduction, 12 percent would raise the gasoline taxes, and 10 percent would tax health care benefits.

On January 3, a 60 Minutes/Vanity Fair poll found that 61 percent of people would rather raise taxes on the rich to balance the budget than cut defense, Social Security or Medicare.

The economic risk of failure to reach a compromise agreement within two to three weeks warrants the political risk of appealing to the public to provide the cover for opponents to tax increases.  The overwhelming odds are it would succeed.


GE Supports Tax Reform!

GE’s CEO, Jeffrey Immelt, and GE spokesperson Andrew Williams have recently commented that they would support tax reform that makes the U.S. more competitive and which would also assure that “everyone pays their fair share.”  See:“GE tax issue still rages on,” Rob Varnon, April 25, 2011, newstimes.com

“’GE supports enactment of a tax system that is consistent with global norms and allows American companies to compete on a level playing field with their foreign competitors,’ Andrew Williams, a spokesman for GE, said Monday . ‘We support tax policies that are consistent with policies encouraging U.S. exports. Our global competitors have tax systems with each of these core principles. The United States cannot afford to be an outlier, as it is now.’

GE Chairman and Chief Executive Officer Jeffrey Immelt said in a speech in March the U.S. tax system is ‘old, complex and uncompetitive. The purpose of a tax code should be that everyone pays their fair share, including GE. But it should also promote jobs and competitiveness and does the opposite.’  He said the nation must close loopholes and lower corporate tax rates to put it ‘in line with every other developed country in the world.’”

While stopping short of mentioning a value added tax, these comments from GE make all the basic arguments for a VAT: encourage exports, level the playing field by taxing imports, harmonize taxes for global competitiveness, eliminate a competitive disadvantage to the U.S., end complexity, assure that “everyone pays their fair share, including GE,” promote jobs, eliminate loopholes, and lower corporate tax rates.

The VAT we have often noted is a political hot potato, and Treasury Secretary Geithner recently affirmed there is “no enthusiasm” for a VAT.  Perhaps Jeffrey Immelt, if he is willing to directly endorse a VAT, could convince the President that this is the measure we should take, i.e., as Laura Tyson has recommended, cut the corporate rate and simultaneously implement a value added tax.

Tyson, Laura D’Andrea, “The Logic of Cutting Corporate Taxes,” Economix blog, The New York Times, 04/08/11

Professor Graetz, and more recently, William G. Gale and Mr. Harris have proposed introducing a value-added tax to reduce the deficit and to finance a reduction in the corporate tax rate.

Most countries that have reduced their corporate tax rates have a value added tax that accounts for a significant share of their tax revenues. To offset the regressive effects of a value added tax, countries have used lower value-added-tax rates on items like food, health care and education, as well as cash subsidies for poor households.

I believe that a federal value added tax with such offsets should be considered as part of a balanced multiyear deficit-reduction package that includes a sizeable reduction in the corporate tax rate.

http://economix.blogs.nytimes.com/2011/04/08/the-logic-of-cutting-corporate-taxes/?smid=tw-nytimes&seid=auto

 

Lindsey, Lawrence B., Testimony before the Senate Budget Committee, 02/02/11

“(O)ur income based system…encourages economic activity to go abroad.  An item that is manufactured in China but purchased in America has a cost structure that involves no U.S. income or payroll taxes on its labor content and virtually no U.S. corporate tax on the capital involved in the production.

Of course China does have an income tax, but it is quite low compared to ours.  The Chinese Individual Income tax produces revenue equal to just 1.2 percent of GDP compared to roughly 7 percent in the United States.  The largest component of the  Chinese tax system is the Value Added Tax, which generates roughly one third of all Chinese tax revenue.  But Value Added taxes are rebated on exports, so this tax does not apply.  Conversely, an item built in America and then sold to China involves labor costs that pay both income and payroll  taxes and capital costs  that involve the whole panoply of U.S. taxation. When they arrive in China the import cost is subject to Chinese Value Added Tax.  And this is not just the Chinese.

Throughout Europe Value Added Taxation has increasingly replaced direct taxation on personal and corporate incomes over the last couple decades and under World Trade Organization rules it is perfectly legal for them to rebate the tax on exports and impose it on imports.

We complain a lot about the advantages the Chinese give themselves through manipulation of their exchange rate.  At the same time we induce this massive self-inflicted wound on ourselves in the form of our income based tax system.  And whenever someone advocates raising rates within our current tax regime they are implicitly calling for these distortions to be larger and therefore for Chinese goods to become even more competitive here and our goods to become even less competitive overseas.”

http://budget.senate.gov/republican/hearingarchive/testimonies/2011/2011-02-02Lindsey.pdf

New York Times, “The Tax-Cut Deal,” , 12/18/10

Deficits are not as pressing a problem as economic recovery. A stronger recovery must not only come first, but is the best way to begin to heal the budget. Fighting to uphold health care reform is also crucial, because, in the long run, that is key to taming the deficit.

Further, near-term stimulus must be paired with a credible plan to reduce deficits as the economy recovers — including tax reform that raises revenue through various changes, like a simplified income tax, a new value added tax and a financial transactions tax. Even though he agreed to extend the Bush tax cuts through 2012, Mr. Obama must educate the public on their ruinous effects: They account for roughly 40 percent of today’s deficit, a share that will grow over time.

When deficit reduction begins in earnest, tax increases and cuts in big-ticket programs — Medicare, Medicaid, Social Security and defense — will be the focus. Before that, Mr. Obama must not be drawn into nickel-and-dime cuts that will not solve the deficit problem — and will impede recovery.

http://www.nytimes.com/2010/12/19/opinion/19sun1.html

Obama Initiates Tax System Overhaul Analysis, 12/10/10

As reported in The New York Times, “Obama Weighs Tax Overhaul in Bid to Address Debt,” 12/10/20, President Obama has asked the Treasury Department to explore tax overhaul options.

The Simpson-Bowles Commission suggested cutting back on credits, deductions and exemptions and thus broadening the tax bases to enable a lower rate to raise revenues. But, this represented more tinkering around the edges of tax reform. The Domenici-Rivlin plan introduces a VAT sales tax dedicated to deficit reduction.

The President’s usage of the word “overhaul” delivers with it the hope that Treasury will be instructed to examine sweeping tax reform including a VAT to make the U.S. more competitive in world trade. The impending Bush tax cut compromise will expand the deficit by an estimated $700-800 billion, and while this additional stimulus may avoid another economic contraction, no one anticipates the economy will grow out of its deficit problem. The increasing debt will have to be addressed with an increase in taxes after the economy begins to turn around, and the best way to do it is with a VAT consumption tax rather than an increase in income taxes.

In the pursuit of simplicity, and not a mere reduction of complexity, tax overhaul analysis should include total replacement of the current tax system: a VAT paired with a flat tax on personal income with a high deductible. Hopefully, Treasury will examine this proposal, once suggested by Herman Kahn, and recently floated again by Gov. Mitch Daniels.

Such a proposal was also at the heart of Gov. Jerry Brown’s presidential campaign in 1991, but Bill Clinton opposed the concept and defined it as a “double tax” which, as a revenue-neutral proposal, it was not. President Clinton now endorses a VAT for the U.S.

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