Paul Ryan’s Consumption Tax
Representative Paul Ryan (R-WI), one of Congress’ most interesting members, was the guest at this morning’s session of TPC’s Tax Reform 2.0 series. He came to talk about his Roadmap for America’s Future—a comprehensive plan for dramatically restructuring both entitlement spending and the tax code. Ryan is nothing if not ambitious.
I’ll leave his proposals for Medicare, Medicaid, and Social Security for another day. But on revenues, Ryan has embraced the idea of a consumption levy to replace the current income tax. (which is really a clumsy hybrid of both).
On the business side, Ryan goes for the Full Monty. He'd dump the corporate income tax for a subtraction method value-added tax. As in similar models, he’d allow businesses to fully expense all capital investment, but firms would no longer deduct their interest costs. The tax, which he’d set at a very low 8.5 percent, would be border adjustable so it wouldn't affect exports. Ryan is hardly the first person to come up with such a tax structure. Years ago, Rudy Penner and others proposed the very similar USA Tax.
But Ryan gets credit for taking the leap on any form of VAT, usually anathema to his fellow Republicans and much of the business community. Bruce Bartlett, another often-heretical Republican, also endorses the VAT in a recent Forbes piece.
When it comes to individuals, however, Ryan loses his nerve. He proposes a full-blown consumption tax, all right, but then makes it voluntary. This is similar to what GOP presidential hopeful Fred Thompson talked about in the 2007-2008 primaries. Taxpayers would be given a choice: They could switch to a simplified income tax with almost no credits, deductions, or exclusions or keep today’s system with all its subsidies and complexity.
Ryan is convinced that taxpayers would flock to the new tax. It would have two rates—10 percent for income up to $100,000 and 25 percent on earnings above that level. It would include a big standard deduction and personal exemption ($39,000 for a family of four). Interest, capital gains, and dividends would be tax free. So would all estates.
The problem, as Rudy noted this morning, is that the wealthy would avoid taxes on their investments by migrating to the new system while middle-class itemizers (many of whom are hooked on their deductions for mortgage interest and the like) would stick with the current mess. The result: A huge revenue sink.
Ryan believes his new system would generate federal revenues of about 18.5 percent of GDP—close to the post World War II average. But TPC found the Thompson plan would cut federal revenues by a staggering $6 trillion to $7 trillion over 10 years, assuming everyone chose the version that most minimized their tax bill. The biggest benefit would go to those making between $100,000 and $500,000. The TPC estimate was static, so actual revenue losses might be more moderate, but still…
In the longer run, young people might go for simplicity before they get hooked on tax preferences and may end up on the consumption tax. But in the long run, as they say, we are all dead.
Ryan’s reason for giving people the choice seems more political than economic. He understands that tax reform usually creates losers as well as winners. So he figures his winners-only option may make a consumption tax more appealing to voters. Still, it is too bad he blinked. But give Ryan credit for at least confronting the failure of the income tax. It is a lot more than most of his colleagues are willing to do.
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OOPS, error in my math. The modified tax where the employee tax and payroll tax were added to the subtraction VAT would be 23.8% (10% individual, 5.3% payroll (non-elederly retirement/survivors), and his 8.5% VAT). While this would be the simplest, again, it would not include the ability to provide subsidies for larger families, leaving such families at an economic disadvantage – or worse leaving their employers at such a disadvantage because they could not pay a living wage to them even if they were inclined to do so. Indeed, the incentive would be stronger to fire workers with families and seniority and hire kids out school for whom the smaller wage goes farther. This already happens in the software industry and it is a nasty practice that could be discouraged by a larger child credit.
Ryan's proposal certainly does not go far enough. He could easily have just forgone all individual taxes below his high income threshold and cut that rate to 15%, while transferring the shifted tax liability to his subtraction VAT for employers, making that rate 18.5%. If he further shifted payroll taxes entirely to the employer, that VAT would be 33.8% (which could be lowered by also introducing a separate VAT that consumers would see on their invoices). If he only shifted non-retirement taxes (which I estimate to be 5% for employer and 5% for employee), the subtraction VAT would be 23.5%. Of course, if you added back in tax subsidies for family size (which may or may not be an offset against the mortgage and property tax subsidies), you would have to have a higher VAT rate, which would also necessitate a consumer invoice VAT – however poor consumers would have enough extra income to pay it. Adding health care reform taxation to the picture, say at a 10% increase to the subtraction VAT, would make it higher still – but you could offset the tax with a credit for providing insurance.
In short, you could have a VAT at a high rate with offsets, leaving an effective tax of around 18% (or even 13% if you had a 5% consumer VAT).
This does not achieve his goal of equity, but it does make taxes invisible to most voters and takes away the annual paperwork requirement. While Len's proposal also takes away the paperwork, it still leaves taxpayers conscious of a 30.3% gouge. It would be better to lower gross income and make them blissfully unaware of some of this taxation.
Ryan's pdf document makes it sound as if everybody is going to get all the goodies they want and the taxpayers will be happy too. No such outcome is even remotely possible. The inflation adjustments below the rate of medical cost inflation will bite hard, and political pressure to increase benefits will be high. I claim that this arrangement is not sustainable, meaning not politically stable.
Second, Ryan does not state whether by choosing to stay under the current tax system you will face the AMT's return to an unindexed 1993 exemption, along with sunset of the 2001 and 2003 tax cuts. When critical information like this is omitted, I assume the worst, and also that the writer's intent was to mislead. Call me a cynic, but this assumption is almost always correct.
Len's point is something on which I have no expertise whatsoever, but Len is always right on these things. Apparently there is another hidden structural defect in the proposal.
I'm pretty sure that the way out of this budget squeeze will include political death matches that continue for decades. There's no magic solution to be found.
Actually, Len, what I said was that the Ryan business tax is similar to the USA Tax. His individual proposal is, obviously, very different.
TPC's estimates were not static. We assumed behavioral response similar to what we guess JCT would, and still concluded that the Thompson plan could lose around $6 trillion over 10 years. (See table 3 in my paper with Jeff Rohaly and Greg Leiserson.) And that did not include the cost of the humongous corporate tax cut–moving to a cash flow tax with an 8.5 percent rate. I though Mr. Ryan's answer to Rudy's question about arbitrage was incredibly disingenuous–that he would leave it to Treasury to figure out how to limit tax sheltering. The folks at Treasury are good, but nobody could keep wealthy people from exploiting that giant loophole.
You said that Mr. Ryan's plan is similar in spirit to Rudy's USA Tax proposal, but that is really unfair to Rudy. The USA Tax had problems, but it was a coherent proposal that could plausibly have replaced the income tax. Mr. Ryan's plan is not.