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.