Conservatives and the VAT
Last week, the Senate voted 84-13 for the following proposition: “It is the sense of the Senate that the Value Added Tax is a massive tax increase that will cripple families on fixed income and only further push back America's economic recovery.” The sponsor was Senator John McCain, which is interesting because in his presidential campaign McCain endorsed a consumption tax, although not quite a VAT.
The Senate resolution seems to be part of a full-court press by conservatives against the VAT. In recent days, the Wall Street Journal editorial page, conservative bloggers, and columnists such as George Will have all written broadsides against the idea. Curiously, the left, which also usually opposes a consumption tax, has been fairly quiet in this round of overheated rhetoric.
Conservatives make two big arguments against the VAT, neither of which makes a lot of sense. The first is that it is a money machine that will suck trillions of dollars into the federal treasury that liberals will immediately spend. Now, it is true that if you give liberals trillions of dollars, they probably would spend every penny. But why would they spend consumption tax dollars more enthusiastically than income tax dollars?
Well, goes the argument, they’d do so because people would not know they are paying the VAT and thus would blindly accept rate increases. Really? Europeans seem more than familiar with their VAT. They certainly complain about it enough. By contrast, as I have noted many times, Americans seem entirely unaware of how much they pay in income taxes.
The Tax Policy Center estimates that a typical American remits less than a dime in income tax for every dollar he or she earns. Ask the next 10 people you see how much of their income they paid in taxes just a week ago and I suspect none of them will get it right.
The more bizarre argument against the VAT is that it is too efficient. Most economists agree that a well-designed consumption levy would tax nearly all spending at a low rate and thus have little effect on economic behavior. But to some, such as Casey Mulligan, it is a good thing if the tax law distorts economic decision making, picks winners and losers, and produces revenue in a clumsy and wasteful way. This might be called the “'nah, nah, I told you so’ argument.’ That is to say, the worst possible tax system is good because it will punish the economy to the maximum possible extent, and make us hate government even more.
If we aspire to such a mess, we are certainly on the right track. Indeed, as my colleagues Rosanne Altshuler, Katie Lim, and Bob Williams reported in their paper Desperately Seeking Revenue, if we try to get the deficit down to 3 percent of Gross Domestic Product by raising income tax rates, we’ll drive the top rate up to nearly 80 percent. Oh joy. Oh rapture.
It is not written that a VAT must supplement the income tax, as the right assumes. Mike Graetz has proposed one that would replace the income tax for nearly all households. And adding a VAT is hardly Nirvana. It will create its own administrative problems and there is a strong probability that Congress will complexify this levy just as it has butchered the income tax. Just think about all the exemptions states have made to their sales taxes.
But our current revenue system has reached its breaking point. To fix our terrible budget problem, we are going to have to cut spending. But we are also going to have to raise more revenue. And for the life of me, I don’t understand why we wouldn’t want to do so in the most efficient way possible. And that may lead us to a consumption tax in one form or another, Senate resolutions notwithstanding.
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Here is another interesting question. If the responsibility for filing taxes were shifted from workers to the employer for both payroll and the lower rates of the income tax (and the bottom 25% of the higher rates), what would this do to incentives regarding the hiring people at lower wages (assume that tax benefits for the poor were distributed to lower wage workers through the employer tax).
Does having employees pay taxes and get benefits make it easier or harder to hire low wage workers – if the alternative were a higher flatter tax rate?
Take fast food joints as an example. The tax obligation that might come from a VAT is instead born by lower wage workers – who may not pay taxes at all – however their labor hours remain untaxed or taxed at a lower rate because workers pay rather than the firm. Does this fact help incentivize the hiring of lower wage workers – or would they try to drive down wages solely because they have the economic power to do so?
Also, if family support were generous through an expanded child tax credit – would not a higher minimum wage be required to make sure that workers made salary over and above their credit payment?(especially if we gave the same credit to people in remedial education and workforce development programs and paid them to participate as well)?
This might make an interesting distributional analysis, although I am not sure it fits in your model, since it is microeconomic rather than macro.
Paul Samuelson also had a piece on the VAT in the Post. I responded to his piece and Will's piece on the Iowa Center for Fiscal Equity blog. I will repost below, but you can see other tasty morsels on the blog (some of which I have posted here in the past).
Robert Samuelson writes in today's Post about a VAT, which follows George Will's criticisms of yesterday. Both got it wrong, at least partially.
Samuelson fears that a VAT would hurt young families and that it would have too many loopholes. This would only be true without the inclusion of a transfer to employees with families to help them pay the tax. According to a recent study by the Tax Policy Center of Brookings/Urban, such a subsidy would allow a much broader tax. Indeed, if you make the subsidy broad enough, you could solve the demographic problems in Social Security by encouraging people to have children and pay for such a subsidy by voiding the home mortgage deduction and the property tax deduction. Overall, this would change the distribution of housing provided, but not the amount, as the biggest expense for growing families is a bigger home.
Will fears the opposite, the elderly will pay too much as they spend down their savings. Whether this is true or not depends on how you handle IRA withdrawls. If you leave traditional IRAs untaxed, or count them as income with a much higher floor for taxation (say $75,000 for individuals and $150,000 for joint filers), you will find most of the elderly avoiding any additional taxation. Roth IRA holders would have to be given some form of rebate, but that won't break the budget. Will also says that the income tax should be repealed with a VAT.
Will is wrong. What should happen, however, is that the income tax should have a higher floor, as I described above, so only the truly wealthy pay income taxes (Michael Graetz, a Republican, proposes this, though with a lower floor than I favor and with more deductions). Non-retirement payroll taxes should also be part of the VAT, or better yet merged entirely into an employer-based levy so that these can be hidden from view and increased to cover hospitalization insurance under Medicare, as well as Medicaid for seniors who need catastrophic care.
I find it amusing that in two days, one Post essayist says seniors will be hurt and then the other says the young will be hurt. They are both wrong.
When people realize that a VAT can replace filing taxes every April 15, as Graetz, Burman and Bindner all advocate, it will be more popular.
Interestingly enough, Graetz does not advocate touching payroll taxes at all. Burman's health VAT would consolidate all health care tax benefits and taxes into a single system funded by his VAT while Bindner would marry low rate income taxes and payroll taxes into an expanded business income tax (adding payroll to the base and including all ownership types) with a visible VAT to fund discretionary spending only.
There will never be a “grand bargain” to gut entitlement spending obligations. Too many conservatives, especially in the Tea Party, depend on or are soon to depend on them (or are glad that they exist because their parents depend on them and they know that without them, these costs would be paid out of their pockets).
The health insurance market is much more likely to crash than the bond market and this will lead insurers to the TARP window and America to single payer insurance. Of course, THAT may crash the bond market if the Chinese and Japanese balk. The market crashing is not a done deal, however, since without legislative action the Bush tax cuts expire in MONTHS. There is a tax debate in our future and if the Senate Republicans draw a line in the sand opposing all changes that don't include keeping tax cuts on the wealthy in play, the only option may be to either let them or extend them for two years. This is playing chicken for keeps and I am amazed that no one else is writing about this. Of course, one GOP vote and a solid Democratic caucus in the Senate settles the issue and permanently changes the budget outlook.
The best thing for the deficit would be to stand firm against an extension, although that may crash the economy. It is high risk. Allowing speculation to keep going by tax rates on the wealthy that are too low can't be good, however. If Obama vetoed an extension and the economy tanked, he would not be reelected unless he could effectively blame the GOP for blocking reform by favoring the wealthy.
A nice, center-left, VAT package could break the log jam although I suspect that Obama's economic team would never sign up for one. This is why we have elections.
I have no doubt that conservatives will support a VAT after entitlement programs, including the new health care commitments, are cut way back from current levels. Liberals will resist those cuts until the government bond market crashes. After that, the Grand Bargain will be possible. But the deal will need to spending have cuts first, tax increases second.
History shows that conservatives would be foolish to trade support of tax increases now for promises of spending cuts later. This explains why conservatives oppose a VAT at this time.