VAT TAX coming???

Tax reform flaws build the case for a new consumption tax

Can ballooning deficits and distortions in the tax code lead both parties toward a value-added tax as an eventual fix?

By DAVID ROGERS

Is the real lesson from tax reform that Americans rely too much on the income tax to fund their government?

Time and again, that box has proven too small a revenue pot to do all that it’s asked by tax writers. And this leads to decisions, however well-intentioned (or not well intended like give massive breaks the wealthy individuals), that contribute to distortions down the road.

Most other industrial nations lighten the load on their income tax by combining it with some form of consumption taxes — a hard sell in today’s Washington. But given the partisan carnage of this latest tax fight, the uncertain result, and very real debt crisis facing the nation, is it time for both parties to start looking at other options? (A "Value Added Tax or VAT)

“Everybody else has managed to lower their corporate rates but they have done so by relying on consumption taxes which are less harmful to economic growth than income taxes,” said Michael Graetz, a former Treasury official who teaches and writes on tax issues at Yale and Columbia Universities. “We stubbornly refuse to go in that direction.”

“If you want a code that is predictable and simple and competitive with rates on the global market place, you have to bring in other sources of income, other than the income tax,” said Sen. Ben Cardin (D-Md.). “A progressive consumption tax is the most logical way to move forward but we’re not there yet. I think ultimately we’ll get there.”

In the latest debate, Republicans tried to get around this problem by allocating $1.5 trillion in their 10-year budget to cover the anticipated lost revenues from their tax overhaul. Even then, tax writers had to sunset hundreds of billions in cuts early, creating new fiscal cliffs in just seven years’ time. And they paid a heavy price too for decisions in the prior income tax overhaul in 1986.

That landmark bill enjoyed bipartisan support, did more to simplify the tax code and kept to a tight budget. But to meet its goals in the confines of the income tax alone, it sowed the seeds of future trouble by leaving behind a significant gap between the corporate tax rate and the top rate for most individuals.

The result was to greatly increase the proliferation of so-called “pass through” entities, each created to qualify “business income” for the lower individual rates of typical households. The 2001 round of individual tax cuts under President George W. Bush re-enforced this shift. And it became harder for Congress to go back and deal directly with the problems on the corporate side.

In truth, there was bipartisan support in the Senate for modernizing the corporate tax structure and lowering the rate to make the United States more competitive with its trading partners. An added incentive was the prospect of recapturing corporate earnings from abroad to help finance needed infrastructure investments at home.

But these discussions were in a framework most often where prominent Republican tax writers were content to cut the corporate tax rate down to 25 percent. Once the decision was made this year to go deeper — down to 21 percent in the final plan — the math was more difficult, and the politics impossible.

This was not just because of the billions in lost revenue on the corporate side but also because it meant expanding costly tax breaks for the now powerful “pass throughs” on the individual side of the bill. Together this exhausted a huge share of the extra money allocated under the GOP budget and helped to force the decision to severely cap federal deductions for state and local taxes.

That recovered hundreds of billions to help Republicans dig out of their hole. But it hurt families in Democratic states like New Jersey, New York, Illinois and California, and was seen as outright partisan war. When wealthy Republicans in the same states complained, House-Senate negotiators lowered the top individual rate to 37 percent in the final talks.

But this did nothing for middle-income families losing the same deductions and reinforced the Democratic critique that the GOP’s bill favored the rich.

Hungry to win back power, Democrats are already talking about repealing and replacing big pieces of the Republican overhaul. But as the GOP learned in tackling health care reform this past year, some fresh thinking might help get the votes.

As a rule, the regressive nature of consumption taxes makes them less attractive to Democrats. But given concerns about climate change, a carbon tax is one consumption tax that has begun to attract some following. And economist Henry Aaron at the non-profit Brookings Institution said Democrats are “short-sighted” if they reject consumption taxes simply on the grounds of regressivity.

Given the aging population and desire to do more to help workers adjust to technologies that threaten their jobs, the needs are there.

“The bulk of redistribution occurs on the expenditure side of the budget,” Aaron said. “Those of us who want more progressivity would rather see a progressive tax … but the impact on income redistribution is going to be overwhelmed by what is done with revenue on the expenditure side. That’s going to completely overwhelm any regressivity in the collection mechanism.”

Graetz has been an intellectual leader in showing how the added revenues of a broader value-added tax, or VAT, can achieve both progressive results and make the U.S. more competitive internationally. He would follow the newer VAT models adopted by countries like New Zealand and Canada and use the revenues to exempt many middle and lower income households from the income tax entirely, while cutting corporate rates.

Cardin has picked up on Graetz’s ideas and proposed his own “progressive consumption tax” with many of the same goals. He has refined his initial language, trying to learn from the feedback he receives, he said, and is preparing a third edition for this Congress to keep the flame alive.

With Donald Trump in the White House, Cardin knows it is a long road ahead and ultimately bipartisan support is crucial. But he feels encouraged by the interest he has begun to draw from members in both parties, in the wake of the tax debate.

“I’ve had several on both sides of the aisle come up to me on the floor,” he said. “I’m not naming names but more than a few.”

Going into the 2018 elections, congressional Republicans are running scared and must stick with their gamble. The deficit impact of the tax cuts is clearly in excess of what party moderates had envisioned last spring. But for the moment, there’s a high level of wishful double-counting among otherwise deficit-conscious law makers who seem in denial about the costs they have incurred.

Sooner or later, it’s expected the lights will go back on and the GOP’s collective “willing suspension of disbelief” must end. The numbers are so sobering they will likely insist upon it.

Last June, the Congressional Budget Office was already forecasting deficits totaling $10 trillion from 2018 through 2027. By CBO’s count, the new round of tax cuts — plus borrowing costs —will add another $1.7 trillion—a 17 percent increase.

Early estimates from the Joint Committee on Taxation are about one-third less after crediting the tax cuts with spurring economic growth. But the 10-year deficit impact would still be about $1.1 trillion, or an 11 percent increase, extrapolating from the CBO forecast.

If that $1.1 trillion number sounds familiar it’s because it effectively wipes out all of the promised 10-year savings imposed on annual appropriations under the Budget Control Act in 2011— after Republicans took over the House. Those cuts, followed by further reductions in 2013, have had a lasting effect in reducing non-defense appropriations, the very same pot of money needed for the public investments in infrastructure and job training so often mentioned in tandem with the business tax cuts.

For example, in the six-year period from 2012 through fiscal 2017, which ended last Sept. 30, capped non-defense appropriations have averaged about $496 billion annually. That’s about 16 percent less than what Democrats had been on course to spend when they last controlled Congress and the White House in 2010. More important, perhaps, it’s 10 percent less than what Republicans first agreed to in 2011, before the BCA was enacted.

In fact, just getting back to the initial BCA cut levels has been a struggle for non-defense programs. And all this has been happening even as interest payments on the federal debt are accelerating.

So much so that by 2025-2026, it’s expected the lines will cross and more money will be going out the door to service the debt than is left for all domestic appropriations.

Thus far, the Federal Reserve has tread lightly in raising interest rates. But by 2020, it now expects its federal funds rate could rise to 3.1 percent. That’s modestly higher than what CBO was assuming last June — the baseline against which the tax bill was scored.

At a time when Republicans are counting every tenth of a percentage point change in growth, it’s worth remembering that CBO estimates a full 1 percent increase in interest rates in its forecasts can mean $1.6 trillion more in red ink over the next 10 years.

That’s eerily close to its estimate of the tax bill’s deficit impact.

(I don't know who this Rogers guy is, but his argument is so Conservatively slanted. A VAT tax is so so regressive. That means poor people will spend way more than rich people as a proportion of income.)