Category Archives: VAT

What Will Happen if We Have a New Fiscal Crisis?

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As I often remind the readers of this blog, the two main topics are what I consider to be America’s two biggest economic and fiscal problems:

  • Slow economic growth, averaging just 2% since the end of the Great Recession in June 2009. This means fewer new jobs and smaller raises.
  • Massive debt, now 77% of GDP for the public part on which we pay interest, the largest since the end of WWII and predicted by the CBO to keep getting worse. As interest rates rise from their currently unusually low levels, interest payments on the debt will skyrocket.

 

The first problem, slow growth, is being addressed by the Trump Administration with various deregulatory actions as well as likely tax reform action by Congress.  Furthermore, the current low 4.4% unemployment rate means that the labor market is tightening on its own.


The second problem, massive debt, is much more worrisome for the future.  Right now interest rates are so low that our entire debt is essentially “free” money.  But every 1% increase will add nearly $150 billion per year in interest payments.  And this continues indefinitely (and keeps getting worse with more debt) because debt is rarely if ever paid back, it is only rolled over!  What are the likely outcomes of such an upward spiral in interest payments?  There are two possibilities:

  • First, the unthinkable. We default on our debt. This would immediately end the role of the U.S. dollar as the international currency and end our superpower status. The fallout would be disastrous for world peace and stability.
  • Second, a huge tax increase. The only alternative to default will be a large tax increase just to keep afloat on interest payments. A likely new tax for this purpose is a consumption tax in the form of a value added tax.

Conclusion. It is extremely shortsighted to keep on delaying a necessary solution to our rapidly worsening debt problem. It’s going to be unpleasant to either cut back on spending or to raise taxes but the longer we delay action the more painful it will become in the end.  Isn’t it obvious that we should get started immediately?

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What Might Fundamental Tax Reform Look Like?

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All four of the major presidential candidates have tax plans. Hillary Clinton would make small tweaks in our current tax system.  Bernie Sanders would raise current taxes substantially.  Both Donald Trump and Ted Cruz would both radically reduce the size of the federal income tax but would also greatly add to the national debt over the next ten years.
I have been trying to make the case on this blog that fundamental tax reform is the best thing we can do to get the economy growing faster in order to create more and better paying jobs.  I have also discussed a specific way to accomplish fundamental reform, namely the so-called Competitive Tax Plan proposed by the tax law expert, Michael Graetz.  It is a progressive consumption tax, a so-called Value Added Tax.
Capture2As reviewed in yesterday’s Wall Street Journal by Reihan Salam, the editor of the National Review, the Graetz Plan has these features:

  • A broad-based VAT of about 14% on goods and services.
  • Families earning less than $100,000 per year are exempt from the income tax. The tax rate would be 15% for incomes between $100,000 and $250,000 and 25% above this level.
  • The payroll tax (supporting Social Security and Medicare) would be greatly reduced for all workers earning less than $40,000 per year.
  • The corporate tax rate would be lowered to 15%, making it among the lowest in the world.
  • The Graetz Plan is revenue neutral as verified by the Tax Policy Center.

Think of the incredible advantages of such a tax plan. Of the expected 145 million tax returns for this year, 120 million would no longer be necessary.  Extravagant deductions such as for mortgage interest would have much less political support. The low corporate tax rate would bring jobs back to the U.S. instead of sending them overseas.  The rampant cronyism involved in tax breaks being handed out by Congress would be greatly reduced.
What is not to like about the Graetz Plan?

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The Root of Greece’s Problem (and Ours)

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Will it be the Euro or Drachma for Greece?  It’s down to the wire as Greece and the European Union negotiate the necessary conditions for Greece to remain in the Eurozone.  I have devoted several recent posts to the Greek fiscal crisis, pointing out the parallels between the Greek situation and our own.
Greece needs a bailout because its public debt is nearly 180% of GDP.  Our own public debt is “only” 74% of GDP at the present time but is predicted by the CBO to reach 175% of GDP by 2040, just 25 years from now.  Furthermore, Greece is currently receiving very favorable lending conditions from the European Central Bank, much better than are likely to apply in the U.S. in the long term.  This means we’re likely to have another deep crisis on our hands much sooner than 25 years from now.
CaptureConsider the data in the above charts from today’s Wall Street Journal.  It shows that Greece is spending 14.4% of GDP on pensions, more than any other major European country.  Furthermore, the efficiency of its VAT revenue collection is the poorest in the EU.  In other words, Greece has a very high rate of entitlement spending and has a poor tax collection system to support it.
Capture1In a general sense the U.S. is in a similar situation.  Today we spend about 13% of GDP on mandatory, i.e. entitlement, programs, compared to a total tax revenue level of 18% of GDP.  Just entitlement spending alone is projected to rise to 18% of GDP by 2050, unless changes are made.
Just as Greece needs to tighten up on pension spending, improve revenue collection and get its economy growing faster, the U.S. needs to tighten up on entitlement spending and speed up its stagnant economic growth as well.
We’re not yet as bad off as Greece is today.  But we’re headed in that direction with no one to bail us out when we get there!

We Need Fundamental Tax Reform!

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Most Americans would agree that our tax code is a mess and needs major reform.  The last reform was in 1986 when the top rate was reduced from 50% to 28% and many deductions were eliminated.  However this reform effort turned out to be short lived in the sense that many of these deductions have now been added back in.  The Romney plan of 2012, cutting all tax rates by 20% in a revenue neutral way, would have been an improvement over our current system.  But, it’s gains would likely also have been only short-lived.
CaptureConsumption taxes are now being used in many parts of the world and, in recent years, the idea of a national sales tax has gained popularity in the U.S.  The so-called Fair Tax would impose a single 30% tax on all sales at the retail level.  The proponents claim that this would raise enough income to replace all federal taxes: the individual income tax, the corporate income tax, the payroll tax and the estate tax.
The tax attorney, Michael Graetz, has evidence that a 34% tax rate would be necessary to replace just the individual and corporate income taxes alone.  This is a large discrepancy.  Regardless, a major argument against the Fair Tax is that such a high single tax of 30% or higher would create a compliance problem because of the incentive for people to try to avoid paying it.
Mr. Graetz has proposed a hybrid consumption and income tax, which he calls the Competitive Tax Plan, as a more reasonable but still fundamental change to our current tax system.  Although I have discussed this proposal previously, I will summarize it again here:

  • A broad-based Value Added Tax of about 14% is enacted on goods and services.
  • Families earning less than $100,000 per year are exempted from the income tax. The tax rate would be 15% for incomes between $100,000 and $250,000, and 25% above this level.
  • The corporate income tax rate is lowered to 15%.
  • The Earned Income Tax Credit is retained and used to provide relief from the Payroll Tax for low-income families.
  • The plan is designed to be revenue neutral as verified by the Tax Policy Center.

There are many advantages of the Graetz Plan over our current system.  100 million returns, for all those with incomes under $100,000, would be eliminated.  This would, in turn, make it less politically expedient for Congress to constantly add new exemptions and preferences into the code.  Lower income tax rates for both individuals and corporations would give the economy a big boost.
The Competitive Tax Plan is an example of the type of bold, fundamental reform that we need to make to our federal tax system.

Wealth and Taxation

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As I reported in my last blog post a few days ago, wealth inequality in the United States and the rest of the developed world is growing rapidly and is likely to get much worse in the foreseeable future.   This is happening because income from wealth, i.e. the return on investment, typically grows faster than wages and GDP.  As income inequality also grows, and top wage earners have more and more money to invest, then the gap between investment income and wage income will become even wider.  There is nothing wrong with this and the more money that is reinvested in our economy, the faster it will grow and the more jobs that will be created.
At the same time that huge new wealth is being created we have an archaic tax system in the U.S. which is not only incredibly complicated and inefficient, but also discourages investment because the top individual and corporate rates are so high.  And it doesn’t collect enough tax to pay our bills.  We have huge deficits already and the CBO says that they’ll just keep getting worse.
Making government operate more efficiently with less spending is highly desirable but will only go so far.  Every government program has a constituency of supporters who complain when their own program is targeted for cuts.  And the biggest and most expensive, the entitlement programs of Social Security and Medicare, have the largest constituency of all, over 50 million retirees at the present time and growing rapidly as the baby boomers retire at the rate of 10,000 per day.
This huge crunch can only be resolved by fundamental tax reform.  Several different ways have been proposed to do this:

  • Reform the current income tax system by broadening the base, lowering rates and eliminating deductions and loopholes to pay for it.  The problem with this approach is that no one wants to give up their own deductions (for mortgage interest, charitable contributions, employer provided healthcare, state and municipal taxes, etc.)
  • Introduce a consumption tax such as the Graetz Plan which I described in my January 7, 2014 post.  It would establish a 14% Value Added Tax on consumption, supplemented by a lower but still progressive tax on incomes over $100,000.  It would avoid being regressive on low wage workers by using an Earned Income Tax Credit to offset the Payroll Tax.
  • Introduce a wealth tax.

Sorry, I’m over my (self-imposed) word limit already.  I’ll describe a possible wealth tax in my next post!

Why a High Corporate Income Tax Is So Damaging to Our Economy

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My previous post, “Fundamental Tax Reform Is the Key to Solving Our Economic and Fiscal Problems II.  The Graetz Plan”, describes a tax reform plan which establishes a 14% national consumption (VAT) tax, exempts families earning under $100,000 from paying any income tax and also reduces the Corporate Income Tax to 15%.  All of this is done in a revenue neutral manner while also preserving all of the progressivity of our current income tax system.
CaptureA recent Op Ed column in the New York Times, by the economist Lawrence Kotlikoff, “Abolish the Corporate Income Tax”, makes the case that such a proposal “might sound like a gift to the rich, but it would actually help workers. … Apple’s tax return says it all:  The company, according to one calculation, paid only 8% of its worldwide profits in United States corporate income taxes, thanks to piling up most of its profits and locating far too many of its operations overseas.”
Our corporate income tax rate, at 35%, is one of the highest in the world and this is what encourages American multinational companies to move their business to other countries.  Whether we abolish the corporate income tax entirely, or just reduce it to 15%, is less important than recognizing the need to overcome popular prejudice about big business and make fundamental changes in our tax structure.
Solving our country’s many problems, from rising inequality at home to projecting adequate strength around the world, requires that the U.S. have a strong economy.  An annual growth rate of 2% of GDP is not nearly good enough to end our current economic stagnation.  To accomplish this will require overcoming the strong headwinds of increasing global competition and the replacement of people with machines.  We will need innovative thinking and initiative to break out of the old ways of doing things which are holding us back.
Are the American people “exceptional” enough to accomplish this challenging task?

Fundamental Tax Reform Is the Key to Solving Our Economic and Fiscal Problems II. The Graetz Plan

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The Yale Tax Law Professor, Michael Graetz, has proposed a new tax system “100 Million Unnecessary Returns: A Simple, Fair, and Competitive Tax Plan for the United States” which would do wonders towards straightening out the huge fiscal and economic problems now facing our country.
CaptureHow do we rev up the national economy in order to put more people back to work and, at the same time, raise the revenue needed to operate the government in the 21st century without mountains of debt?  Mr. Graetz’s basic idea is to tax consumption rather than relying totally on an income tax.  Under his plan both savings and investments will be taxed at a lower rate which will encourage more of both.  The Plan has these features:

  • A broad based Value Added Tax of about 14% is enacted on goods and services.  The U.S. is the only advanced economy without a VAT.
  • Families earning less than $100,000 are exempted from the income tax.  For incomes between $100,000 and $250,000, the tax rate would be 15%.  For income over $250,000, the rate would be 25%.
  • The corporate income tax rate is lowered to 15%.
  • The Earned Income Tax Credit (EITC) is used to provide relief from the VAT burden to low-income families by using payroll tax offsets.
  • The plan is designed to be revenue neutral as verified by the Tax Policy Center.

This plan has many advantages including:

  • Taxing consumption and lowering the corporate tax rate to 15% from its current level of 35% would dramatically encourage investment in the U.S. thereby stimulating the economy and creating both new jobs and higher wages for American workers.
  • It would eliminate more than 100 million of the 140 million U.S. tax returns.
  • With many fewer Americans paying income taxes there would be far less temptation for Congress to use income tax exclusions, deductions and credits to try to address social and economic problems.
  • The plan retains all of the progressive features of our current tax system whereby higher income earners pay higher tax rates.

The point of describing the Graetz Plan in some detail is not to suggest that it is the best way to implement tax reform but rather that here, at least, is one attractive way to do it.  The purpose is to move the discussion forward.  We badly need to make changes along these lines!