"Broad-based consumption tax" - 21st century necessity?

The Wall Street Journal for today (Feb. 8) includes an op ed (Toward a Different Fiscal Future) by economist Glenn Hubbard who previously worked in the Council of Economic Advisers for George W. Bush. Dr. Hubbard points out the serious issues in the US budget that are not sustainable even with an income tax increase for high income individuals (who are only about 1% of the public).

One of his suggestions is for a "broad-based consumption tax." He doesn't state what this would be. I'd guess that the supporters of the Fair Tax will jump on this suggestion and say it should be the Fair Tax. Of course, that group advocates the Fair Tax as a replacement for today's income, payroll and estate/gift taxes, not as an add on. Dr. Hubbard is noting the need for an add-on due to deficits and continued spending desires as well as mandatory spending items in the federal budget. He is not the only one to suggest this. Paul Volcker has also suggested the need for a VAT (which is a broad-based consumption tax).

Does this make sense as a way to move our tax system into the 21st century? Well, yes and no.

Yes, we have deficits, growing debt and lots of spending that no one seems to want to seriously reduce or even freeze (President Obama proposes to only freeze a very small percentage of spending for three years). Someone has to pay for this. "Broad-based" means that everyone would pay. That would be true if we had a VAT. Every time you bought a good or service, you'd pay the federal VAT. If designed as a credit-invoice model that most of the rest of the world uses (in addition to income taxes), businesses would also pay VAT. However, businesses would get their VAT rebated to them. So, the VAT is a much better form of sales tax than our sales tax which businesses do have to pay, but economically and technically, should not. The consumption taxed should only be final consumption of consumers.

The typical concern raised about a US VAT is that it would be a "money machine." Opponents suggest that it would be too easy to raise the rate and generate lots of money. I don't know how true that is because this tax would affect 100% of voters (rather than the 1% affected by any tax increase on those making over $250,000) so I think it would be politically difficult to keep raising the rate. Of course, then it might be easier for legislators and the President to tell voters that the alternative to a VAT rate increase is to cut spending.

Any benefits of a VAT? I think it would really help the states because they could replace their sales tax with the federal VAT by just adding on to it. The state rates could be lower and the pyramiding that exist with the state sales tax would end. Relief to address the regressivity of the VAT could be down with refundable income tax credits (federal and state) which would avoid giving VAT breaks to high income individuals. Also, the rest of the world (mostly) uses a VAT. Perhaps there are advantages to using it, such as allow for exports to be tax-exempt and imports to be taxed.

And, yes, if spending can't be better controlled, the feds have to find revenue somewhere.

BUT, I hope that alternatives would be considered because the VAT rate would likely have to be high and would adversely affect many low and middle income taxpayers. We have a significant and growing deficit. Why are new tax breaks being added for individuals - such as the American Opportunity Tax Credit, or increases in existing tax breaks. Just as President Obama says we need to freeze spending for 3 years, we need to freeze spending that exists in the tax law.

Also, adding more tax breaks just makes the system more complicated than it needs to be.

What type of "broad-based consumption tax" do you think is appropriate, if any, at the federal level? What about the alternatives that can still help to reduce our deficit and debt?

btw - the National Taxpayer Advocate's annual report to Congress for 2009 includes a report on administrative issues of a consumption tax, such as a VAT or national sales tax (Volume II, page 35). Fortuitous?

Complexity of Simplified Sales Tax

I finally just had a moment to read the background materials for a 1/20/2010 SSUTA meeting that dealt with vendor compensation for collecting state sales and use taxes. Some of the discussion questions are interesting in that I think they raise the issue of whether the SSUTA has made sales tax compliance simple enough such that Congress should allow adopting states to make remote vendors collect.

Here are a few of these discussion questions that, I think, raise additional issues beyond vendor compensation approaches.

1. "How do you determine who is a volunteer seller and who is a nexus seller initially and going forward?" I think this implies that it is not always clear when a seller has nexus in the state. And generally, that is true.
2. "Should additional compensation be required in states with more complex tax structures? What complexity factors should be considered?" Why would an adopting state's tax structure be more complex than others? If this is the case, then wouldn't it still impede interstate commerce to make a remote vendor have to collect from customers in the states with the more complex tax structures? If yes, Congress should not allow adopting states to require remote vendors to collect tax. I think this question might mean that additional simplifications are needed, such as one rate per state.

What do you think?

Tax System Challenges of Odd Budget Processes

Congress has passed H. J. Res. 45, the Statutory Pay-As-You-Go Act of 2010 (2/4/10). While it sounds good - basically, tax cuts should be offset by certain types of spending cuts or other tax increases, it has an enormous whole in it. PAYGO won't apply to tax changes that are considered part of "current policies."

Here is the section of the resolution: "ADJUSTMENT FOR CURRENT POLICIES.
(a) Purpose- The purpose of this section is to provide for adjustments of estimates of budgetary effects of PAYGO legislation for legislation affecting 4 areas of the budget--
(1) payments made under section 1848 of the Social Security Act (referred to in this section as `Payment for Physicians' Services');
(2) the Estate and Gift Tax under subtitle B of the Internal Revenue Code of 1986;
(3) the AMT; and
(4) provisions of EGTRRA or JGTRRA that amended the Internal Revenue Code of 1986 (or provisions in later statutes further amending the amendments made by EGTRRA or JGTRRA), other than--
(A) the provisions of those 2 Acts that were made permanent by the Pension Protection Act of 2006 (Public Law 109-280);
(B) amendments to the Estate and Gift Tax referred to in paragraph (2);
(C) the AMT referred to in paragraph (3); and
(D) the income tax rates on ordinary income that apply to individuals with adjusted gross incomes greater than $200,000 for a single filer and $250,000 for joint filers."

These are some costly provisions - 2 years of the AMT patch (2010 and 2011) and reinstatement of the tax cuts for individuals with income under $250,000 ($200,000 if single).

This doesn't really seem quite honest. It also enables Congress to enact lots of tax cuts that are not paid for. This means the deficit will go up as will the debt and interest expense and someday, someone will have to raise taxes to pay for this. Enacting PAYGO with big holes in it is like someone saying they are going to only spend within their income level, while at the same time running up their credit cards to pay for extra spending.

I was really thinking that the high cost of keeping any of the 2001/2003 tax cuts would cause Congress to have to enact some major (or at least significant) reforms of the income tax. Such reforms would "mask" the reality that when the tax cuts expire after 2010, there is, in effect, a tax increase for everyone. Reform could have included a thorough review of all special deductions, credits and exclusions to see if any are not needed or can be cut back to better meet their intended purpose and to be made more equitable.

This deceptive PAYGO provision is really a way to run up an already high deficit and debt, and avoid the tough job of modernizing and improving our federal tax system.

What do you think?

AB 1178 Sales Tax Exemption on Textbooks - Wrong Way to Go!

AB 1178 has passed in the Assembly and gone to the Senate. This is too bad for good tax policy. AB 1178 includes a state level sales tax exemption for textbooks and supplies purchased by a student of a UC, CSU or community college between July 1, 2011 and December 31, 2014. [Click here for Board of Equalization analysis of AB 1178.]

The problems:

1) Makes the tax laws more complex: Can you imagine the complexity involved? Stores will have to verify that the buyer is a student in a public higher education institution and that the items are for school. And the store must still charge the local sales tax. This really complicates compliance for sellers of books and supplies - and that's a lot of businesses (college bookstores, Office Depot, 7-11, Costco, Borders, Safeway, etc.).

What if a student at a private college also takes a course at a public university? They will have an ID card from the public university. Is the store required to review their course syllabi or get a note from the professor to verify what is required for a class?

What if the supply is an iPod which will also be used personally?

This is NOT the way to write a tax law. Whenever there are special exemptions, rules are needed to define who gets that exemption and what exactly is exempt. That is complicated for both vendors and tax administrators.

2) Savings might not all go to the student: While the sentiment behind the bill - reduce cost of textbooks sounds good, it won't work. When stores are setting their prices, they are most likely to factor in that the students won't have to pay state sales tax on the item, so they can increase the price of the textbooks a bit.

3) Equity issue: Many students can easily afford textbooks and sales tax. This partial exemption doesn't factor in the income of the buyer. So, even wealthy students get a tax break.

4) Not needed: Students usually have lower cost options for acquiring books. Many find great deals online. Often they can buy a used book. They might also share a book and some schools have book rentals. Also, if a student in California gets an electronic copy, our sales tax already exempts that book (which is a flaw in the law).

5) Dishonest budgeting: This is deceptive by lawmakers. If they are concerned about costs for students in public higher ed, they should increase the funding that goes to these organizations so that fees do not need to be increased as much, so students can graduate earlier because more courses can be offered, etc. When lawmakers already control the funding of higher ed, there is absolutely no need to create a complicated, inequitable and unnecessary tax rule to reduce costs for students. They should use the budget line item instead.

I hope this bill is defeated by the Senate and if not, is vetoed by the Governor. Let's not make the California tax system worse than it needs to be and let's encourage legislators to reduce costs for college students by increasing funding for the UC, CSU and community colleges by an amount equal to the estimate of the tax dollars that would be lost from this inappropriate exemption.

Note: At least 9 states have exemptions for sales tax. I found a list at the Barnes & Noble website, which also includes instructions to student buyers that indicates the compliance complexity of such an exemption - here (see bottom of the bn.com page).

What do you think?

S Corporations and the Tax Gap

In December 2009, the GAO released a report, Actions Needed to Address Noncompliance with S Corporation Tax Rules, detailing a variety of errors found on S corporation returns. These include:

• mireporting income
• shareholders claiming losses greater than their basis
• deduction of personal expenditures
• not paying adequate compensation to employee-shareholders

The income misreporting problem generates at least an $8.5 billion annual tax gap. The GAO found that the error rate among returns prepared by paid preparers was not much different from returns that were self-prepared.

I've got a short article on the report, and the relevance of the key findings - S Corporations, Complexity and the Tax Gap, AICPA Corporate Taxation Insider (1/28/10).

State of the Union Speech Includes Tax and Budget Deception

President Obama's State of the Union address included some conflicting statements which I think he can easily get away with because most people don't think of tax credits and special tax deductions as being the equivalent of government spending. For example, the new tax credit he mentioned for creating jobs - any company that claims this will have a reduced tax liability. It is the same effect as if the government had issued a check to this employer.

So, when President Obama says he wants to freeze some spending categories starting in 2011 while at the same time adding new tax credits and tax deductions (although it sounded like he wanted to do this starting in 2010), spending is not frozen - it is likely going up. More specifically, the spending that is buried in the tax law increases.

Of course, he did also mention some tax reductions, such as for oil companies and companies that shift jobs outside of the US.

But, if you are going to freeze spending, you will not meet your goal if you create some new spending and bury it in the tax law. This would be like Jane saying she us going to cut down on her spending, but then asking her employer to send part of each of her paychecks to a travel agent to cover the cost of a vacation she is planning. While Jane might not be paying any increases in her cable or utility bills (because she is "freezing her spending"), she is spending more by diverting some of her paycheck to pay for a vacation. Even though her employer writes the check to the travel agent, it is Jane's spending. (Even though the government doesn't write a check for hiring the new employee, it has spent money because it collected less tax from that employer.) Let me know if you have a better analogy.

The Tax Foundation blog has a nice list of the tax cuts and increases noted in President Obama's address.