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Monday, February 8, 2010

"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?


Daniel Nelson said...

This is true that it has become a nesessity for everyone and I think this is really good post for knowing it better.

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Anonymous said...

KISS, Keep it Simple Stupid is needed. The whole thing is beyond belief. States should NEVER had these rights and instead a Federal Agency should have be overseeing and doling out the funds collected from one entity collected by electronic means or by Retailers. Just ONE Single Rate period. Say it was 5.25% with a minimum of $1.00 and a maximum of $125.00 per Item. Then all that loot with States would have to propose and show dire need if that were the case such as the mismanagement of the New Orleans wall that caused billions of damaage. So if such things happen again and they will... Then States could have a period of relief where they could temporarily get a larger portion of the pie or the Fed would raist the sales tax rate by .25 % Forget Nexus totally. It was good for 100's of years. But today any business can be online and should be. And since there is not really a nexus per se but States try to fictiously and with vengence create or make up rules to make a nexus appear such as the Amazon Tax. and many others.... Dont let them anymore. Instead of their picking on business or endusers the Federal Government should be the decider and States should lose this "right". Certain goods and services could still be Tax Free but it would have to be from a prescribed list with a simple code to turn it off and on for each State and County but the retailer should not have to even deal with it. And the money would be sent just to the Federal Level agency and then the States have rights to the funds based upon their economic need, population, school age children, homeless and disabled populations and eldery. This would save must cost in Accounting and Court time for this entire big mess as the Supreme Court called it. States could still tax building, real estate, physical machinery etc. but no longer drive retailers up a wall and hold them hostage as it would be Clear Cut and Dry. just the European Union came up with an ablity for Countries to work together.... So should the Federal Government find a way for the States to work together under the Federal Government for collection of consumption taxes. If it should even be such a tax. Instead they should come up with ways to make money and produce income not how to take it from citizens and business. Like they did with the Post Office for many hundreds of years.... It could be a Federal Business Service, FBS maybe. Which would advise business and license software to them and be the service to collect the funds and be compensated based upon the number of transactions and the amount of tax collected as a business service. It would reduce the number of needed accountants and politicians in each state and courts and agents needed as it now used.

Anonymous said...

The Fair Tax seems to meet the broad-based consumption tax and is even simpler. What is the problem with giving the American people their money and then letting them decide how much tax they pay by deciding how much money they spend. Besides the many benefits claimed by the Fair Tax advocates, I would think this would boost consumer confidence and encourage savings by the middle class. As a member of that middle class, I would love to have my payroll withholding availalbe to pay my mortgage and save for my retirement. I am pretty sure I can't count on the government to take care of me.