Shifting tax base to consumption tax is bad idea

In January 2020, a Nebraska legislator introduced LR300CA, to amend the state constitution to prohibit all forms of taxation other than a consumption tax. The proposal states that the tax is to be at a single-digit rate. Presumably, both the state and local governments could have a single-rate tax. It would apply to all new goods and services, but does not define this term. It sounds like it means tangible personal property and services, possibly also travel and entertainment, but not clear.

It is unlikely that such as tax can raise as much revenue as an income tax, even with no exemptions to the sales tax. High income taxpayers don't spend all of their income, they save it and invest it. So that drops the tax base compared to an income tax.  Consider these two formulas and you'll see the base for an income tax is broader.

   Income = consumption + savings

   Consumption = Income less savings

And, with an income tax it is easier to have a progressive rate structure to increase vertical equity in the system.

One new category that would become taxable and affect higher income individuals more than lower-income is to tax food. Currently, Nebraska doesn't impose sales tax on food.  According to data from the Bureau of Labor Statistics, the top 20% of income earners buy 1/3 of total food purchases. They also buy 41% of all entertainment spending. Hopefully the Nebraska proposal  intends to apply sales tax to entertainment.

The proposal is likely to be a tax increase for low-income individuals as there is no exemption for low-income as there easily can be for an income tax.  With removal of income and property taxes and only a single-digit sales tax, it is likely that government would have to cut services which would also disadvantage lower income individuals.

What about alternatives?  Here are a few ideas:

• Repeal income tax preferences such as the mortgage interest deduction.

• Impose sales tax on food but provide an income tax credit to low-income individuals to reduce the impact to them of the tax.

• Expand the sales tax base to include high-end consumption such as entertainment, travel, and household help.

Also in 2020, a California legislator introduced AB 2712. This calls for a universal basic income amount of $1000 per month to be paid to individuals age 18 or older with income below 200% of the median per capita income for the person's county of residence (measured by the BLS). This amount would not be subject to tax in California or affect income based tax and other benefits. AB 2712 defines "universal basic income to mean unconditional cash payments of equal amounts issued monthly to individual residents of California with the intention of ensuring the economic security of recipients." The payments would be handled by the FTB.

To pay for this, the bill calls for that "on or before July 1, 2024, the California Department of Tax and Fee Administration shall submit a report to the Legislature on the feasibility of establishing a new state tax to finance the California Universal Basic Income (CalUBI) Program. The report shall consider the feasibility of establishing a value-added tax on goods and services in the state, an analysis of the feasibility of taxing the sale of services offered in the state, and an analysis of the feasibility of raising the corporate tax. The report shall also include projections of expected tax revenue."

Adding a VAT on goods and services to fund the UBI would impose a burden on those receiving the UBI. Aside from rent, much of what is left over each month is spend on goods and services with most of the goods (other than food) subject to sales tax. Adding a VAT on top of the sales tax would also add complexity. Consideration should instead go to replacing the sales/use tax with a VAT with a broad base and low rate.

A higher corporate rate will be borne by employees, owners and customers and so can also hurt low-income individuals.

Why not remove tax breaks that primarily benefit high income individuals such as the mortgage interest deduction, sales tax exemptions for household utilities, personal service, entertainment and food? And consider if the EITC should be increased in place of a UBI although the EITC is only for workers.

Two of my colleagues and I wrote a paper in 2017 on a proposal for a different type of consumption tax that could be paid along with one's state income tax, but exempt low-income individuals. And businesses would not be subject to it (similar to how a VAT work and how a consumption tax should work to avoid pyramiding). Please check it out. I think it would be groundbreaking for the first state to adopt it in terms of removing regressivity of this consumption tax and making the state very attractive for businesses.

A UBI should be discussed as a way to help low-income individuals to know if it will help more than other programs such as greater education opportunities and medical care for all. 

And we have lessons learned from the pandemic and federal and state programs aimed at helping those with health and financial needs. This included funds for businesses of all sizes, unemployment benefits extended to self-employed individuals, economic impact payments and other provisions. Were these benefits equitably distributed? Did they help those most in need? How will the increased deficits and debt (and its interest expense) be paid?

How will these topics get attention in the public arena?

What do you think about such proposals?

EU's New VAT "MOSS" - Relevance for MFA?

On January 1, 2015, the EU's new approach for charging and collecting VAT on B2C sales of e-services and digital goods begins. The key to the approach is that all businesses will charge based on the customer's location (destination basis). That makes sense for a consumption tax, but has its challenges.  One key one is knowing where the customer is, which is not always easy to determine for digital goods relative to physical goods.

One administrative simplification is the Mini One Stop Shop or MOSS. This allows a business to register in one country for filing purposes. The business still has to collect the appropriate VAT for the country where the consumer is, but rather than quarterly filing in each country, the business just files in the MOSS country. That country makes sure the funds get to the right country (and handles the currency translation since not all EU countries use the Euro).

As I learned more about the MOSS, I was intrigued as to whether this model might help for collection of sales tax from remote sellers, such as if the Marketplace Fairness Act is enacted.

I have more on this in a recent article on this topic in BloombergBNA's Weekly State Tax Report (11/21/14).  I hope you'll take a look. I provide some background on challenges of taxing digital goods, the old and new EU VAT regimes for these items and how the MOSS (and some other VAT B2C aspects) might be relevant for the MFA.  Yes, I know that few states tax digital items, but I suspect more will start to do so to address eroding sales tax bases and the MOSS is relevant for not only digital goods, but for any consumption tax items (in the EU, it will just be for e-services, digital and broadcast; but that could change later).

What do you think?

New York Times Tax Reform Suggestions

A December 29, 2012 editorial in the New York Times, part of a series of suggestions for President Obama for his second term, makes the following recommendations.

• Tax capital gains at the ordinary income tax rates. They note that the top 1% receive 70% of capital gains while the bottom 80% receive just 6%. Thus, they argue, taxing capital gains at 15% or 20% is "an indefensible giveaway to the richest Americans."
• Cap the benefit of deductions for individuals at 28% or convert them to tax credits.
• Higher rates on individuals with income over $1 million.
• Restore the estate tax (presumably at the 55% rate scheduled to return on 1/1/13).
• Higher corporate tax rates.
• No more deferral of tax for US companies for income earned abroad (presumably they mean by subsidiaries).
• The Treasury Department should "start work on tax reform now" including consideration of a carbon tax, VAT and financial transactions tax.

That is quite a list!

The editorial board notes that our current system is not bringing in enough revenues to cover spending and investment so new revenues are needed.

I have a few comments to offer:

1. Yes, tax reform is needed but not exactly for the reasons noted. The key reason for reform should be that our current system does not meet principles of good tax policy or fully recognize that we are operating in an information-age, global economy. Our tax system has grown complex by the addition of over 100 items after the Tax Reform Act of 1986 and has too many provisions that are temporary and often expired awaiting what often becomes retroactive renewal.  Our tax system is not equitable. Significant deductions and exclusions provide significantly larger benefits to those in higher brackets. There are too many special rules that benefit just a few companies or industries. We have a $450 billion annual tax gap.
2. We have spending problems.  One big one is that significant borrowing, particularly in the past few years has greatly increased the country's interest expense obligations. The GAO has issued a few reports pointing out over 100 areas where there is "evidence of duplication, overlap, or fragmentation among federal government programs." There is significant waste and inefficiencies in the medical care system with much of that paid for by the government (we hear about this often; I have seen this first hand lately with my 80-year old mother who now lives near me). AND, we have significant spending problems in our tax system with its $1.1 trillion dollars of annual tax expenditures (see page 28 of the Deficit Commission's 2010 report). If these could instead be relabeled as direct spending in the appropriate agency's budget, it would likely be easier to get rid of them.  For example, I think that if the HUD budget had a line item - "Subsidy to middle-to upper income individuals to pay mortgage interest on vacation homes," the mortgage interest deduction for second homes would be gone. That is just one example.  But all tax expenditures (special deductions, exclusions, credits and special rates not crucial to the design of an income tax) should be examined to see if they are serving a legitimate purpose, can be improved to better meet equity and simplicity goals, or can be eliminated in exchange for a lowered rate.
3. There are some reasons to tax capital gains at lower rates, particularly long-term capital gains. For example, some portion of a long-term capital gain does represent inflation. But treating all gains on assets held over one year at the same lower rate doesn't make sense. And, the lowered capital gains rate is not tied to inflation. So that theory doesn't work well with the current system. With the Tax Reform Act of 1986, the top rate for both ordinary and capital gain income was 28%.  We managed to live with that. I think there are a variety of reforms needed for capital gains. Certainly, they should not be taxed at rate lower than the payroll tax rate for employees and self-employed (15.3% (other than in 2011 and 2012)) + the lowest individual tax rate.  Why not use an inflation factor rather than a flat lower rate?
4. Given that other countries have lower corporate income tax rates and we are in a very competitive global marketplace, we should not increase the corporate tax rate. We should further examine how to modernize our business tax system (not just corporate tax system) for our new economy.
5. Yes, let's look at a VAT and see if it is something that states could join in on to help modernize their out-dated sales tax systems. The VAT might help with other federal issues. After all, almost all other countries have a VAT and that is likely how OECD countries help funded a lower corporate tax rate (by increasing the VAT rate).
6. Yes, let's look at a carbon tax as a polluter-pays tax to help reduce greenhouse gas emissions. We should see if this needs to be a separate tax or can be accomplished with a higher gasoline excise tax and some type of tax on other fossil fuels and other sources of GHG.
7. We should also be exploring how technology can improve tax compliance.
8. Starting point - let's articulate our economic, societal and environmental goals. Then let's see how our current taxes may work counter to those goals. That would help us in identifying problems along with evaluating our current rules against principles of good tax policy.

What do you think?

Paul Volcker Again Mentioning a National VAT

CBSMoneyWatch.com has an article today - "VAT: New Tax Coming Soon?" by Cait Murphy (4/7/10). It states that in response to a CBS MoneyWatch.com question on April 6 in NYC, Volcker said that a VAT in the US was "not a toxic idea." The article also notes that Speaker Pelosi and Senator Conrad likely support not leaving the topic off the table. This is really important because:

• Volcker advices President Obama.
• The US is the only industrialized country without a VAT (although we have state sales tax).
• A VAT can be more efficient than a sales tax and with a federal VAT, states could adopt it (at rates lower than existing sales tax) and get rid of their troubled sales taxes.
• The current income tax is unlikely to solve our deficit problems (and yes, reduced spending should also be considered in addition to tax reform). See the Tax Foundation Fiscal Facts of 3/12/10 - Can Income Tax Hikes Close the Deficit?

I've discussed this before a few times (for example, 2/8/10 post which also notes Volcker's interest in a VAT).

I think a VAT is something that should definitely be discussed at the federal level with the states participating. I'll be writing more on the issues and opportunities of this (including using materials I wrote back in the mid-1990s when major federal tax reform was a very hot topic). I do have a brief overview to how the VAT works if you are interested - here. Here is a longer paper presentation from 1999 on major federal tax reform - much of it is still relevant today although the need for reform is likely greater today than ten years ago.

What do you think?

"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?

VAT - Why do we avoid the word in tax reform debates?

A few days ago, the GAO released a report - Value-Added Taxes: Lessons Learned from Other Countries on Compliance Risks, Administrative Costs, Compliance Burden, and Transition.

Why? Doesn't the GAO know that the US doesn't like the VAT?

In the report, the GAO notes that tax reform includes discussion of a VAT and that it was asked to do this report by Congressmen Jim McCrery and Jim Ramstad of the House Ways & Means Committee. The countries reviewed by the GAO in this report are Australia, Canada, France, New Zealand and the UK.

A search of bills in the 110th Congress with the word VAT only produced H.R. 2600 dealing with the WTO and border adjustments. Of course, there are proposals that are VAT variations, but they do not use that word. For example, the Freedom Flat Tax (H.R. 1040) appears to be the Hall/Rabushka model that was also promoted for years by Congressman Armey. That tax is a modified subtraction method VAT for businesses. The key modification is that businesses get a deduction for wages (which they would not get under a VAT because wages are a key element of valued added - which is taxed). But, the wages are taxed at the employee level to allow for a large personal/dependency exemption designed to alleviate some of the regressivity of a VAT.
But H.R. 1040 doesn't use the term VAT. Former Congressman Armey took the same approach. Years ago, I tracked down a few quotes from him including that the VAT is "possibly the most insidious tax scheme ever devised." [See article by Armey, Caveat Emptor: The Case Against the National Sales Tax, Policy Review, Summer 1995, p 31 and Anne Reilly Dowd, Politics and Policy: Real Tax Reform Gathers Steam, Fortune, 3/16/95, p 14 quoting Congressman Armey as saying, "a VAT is an insidious hidden tax, which I will fight forever!"] Congressman Armey had a PhD in Economics so it is likely he knew the flat tax was a modified subtraction method VAT. Perhaps it was the simpler credit invoice method he thought was awful.

In 1996, Congressman Gibbons introduced H.R. 4050 which specifically used the term VAT. This bill called for a 20% subtraction method VAT. This proposal kept an income tax for high income individuals to help preserve the distributional neutrality of the current tax system.
The AICPA and ABA Tax Sections (among others) have issued reports (years ago) on the credit invoice VAT. People have talked about it and many businesses today deal with it.

The US is the only industrialized country that doesn't have a VAT. In the tax reform discussions in the mid-1990s, Australia was also without a VAT, but it added a goods and services tax (GST) in 2000; the GST is a VAT.

Almost all states use a sales tax and some use either as an addition to a sales tax or instead of a sales tax, a gross receipts tax (GRT). The sales tax and GRT have flaws that could be eliminated with a VAT - notably pyramiding where a tax is paid on a tax because of the continual payment of sales tax or GRT along the production and distribution chain (although states do not impose sales tax on good purchased for resale, there is still sales tax paid on other items by businesses).
So, it seems that lawmakers may have a notion that the public doesn't want a VAT. While a VAT (as well as any tax), can be designed to be simple, the addition of special rates and exemptions creates complexity. The GAO report helps explain where complexities exist and the experiences in other countries - we can learn from the many examples out there of how to create a simple VAT.

While I'm not necessarily advocating for a VAT, I would say that as states continue to struggle with a variety of sales tax issues and some consider GRTs, and the feds consider a flat tax, national retail sales tax and other forms of consumption taxes, a VAT should also be considered. It should not be left out of the debate under some notion that the public has VAT-phobia or that VATs are too complex. And if the public and perhaps lawmakers have VAT-phobia, then we need to help educate people on how a VAT works, the forms of VAT and its advantages and disadvantages compared to other types of taxes we are familiar with.

In addition to the GAO report, some additional background information can be found at:

• A brief summary on consumption taxes with VAT examples (by me)
• A report on tax reform by the AICPA (2005)
• GAO, Understanding the Tax Reform Debate (2005)
• Links to a variety of information on tax reform (my tax reform website)

What do you think about a VAT? What do you think about being more honest in tax reform debates as to which proposals are VAT variations?