All Fiscal Roads Lead U.S. to a Value-Added Tax: Albert R. Hunt

President Barack Obama, nearing the end of a bruising health-care battle, should consider the counsel of a former Bush official and propose a radical new consumption tax that most Americans oppose.

Sounds nuts. It really isn’t. Just follow along for a bit.

The federal budget deficit problem is chronic and most experts, and ultimately markets, see it as systemic and lethal; partial fixes involve painful spending cutbacks and middle-class tax increases.

The promise of the president’s bipartisan fiscal commission, due to make recommendations after the November congressional elections, was set back last week when five of the six Republicans named to the panel by congressional leaders are theological opponents of any tax increases (the exception being New Hampshire Senator Judd Gregg). No one seriously believes the deficit can be controlled without cutting spending on entitlements and raising taxes.

With this background the proposal by Columbia Law School professor Michael Graetz, a top Treasury official in the first Bush administration (the better Bush years in the view of most Democrats and independents), to partially replace the federal income tax with a consumption tax may start to look like more of a winner, on the substance certainly, and perhaps even politically.

Worsening Deficit

Last year, Graetz published a book on this notion, “100 Million Unnecessary Returns: A Simple, Fair, and Competitive Tax Plan for the United States.” In an interview last week, he said he had tweaked his proposals to adjust for the worsening deficit realities and some new data.

A look at the options in fiscal year 2015 is instructive. Using reasonable economic assumptions, to reach Obama’s target of a deficit that is 3 percent of gross domestic product by that year would require about $400 billion in spending cuts or tax increases (That assumes terminating the Bush tax cuts for the wealthy, which most Republicans resist).

Graetz would impose a 14 percent value-added tax on goods and services; it would be collected piecemeal at each stage of production. Small businesses, those with gross receipts of less than $500,000, would be exempt.

Ending Income Taxes

He then would eliminate the federal income tax for taxpayers making less than $100,000 a year. A 25 percent rate would be slapped on income above that level, and, he says, a 30 percent or 35 percent rate on income above $500,000. This would remove up to 150 million Americans from the federal income-tax rolls.

The corporate tax rate would be slashed to below 20 percent from the current 35 percent. This would make American corporations more competitive globally and the U.S. a more attractive place to invest. Almost 150 nations have a value-added or consumption tax, the outliers being some African and Middle Eastern countries, Greenland and the U.S.

Payroll taxes would be unchanged and, with cost of living adjustments, Social Security recipients unaffected, as would expenditures in education and most health care. Adjustments would be made so the working poor, recipients of the current earned income-tax credit, would do just as well.

Trimming Deductions

An important question, Graetz says, is exactly which current deductions would be eliminated; this is a political and budgetary consideration. He envisions doing away with state and local tax write-offs as incentives would be created for states to piggyback off the value-added tax. Charitable deductions would be unchanged.

There would be savings in compliance costs; Graetz dismisses complaints about that. “If Sri Lanka can administer a value-added tax, we can,” he says.

A bottom line, he sees, would be a tax system that even if isn’t more progressive and more simplified than the current one, at least encourages economic growth and investment, and is easier to adjust for changing economic circumstances.

“We can no longer afford the luxury of a tax system that relegates the goal of economic growth to the back burner,” Graetz declares.

Five-Year Plan

The most compelling case for the Graetz tax may be the alternatives. To reduce the deficit by $400 billion five years from now, assume half from spending cutbacks and half from more revenue.

On the spending side, a big contributor would have to be the politically sensitive pension programs such as Social Security. Reducing the cost of living increases, boosting the retirement age and doubling the wages subject to Social Security taxes would get about a third of it. The other two-thirds would have to come from cutting the defense budget -- that means more than a handful of the big politically potent weapons systems --and freezing most discretionary, while killing more federal, programs than the government has done combined over recent decades.

On the tax side, curbing or killing deductions for state and local taxes, the mortgages, charitable contributions and the exclusion from taxes for employer provided health coverage would get fairly close; the target could be met by a carbon tax. All this would be while keeping the current federal income tax. Remember the terrible tempest over any part of this package --limiting the exclusions for employer health plans or charitable donations or cutting the home-mortgage deduction.

Political Peril

Yeah, political realists say any consumption tax --aka a national sales tax -- is suicidal. It cost Al Ullman his seat, they say. Since almost no one outside of Oregon remembers the late Democratic congressman, he was the House Ways and Means Committee chairman from 1975 to 1981 whose Washington duties caused him to lose touch with his sprawling district. He would have lost even if he had never mentioned a value-added tax.

Yes, a consumption tax would be politically perilous. Yet, this fall, voters and the press should ask every congressional candidate if it’s acceptable, five years into the recovery, to run a budget deficit that by some estimates may reach almost $1 trillion. If not, they should be forced to spell out precisely how they would get it to $500 billion.

The alternatives then will seem more perilous than Michael Graetz’s value-added tax.

(Albert R. Hunt is the executive editor for Washington at Bloomberg News. The opinions expressed are his own.)

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To contact the writer of this column: Albert R. Hunt in Washington at ahunt1@bloomberg.net.

To contact the editor responsible for this column: Max Berley at mberley@bloomberg.net.

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