Slow-Growth U.S. Now Ripe for Consumption Tax: Kevin Hassett

The prospect of meaningful tax reform has become the hot topic in the hearing rooms and, just as important, the back rooms of Washington.

House Ways and Means Committee Chairman David Camp, Republican of Michigan, devoted his first hearing to the topic, and President Barack Obama’s team is talking up the subject in private and in public.

“We’re examining whether we can find the political support for a comprehensive tax reform,” U.S. Treasury Secretary Timothy Geithner said on Jan. 12. Two days later, he met with financial officers from major companies, including Microsoft and Cisco Systems, to discuss the corporate tax rate.

The last overhaul of the tax code was in 1986, when President Ronald Reagan and congressional Democrats including Representative Dan Rostenkowski and Senator Bill Bradley crafted legislation that should be in the Tax Policy Hall of Fame, if there was one. In pairing lower marginal rates with an assault on exemptions and other loopholes, the Tax Reform Act of 1986 proved the benefit of broadening the tax base.

Now it’s time to take that one step further.

In 1651, the English philosopher Thomas Hobbes became the patron saint of tax geeks when he called for government to switch to a consumption tax -- one based on the money people spend, not what they earn. Such a tax, he argued in his book, “Leviathan,” was morally preferable:

“For what reason is there that he which laboureth much and, sparing the fruits of his labour, consumeth little should be more charged than he that living idly, getteth little and spendeth all he gets; seeing the one hath no more protection from the Commonwealth than the other?”

Passing Favors

Like Hobbes, those who today decry the irrationality of the tax code and advocate fundamental reform are ignored by elected officials. Rather than a simple-to-understand code, politicians prefer the current mess, a tangle of exceptions that makes it easy to pass out favors without being noticed.

Just figuring out what you owe is so complicated that few Americans dare do their own taxes. Talk about busywork: In her annual report, the Internal Revenue Service’s national taxpayer advocate, Nina Olson, estimated that American taxpayers and their hired preparers spend 6.1 billion hours annually complying with the law. That’s equivalent to the hours of 3 million full- time workers.

What might we accomplish by dedicating the work of these hypothetical 3 million people to something more productive?

Big Idea

Persistently slow growth has become the kind of problem that calls out for a big idea, one that can produce steady improvement, not just a short-term jolt. Moving toward a consumption tax would encourage investment in capital, potentially increasing future growth.

Lawrence Summers, writing in 1981 -- more than 25 years before he would serve as Obama’s chief economic adviser -- estimated that “a complete shift to consumption taxation might raise steady-state output by as much as 18 percent.”

Harvard University economist Dale Jorgenson, in a 2003 article, said a U.S. move to a true consumption tax is unlikely because it “would shift the burden of taxation from the rich to the poor.”

Instead, he proposed redrawing the existing income-based system so that that earned income is taxed at 10 percent, investment income is taxed at 30 percent, and every dollar of a business’s income generates a credit against its taxes. Jorgenson estimated that such a system would produce gains “equivalent to 19 cents for every dollar of U.S. national wealth.”

Boosting Output

For a book on fundamental tax reform that I edited in 2005 with Alan Auerbach of the University of California-Berkeley, we looked at literature on different models and concluded that switching to an ideal system might eventually increase economic output by 5 to 10 percent.

Our glaring need for economic growth is why, after so many years of talk, there seems to be a growing consensus behind real improvement to our tax code.

The groundwork for this consensus was established by President Obama’s National Commission on Fiscal Responsibility and Reform, which recommended reducing individual tax rates to three tiers of 8 percent, 14 percent and 23 percent, and reducing corporate taxation to a single rate between 23 percent and 29 percent, down from today’s top rate of 35 percent.

Political realities also argue for progress. House Republicans need to give their animated base a win, of course, and Obama needs a big reform as he approaches his 2012 reelection bid.

It’s been 360 years since Hobbes first called for the elimination of income taxation and wholesale adoption of a consumption tax. Its time may finally have come.

Kevin Hassett, director of economic-policy studies at the American Enterprise Institute, is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Kevin Hassett at khassett@bloomberg.net

To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net

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