Category: The Dish

I stand corrected on points one and two, Bruce, although points three and four are still concerns to some extent. But I’d nevertheless be more than open to establishing a mixed VAT/income-tax structure.

But I think we can both agree that when all is said and done, the overall tax burden as a percentage of GDP has to go up in order to pay for the mass of entitlement spending and military commitments that George W. Bush has subjected us to these past years. Few of us seem to care about the national debt and permanent deficits, unfortunately, even though that bill will come due sooner or later in a massive fiscal/monetary crunch if we do nothing.

And while we can quibble about the details, at the end of the day the overall tax rates will have to go up considerably. There’s just no way around it, despite the Lafferist excesses we saw at yesterday’s Republican debate.

Some of the readers are finding the conversation that Bruce and I are having to be really boring. I hear your complaints, so let’s mix things up a little with a daily wacky feature:

Re Eric’s comments:

1. It’s not really practical to have a VAT at the state level. One state, Michigan, tried it and eventually repealed it. There are some things that only work at the national level and this is one of them.

2. A tax on value-added is not a tax on profits at all. A company collects and pays the tax whether it’s making a profit or running a loss. Since the tax falls on the difference between what a company buys from producers or other companies and what it sells its own output for, a VAT mainly falls on the company’s wages; that’s what creates the value-added.

3. There is a problem with exemptions from the VAT, but my observation from other countries is that this almost never involves the kind of corporate welfare we have here. The exemptions are mainly enacted to relieve the regressivity of the tax, such as by exempting food. However, all economists recognize that any exemptions create enormous complexity that undermines the VAT’s efficiency enormously. It would be highly desirable to have one rate on the broadest possible base and relieve the regressivity by cutting other taxes, increasing welfare benefits or some means other than exempting certain goods and services.

4. I don’t like the rebate idea because it would quickly become a de facto entitlement program. But I don’t think it would be necessary in my thinking of a VAT as an add-on tax. There will still be plenty of other taxes that could be adjusted to compensate for the VAT’s regressivity. If we were talking about a wholesale replacement, which ain’t gonna happen, that would be a different matter.

On a final note, I would remind people that every other major country on Earth has a VAT–the U.S. is the sole holdout. This means that there is lots of experience we can draw upon should we go down this route. That’s a key reason why I favor a VAT over a national retail sales tax, which has been rejected by every country that ever considered it. Many countries with a VAT had socialist governments when the decision was made. Those on the left can look to these countries for guidance on how distributional problems were handled.

Our host, of course, is a leading champion of gay marriage. Indeed, reading his work on the subject, has persuaded me the law ought to recognize some form of committed partnerships between same-sex couples. Whether you call it a civil union or marriage is a matter of indifference to me, although it seems obvious that a decent respect for the opinions of others and the freedom of religion mandates that the union have solely civil implications. One would hope that as gay marriage comes to be accepted, for example, that civil rights and anti-discrimination laws could not be used to sue priests who refuse to perform religious marriage ceremonies for same-sex couples.

Where Andrew and I may differ strongly, however, is whether this is an appropriate question for courts.

Judicial resolution of hot button cultural issues has all too often contributed to polarization and social division.

Consider the case of abortion rights. Former Democratic Congressman, Clinton Administration White House Counsel and federal judge Abner Mikva once explained that: “I support the result of Roe v. Wade. … But … in retrospect, I wish the court had stayed its hand and allowed the political process to continue, because we would have legislated the effect of Roe v. Wade in most states — not all of them, but in most states — and we wouldn’t have had to pay the political price we’ve had to pay for it being a court decision. The people who are angry at that court are angry beyond measure. As far as they are concerned the whole system is rotten because they’ve lost their opportunity to slug it out.”

Justice Ruth Bader Ginsburg has likewise stated that “Roe v. Wade … halted a political process that was moving in a reform direction and thereby, I believe, prolonged divisiveness and deferred stable settlement of the issue.”

Because it is custom, tradition, and long familiar patterns that enable people to live together peaceably, social change needs to come slowly. Change and progress are necessary, of course, but sudden change disrupts social bonds, induces stress and engenders controversy as old and vested interests are upset.

Sudden change by a cabal of unelected and largely unaccountable judges is particularly likely to engender controversy. Again, I’ll let Judge Mikva explain: “I don’t think it’s an accident that our founders put the legislative branch in the first article of the Constitution. The reason is that they perceived it to be the first among equals. Most of the people who’d been in Philadelphia had been members of the colonial legislatures, had been members of the Continental Congress, of the early congresses, and they understood the legislative process. They knew how it worked, and they recognized that there was a direct tie between where the people were and where the legislative branch was. They … were nervous about the judges because the English judges had not been an unmixed blessing as far as the colonies were concerned.”

The founders knew, like Spiderman, that “with great power comes great responsibility.” They ensured that Congress and the President could be held to account. If you don’t like what Congress is doing, you can vote for legislators you like better. You can contribute to candidates all over the country who share your views (of course, your ability to do so is limited because our judges have decided that political campaign contributions deserve less First Amendment protection than, say, child porn). You can give to 527 organizations that will promote your agenda. And so on.

Unfortunately, perhaps because they could not envision the extent to which modern judges would assert control over virtually all aspects of society and culture, the Founders failed to provide adequate accountability mechanisms. If you don’t like what the Supreme Court does, tough. All you can hope is that you can elect leaders who will eventually replace enough of those nine unelected old men and women with individuals whose views are more to your liking.

Abraham Lincoln saw the problem coming. He said of the Supreme Court’s Dred Scott decision that: “If the policy of the government upon vital questions affecting the whole people is to be irrevocably fixed by decisions of the Supreme Court, the instant they are made in ordinary litigation between parties in personal actions the people will have ceased to be their own rulers, having to that extent practically resigned their government into the hands of that eminent tribunal.” And so it is today.

We must hope that judges can tell the difference between cases where intervention is necessary and appropriate and cases that should remain in the political arena. The New York Court of Appeals in 2006 argued that gay marriage fell into the latter category:“We hold that the New York Constitution does not compel recognition of marriages between members of the same sex. … Whether such marriages should be recognized is a question to be addressed by the Legislature,” the court said. Now if only we could get those nine oldsters in Washington to emulate their northern counterparts.

I have no doubt that some form of gay marriage is coming. And that will, I think, on balance be a good thing. But the way in which it arrives matters a lot. One hopes that even ardent supporters of gay marriage recognize that the decades of Kulturkampf that followed – and still follow – Roe v. Wade is not something that ought to be repeated.

I do think it would be worthwhile to shift to a pure consumption-based tax system. I would do it by exempting all saving from taxation. This could be done by consolidating all existing tax deferred savings accounts–IRA’s, Keoghs, 401k’s, etc.–into one savings vehicle. All contributions would be tax-deductible, all withdrawals would be fully taxed at ordinary income tax rates. Money inside the account compounds tax-free until withdrawn. There would be no limit on contributions, no limit on withdrawals; no age restrictions and so on. Since there are only two things that can be done with income–either save or spend it–all taxation would necessarily fall on consumption if such accounts existed.

This sounds great on paper, and some of the principles behind it might be worth incorporating into our current system.

But off the top of my head, the problem seems to be that this creates an initial incentive for people to save a lot, perhaps too much savings with frequent withdrawals. And that means that if they then anticipate a cut in the tax rates — meaning the value of their savings would go up — they would be overly averse to withdrawing money in the short term, causing a brief slowdown in withdrawals and thus in consumer spending.

The opposite would be worse. If the income-tax rate goes up, then that means the amount of money they effectively have in savings just went down. But that furthermore means that if people anticipate an increase in the tax rates, there could be a great mass of withdrawals as people cash out of the savings accounts and put their money into other investments. And that could then turn into runs on the savings accounts. And as we know, runs are definitely not fun.

What mechanisms would you put in place to stop these sorts of hazards from occurring?

Some further thoughts:

1) It occurs to me that if a VAT were to be attempted in this country, some individual state would have to be the first to try it, then you could talk about taking it national if it worked. That’s the great thing about federalism: an idea can be tried on a small scale before we put it over the whole country. If it turns out to be a flop, the damage has at least been contained.

2) Since it’s a tax on a company’s added value to a product or service (in other words, profits) it could possibly replace not only retail sales taxes but also taxes on corporate income. Although this would probably mean the rate would have to be higher to get the same revenues, you would still get some consolidation/simplification out of it, and that’s probably a good thing overall.

3) It would be prone to some of the same political problems that retail sales taxes and corporate income taxes have, such as every last business sector lobbying for exceptions, deductions or lower rates. And then we’d get all sorts of horrible distortions finding their way into the economy — along with the potential for the same bloated tax code we have now, just administered differently.

4) In terms of raw politics, you can’t base a tax structure entirely upon it. Even if you think a pure VAT would work on the economic merits — I’m undecided and honestly out of my league on that question — small-d democratic considerations would demand some progressive element be put into the federal tax system. And that means someone would start calling for a universal rebate — which leads us to that whole labor incentives problem. And then we’d see a really bad idea coming in through the back door. Even if you’re against it in theory, any inefficiency introduced by a separate progressive income tax would still be a small price to pay in order to stop the emergence of an enormous welfare underclass.

Well, technically, it’s from my deck. Toby and I are looking out across West Hollywood towards Century City.

A reader:

Eric: The devil’s in the details, but both conservative and liberal friends have responded positively to the idea of a VAT, elimination of income tax, and a universal tax rebate that covered necessities. Milton Friedman of course proposed a similar “negative income tax” and Nixon as President actively supported the proposal.

This model could address the regressive taxation problem, and perhaps we could completely eliminate personal income taxes and simultaneously make the process much less complicated for individual citizens if we shifted some of the burden over to corporate, capital gains, and/or estate taxes (given the rights bestowed on corporations as fictional people, I think it’s better to tax them than individuals).

I once read Friedman’s negative income tax idea a few years ago, and was very briefly smitten with the notion. Then the enormous flaw in it hit me: a minimum guaranteed standard of living really messes with incentives at the bottom of the economic ladder. If you’re happy with the check the government is sending you every month, there’s no reason to work at all.

You’d end up with a whole mass of people on the low end ceasing to be productive workers and instead just living off the dole. Now that’ll really stunt an economy’s growth.

Ideally, welfare should exist to be a security net during tough times for people who could normally work, and also to care for people who truly cannot provide for themselves. But one thing it should not be is a permanent way of life for people who could be working otherwise. The negative income tax/universal rebates just creates too many opportunities for that to happen.

I do think it would be worthwhile to shift to a pure consumption-based tax system. I would do it by exempting all saving from taxation. This could be done by consolidating all existing tax deferred savings accounts–IRA’s, Keoghs, 401k’s, etc.–into one savings vehicle. All contributions would be tax-deductible, all withdrawals would be fully taxed at ordinary income tax rates. Money inside the account compounds tax-free until withdrawn.  There would be no limit on contributions, no limit on withdrawals; no age restrictions and so on. Since there are only two things that can be done with income–either save or spend it–all taxation would necessarily fall on consumption if such accounts existed.

The VAT and the so-called fair tax would arrive at this goal by taxing consumption directly. The VAT would essentially tax producers and the tax would be embedded in the prices of goods and services, the fair tax would impose a national retail sales tax and tax final sales. It’s a grave mistake, however, to lump all of these types of consumption taxes together as economically the same.  There are critical differences in distribution and administration between them that cannot be glossed over.

For example, under my preferred system, you could still have progressive tax rates.  You really can’t with a VAT or retail sales tax. Regressivity would have to be offset with some sort of rebate mechanism that would quickly become the biggest entitlement program of all time. Furthermore, a sales tax large enough to replace all federal taxes would have to be around 60 percent, according to Bill Gale of the Brookings Institution. In large part, this is because there would be massive incentives for evasion and very easy opportunities to avoid the tax.

Basically, the fair tax is a totally crackpot idea in the view of virtually every serious tax expert. The sole exceptions are a couple that the fair tax people have bought off. To make it work, you would have to convert it into a VAT, which solves all of the administrative problems inherent in the sales tax. But for some reason, the fair tax kooks won’t buy this and insist on their plan or nothing.

In any case, there is zero chance that this country will ever replace the entire tax system with a sales tax, a VAT or anything like it. Any changes, no matter how large, will be incremental in nature. In my opinion, the most likely option is some sort of add-on tax, which is what the Europeans have done. A low–I emphasize low–retail sales tax might be viable in this regard, but will probably run into insurmountable opposition from state and local governments, which view the general sales tax as theirs exclusively. Therefore, a VAT is much more likely.

One point that has helped VAT efforts in other countries is that it applies to imports, but is rebated on exports. Although this looks like a trick to reduce imports and subsidize exports, it really isn’t. Nevertheless, there are a lot of businessmen who think this is the case and support a VAT for this reason. Thus there is a built in constituency for a VAT in the business community, especially if they think the alternative is higher corporate taxes.

As I said earlier, my premise is that this will not become an issue until there is a fiscal crunch. There is zero chance of a VAT until and unless there is a budget crisis that demands a large increase in taxation. Until then, all of this discussion is merely theoretical. But it could be important in shaping how policymakers perceive their options when some action-forcing event comes along.

If you’re going to offer the thesis statement that Larry Summers is a smart man, you’ll get no argument from me.

The huge problem with VAT proposals in this country is that the right muddies the issue by saying we should completely replace the income tax structure with only a VAT — or as they thought to call it in a fit of sloganeering, the “Fair Tax.” If someone needs to call his proposal the “Fair Tax” in order to make it sound good, then you know something must be wrong with it.

And I’m not automatically opposed to any regressive tax. I just don’t think for a moment that the whole tax system should be built around it, as the “Fair Tax” acolytes seem to think. For example, the gas tax is regressive in that a poor man’s and a rich man’s personal gasoline needs probably won’t differ all that much, if we assume they’re using the same types of vehicles. But at the end of the day, the gas tax is a sensible user fee for the construction and upkeep of the roads they both drive on, and the argument that it can be regressive doesn’t really outweigh that.

That said, I’d certainly be open to enacting a national sales tax alongside the present income-tax structure. After all, most state governments use both and seem t get along just fine, so why not the federal government, too? Obviously we’d cut the income tax rates somewhat as we make room for the brand-new VAT, but the income tax system would have to essentially remain in place.

I remember reading a Jack Kemp piece a few years ago in Human Events*, in which he was practically calling George W. Bush an economic visionary on taxes and spouting the basic Lafferist line. And he’s only gotten worse over time. It’s kind of hard to respect him as an intellectually honest man after that — he’s become just another ideologue, in a covenant marriage to theories that were relevant to the problems of the 1970’s but are now out of date.

As for the distinction between “taxes” and “tax rates,” this strikes me as just so much Lafferism. It held true to a certain extent in the late 70’s and early 80’s, but I don’t think it really has a place in current discourse. Nowadays if you cut taxes you will get some increase in revenue after a short while, but it’s only through a backdoor mechanism of Keynesian deficit stimulus. And this means the increase in tax revenue will be more than wiped out by the concurrent growth of the national debt, so you’ll have to raise tax rates (yes, I said “rates”) even higher in the future. The Kudlow-Kemp types are looking for a free lunch.

(*The original Kemp piece had paragraph breaks. Human Events’ formatting got botched on old stuff when they switched to a different platform.)