The Dish

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.)

It’s true that Larry Kudlow has never seen a tax cut he didn’t like, but I know that’s not true of Jack Kemp. When I worked for him, he would berate me if I ever said we were trying to cut "taxes." He patiently explained that there were any number of ways of doing that, some good, some bad. Our interest was in cutting marginal tax rates. So he insisted that I always use the term "tax rates" and never just say "taxes."

In my view, the tax debate we should be having is how to raise a fairly substantial amount of revenue over the next few years–on the order of several percentage points of GDP–in such a way that we pay for the spending that is in the pipeline without killing the goose that lays the golden eggs. Without such a debate, there is a great danger, when the crunch comes, that Congress will raise taxes in ways that will be very harmful to growth–soaking the rich and things of that sort.

I know there are people on the Democratic side who understand this. They know that those on the left in Europe figured out in the 1960s that the price of a welfare state is a broad-based tax on consumption. Those on the left in this country haven’t figured this out yet so they will probably make a lot of mistakes when they move to raise taxes. If the left tries to do something really stupid like jacking up the capital gains rate, the economy will tank.

Conservatives will capitalize on this to get back in power, but they will quickly discover that there is no public support for the magnitude of spending cuts in entitlement programs, especially Medicare, that would be necessary to allow for the tax increases to be reversed. At this point, I think they will finally come to appreciate the wisdom of a VAT and implement it as a tax reform so that income tax rates and taxes on capital can be cut.

To put the issue more succinctly, let me quote Larry Summers, who once said something to this effect. We don’t have a VAT because liberals think it is regressive–it takes more in percentage terms from the incomes of the poor–and conservatives think it is a money machine. We will have a VAT, Summers went on, when liberals figure out that it is a money machine and conservatives realize that it is regressive.

Wiser words were never spoken on this topic.

I can see some of your points, Bruce. The problem, however, is that you’ve so far cited Larry Kudlow and Jack Kemp as important supply-side names. And those two guys are some of the same people spouting today what you call bastardized supply-side economics.

I’d agree that it was important in the late 1970’s and early 1980’s to cut marginal income tax rates. They really had crossed the point of diminishing returns and were stifling the economy. But at the end of the day, tax rates are just one part of the equation. And this fundamentalist-like devotion to constantly cutting taxes that we see from modern Republicans is simply irresponsible. They’re playing Santa Claus for current gains and passing a bill to future generations that would make Lyndon Johnson blush.

So given that we have a massive national debt, expensive foreign engagements, literally crumbling infrastructure, and grand new entitlements from the same administration that cut our taxes — as you said, “starving the beast” is a sham — we’ll need to get the government revenue somehow. The alternative is we eventually default on Treasury Bills, which would plunge the economy into an even worse mess than any large-scale tax increase. It would be so bad, Americans would be illegally crossing the Southern border to look for jobs in Mexico while the United States is making concessions to the IMF and the World Bank.

So what would you do? You’ve mentioned passing a VAT/national sales tax, but what would the tax system look like when you were done? How much of it would be income tax, how much sales? And what would the total tax rate be, relative to GDP?

And remember, Larry Kudlow and Jack Kemp will probably hate just about any answer you give. After all, you seem like a pretty smart and responsible guy to me.

I guess I need to repeat an argument I made in a New York Times op-ed on April 6. In that article, I explained that tax-cutting has gotten completely out of hand. People are now making outlandish claims for the power of tax cuts that are far, far beyond what people like Jack Kemp were talking about in the 1970s when supply-side economics first developed.

The supply-siders’ original concern was less about the level of taxation than its structure. If we had only been interested in cutting taxes we would have not been so particular about the way we wanted taxes cut. It was essential, in our view, that marginal tax rates be cut; we opposed gimmicky tax cuts like tax credits and tax rebates. We thought those were worse than doing nothing.

Obviously, all this has been forgotten by the current crop of Republican candidates. I can’t really blame them, however, because it’s also been forgotten by George W. Bush, Republicans in Congress, and many of the Republican-oriented pundits as well. In short, supply-side economics has become thoroughly bastardized and bears little, if any, resemblance to its original form. This is a sufficient reason to get rid of it, which I explained in my article.

One of these days, conservatives will have to get back to basics. They need to understand that in the long run spending must be paid for and if spending is going to rise, then so must taxes. Unfortunately, somewhere along the way, conservatives became convinced that cutting taxes was the ONLY thing they had to do to restrain the growth of government. Through a mechanism that I call starving the beast, lower taxes would automatically reduce spending. I just published an article in an academic journal explaining why this is a myth. It’s online here. Here’s a link to a new paper by UC/Berkeley economists Christina and David Romer that comes to the same conclusion–starving the beast doesn’t work.

I have said on many occasions, including in my Impostor book, that taxes must rise and will rise. This conclusion has made me persona non grata in the conservative movement, but killing the messenger won’t change reality. I am on record as saying, repeatedly, that America must give serious consideration to a value-added tax to pay for all the spending in the pipeline. If we add to that a crash program to rebuild our aging infrastructure in the wake of the Minnesota bridge collapse, the case becomes even stronger. If we try to raise the kind of revenue we are going to need by raising tax rates, the economy will collapse. That is a lesson of supply-side economics that is still true.

I have to disagree with your contention, Bruce, that supply-siders are a dying wing of the Republican Party. If anything, they’re now all supply-siders to the point that it’s not even a point of self-identification anymore. Just look at this morning’s Republican debate: Not one of the candidates said they would raise taxes to repair roads and bridges. Rudy Giuliani and Mitt Romney started saying they’d cut taxes to raise the government revenues.

If that’s not a consensus of Lafferism, I don’t know what is. Republicans have really bought into this little fairy tale, that we are forever and always on the far side of the hypothetical curve, and it seems like nothing can convince them otherwise — no matter how big the national debt gets along the way.

And furthermore, what exactly does the Laffer Curve look like? Can anybody produce one, based on actual economic statistics over a long period of time? As it is, the GOP has made a religion out of the fiscal solutions of 1981, and the imaginary curve just keeps getting pushed further and further back to justify more tax cuts. Forget about the religion and the articles of faith, I want to see some evidence.

Which brings me to these questions: under what circumstances would our modern Republicans approve of tax increases? Is there any such scenario where a pressing need would justify a raise in the marginal tax rates? Or is the solution to every last problem a tax cut, resulting in a quasi-Keynesian stimulus and debt accrual, all of which is then hailed as a victory of small-government conservatism? How will those Treasury Bills finally get paid?

It was absolutely tacky and shameless for ABC to have George Stephanopoulos read their new Iowa poll while introducing the candidates. The point of a debate is that viewers have an opportunity to weigh the candidates on their own merits, free from press spin and poll numbers, and see them as human beings running for office. Instead, even this small hour-and-a-half oasis was ruined.

Hopefully, this will never happen again. Sadly, I suspect it will become the new big thing.