[Mb-civic] ECONOMY A New Money Machine for the U.S.

[Michael Butler]

http://www.latimes.com/news/opinion/la-op-bartlet29aug29.story

ECONOMY

A New Money Machine for the U.S.

The old ways can't keep up. We need a value-added tax to meet revenue
demands.
 By Bruce Bartlett
 Bruce Bartlett is a senior fellow at the National Center for Policy
Analysis.

 August 29, 2004

 WASHINGTON ‹ The United States needs to adopt a value-added tax. Passage of
the prescription drug legislation last year demonstrated that there is no
longer any hope of holding the line on government growth ‹ especially when
Republicans voted for the multitrillion-dollar entitlement program.

 That being the case, the only relevant question is how to finance the
growth of government. A value-added tax, or VAT, isn't the complete answer.
Other taxes are also going to rise. But a value-added tax is the least bad
way of raising the needed revenue because there is little likelihood that
spending will be cut enough to avoid that necessity. If some of a VAT is
used to finance improvements to the tax code, more total revenue could
conceivably be raised at less economic cost.

 Under the Congressional Budget Office's most likely long-term scenario,
Medicare and Medicaid spending alone will consume 21.3% of gross domestic
product by 2050 ‹ more than all federal spending today. Social Security will
add 6.3% more, meaning that federal revenue will have to rise by nearly 12%
of gross domestic product from where it is now even if interest on the debt
is ignored and every other government program, along with the Defense
Department, is abolished.

 Congress isn't going to go that far, which means that federal spending
would rise to about one-third of GDP over the next several decades, absent
substantial and highly unlikely changes in major entitlement programs. Given
that Republicans just created one of the biggest such programs in history
with the prescription drug legislation and that Democrats want to expand
healthcare to the uninsured, we can assume this is a bare-minimum estimate.

 In effect, the United States would slowly move toward European levels of
spending as a share of GDP. And if we spend like Europeans, we will have to
tax like them too, and embrace a value-added tax.

 The tax was originally adopted as part of European integration in order to
avoid double taxation by national sales taxes. Its key feature is
refundability at the border. This requires tax authorities to know exactly
how much tax is embedded in the prices of all exports. The VAT provided that
paper trail. In its classic form, the tax is paid at each stage of
production and distribution, with a credit for taxes paid at earlier stages.
Because producers and retailers need to show that they paid the tax to be
credited for the taxes included in the prices of the goods they purchased,
the system is largely self-enforcing. And the invoice trail allows
governments to refund the entire tax on exports at the border.

 From the point of view of consumers, a value-added tax is embedded in
prices, which tends to make it less transparent than the state and local
sales taxes Americans pay. And because a VAT falls only on consumption, it
doesn't burden saving or investment. This makes it a highly efficient tax in
the sense it discourages less economic output ‹ what economists call the
"deadweight" cost of taxation ‹ than income taxes of similar magnitude.

 The lack of transparency and the low economic cost of a value-added tax
make it possible for this tax to raise substantial revenues relatively
easily, both politically and economically. The average VAT in Europe is 20%,
and European governments raise about one-third of their total revenue from
consumption taxes, including excise taxes on gasoline, tobacco and other
items. The U.S. raises about half that, including sales taxes at the state
and local levels.

 This suggests there is substantial room for raising broad-based consumption
taxes in the U.S. without overburdening the economy. A very broad
value-added tax levied on virtually all personal consumption could raise
about half a percent of GDP in revenue for each 1% tax rate. But this sort
of value-added tax is highly unlikely, though it would be best to treat all
consumption equally. In practice, it is unlikely that more than 30% of GDP
would be taxed, meaning that a 10% VAT would raise revenues equal to 3% of
GDP ‹ about $350 billion this year. We could raise twice that at a rate no
higher than now exists in most European countries.

 The great bugaboo of a value-added tax is its regressive feature ‹ taking
more from the poor than the rich. In the short run that's true, because the
lower one's income, the higher one's consumption is as a share of income.
Over a lifetime, however, consumption is roughly proportional to income, so
a VAT would also be proportional ‹ taking about the same from rich and poor
alike in percentage terms.

 In any case, no value-added tax will be introduced without substantial
changes in other taxes and spending that could offset its regressive
element. For instance, VAT revenues could be used to abolish the alternative
minimum tax and sharply raise the standard deduction.

 Conservatives often complain the value-added tax is a money machine to
finance government growth. There is truth in this. But government is growing
rapidly. The only real alternative is to raise existing taxes significantly.
If we did that, it would mean higher tax rates and abolition of many
pro-growth elements of the 2001-2003 tax cuts, such as bonus depreciation
and lower rates on capital gains and dividends. A VAT might also finance
other pro-growth initiatives, such as abolishment of the corporate income
tax.

 There won't be much resistance from the corporate community to a
value-added tax. Big corporations like its refundability feature. They will
also view any alternative as higher taxes on them. Although they will have
to collect the VAT, its burden is passed through to consumers and does not
fall on the corporation. Small businesses, especially retailers, are more
likely to complain about a value-added tax, but most could be exempted from
collecting it at little revenue cost. Because they will pay the tax when
they buy goods to sell, the only revenue lost would be on the final retail
markup.

 Some years ago, economist (now Harvard President) Lawrence Summers quipped
that the reason the U.S. doesn't have a value-added tax is because liberals
think it's regressive and conservatives believe it's a money machine. We
will adopt such a tax, he said, when liberals realize that it is a money
machine and conservatives see that it is regressive. Perhaps that day has
come.


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