A More Investment Oriented Tax System

Duncan Currie National Review December 16, 2010

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Duncan Currie

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December 16, 2010 4:00 A.M.

Tax hikes, in one form or another, are simply unavoidable. Thatâ??s the blunt message conveyed by Erskine Bowles and Alan Simpson, chairmen of the Obama deficit commission, in their much-ballyhooed portfolio of budget recommendations. Their smartest tax proposals include lowering and simplifying individual-income-tax rates, widening the base by abolishing or capping tax â??expendituresâ? (such as the mortgage-interest deduction) that disproportionately benefit the wealthy, ditching the Alternative Minimum Tax, and trimming the corporate rate while closing loopholes. They also suggest lifting the payroll-tax threshold for Social Security, raising the federal gasoline tax, and dramatically boosting tax rates on capital gains and dividends by treating them as regular income.

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Bowles and Simpson deserve lavish praise for their contribution to solving Americaâ??s fiscal problems. Yet their tax plan is insufficiently focused on the growth imperative, which reflects a failure of imagination. In the aftermath of a calamitous financial meltdown triggered by a debt-fueled housing binge, tax reform cannot be divorced from the broader structural adjustments necessary to build a more sustainable, investment-oriented economic model. â??If the economy must pivot toward investment and exports,â? writes Glenn Hubbard, who was chief White House economist under George W. Bush, â??tax policies must be changed to encourage productive investment over consumption.â?

In other words, American lawmakers need to craft a revenue structure that relies more on consumption taxes and less on income taxes. Jacking up tax rates on capital gains and dividends would move us in the opposite direction. It would also be a terribly inefficient way to plug the deficit. Economists Mathias Trabandt of the European Central Bank and Harald Uhlig of the University of Chicago have estimated that raising U.S. capital-income taxes could yield a maximum revenue increase of only 6 percent. For that matter, Trabandt and Uhlig calculate that 51 percent of a capital-income-tax cut would actually be â??self-financing,â? i.e., a cut would effectively pay for half of itself.

â??Taxing capital distorts economic incentives enormously,â? says UCLA economist Lee Ohanian, who favors transferring a hefty portion of the tax burden from income to consumption. The Economist has rightly argued that â??Americaâ??s tax system stands out as one of the least efficientâ? in the OECD because of its excessive dependence on taxing a relatively narrow base of income. While Democrats often kvetch that Americaâ??s income-tax structure is slanted in favor of the rich and has fostered yawning economic disparities, a 2008 OECD study controlled for income inequality and found that household taxes are more progressive in the United States than they are in Australia, Canada, Japan, New Zealand, South Korea, or any major Western European country save Ireland.

Household taxes, mind you, do not include regressive consumption taxes such as the notorious value-added tax (VAT), which provides a significant chunk of government revenue in those countries. America is the only OECD member that still lacks a national VAT, and the Bowles-Simpson blueprint does not advocate one. By contrast, the fiscal strategy mapped out by the Domenici-Rivlin panel (a task force organized by the nonprofit Bipartisan Policy Center) would introduce a â??debt-reduction sales taxâ? of 6.5 percent.

Despite the mind-boggling severity of Americaâ??s fiscal mess, the VAT remains radioactive on Capitol Hill. Earlier this year, 85 senators â?? including most Senate Democrats and every single Senate Republican serving at the time â?? endorsed a nonbinding resolution expressing their opposition to the tax. But if the federal government needs more revenue, it should seek to collect that revenue in the least damaging way possible. A 2008 OECD paper concluded that corporate taxes are â??most harmful for growth, followed by personal income taxes, and then consumption taxes.â? Indeed, there is a strong case for replacing a large portion of federal income taxes (both corporate and personal) with a VAT.

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larrytex56

12/16/10 14:24

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I agree with the basic thrust of Duncan Currie's article. What Prof. Graetz proposes makes sense - I would eliminate the income tax for most (I would raise his $100,000 exemption to $200,000) and substitute a VAT with debit cards for the poor based upon the usual poverty level calculations or some other reasonable criteria. I would slash the corporate income tax to about 10%. For those who worry about more spending by the left, I would pass the Pence balanced budget amendment to restrain the worst insticts of our politicians.

The truth is, you folks who are complaining about this article, that we still will have a huge budget for those things even the Tea Party doesn't want to do away with - defense, reasonable regulatory activity, Social Security, Medicare, and the cost of administration in even a reduced, limited government will be high. So chill out, and let's let these ideas develop further to make them better instead of trashing them outright.

Ogrepete

12/16/10 13:58

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Wow.

And I thought the election was over. The "RINO" throwing folks are showing their innocence.

There is a large difference between what is best and what is possible. It would be great to go back to relying on ourselves and our families for a safety net. Cutting Federal spending down to 8% of GDP would be awesome! That would be best.

That isn't going to happen with 52 Democratic Senators and a Democratic POTUS. It's also not going to happen while we owe trillions of dollars on the National Debt. Before we can go to what is best, we've got to move through what is possible.

Replacing part of the corporate income tax with a VAT is certainly possible and also, IMO, a good thing, assuming we conservatives keep our eye on the Government to prevent "tax creep."

Brian Clendinen

12/16/10 12:46

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Can anyone say RINO. No one in their right mind can call themselves a fiscal conservative and be for VAT taxes. That is a liberal tax policy. As Milton Friedman put it, the VAT tax is the most regressive hidden tax in existence. I am not for progressive taxes either. I am more for a National Sales Tax with no exemptions or rates differences that has some VAT attributes. Mainly 100% deductions for purchase of product/services from other U.S. corporations. Now this is not to say a national sales tax would not have issues but it is better than the alternatives.

Zeb Barber

12/16/10 12:29

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To Bill Carson-

Right on!

SheepGirl

12/16/10 12:05

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I have a better idea, lets get rid of all federal taxes on business entirely.

Business don't pay taxes anyway, it is just another cost that is passed on in the price of the product or service.

Timbo 53

12/16/10 11:54

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I have to respectfully disagree. While I would love to see all income taxes lowered a VAT Tax is usually hidden along the way and no one really know what part of their purchase goes to taxes. This is just another way for crooked politicians to steal "our" money. Why not do away with income taxes all together and replace it with a retail sales tax that shows up on your purchase receipt? At least we would all know what we were paying and those that currently are working, lets say under the radar, would pay if they wanted food, clothing, etc..

What we really need is to reduce spending and we wouldn't need to have these kind of conversations.

Ronald A. Lau

12/16/10 11:54

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VAT? Hell No.

This is the flaw in Duncan Currie's logic:

The Government is untrustworthy.

There is no tax plan that can save the Government from deficits. Only spending restraints can do that.

BillCarson

12/16/10 11:06

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Yeah, what a wonderful idea! Take someone like me who paid income taxes all his life, retire him, and then take away 20% of his retirement assets by making him pay a VAT tax. Are you crazy?

elborbah

12/16/10 09:39

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Mr. Currie,

Most of your points are right on the money. As a CPA who has worked in public practice and now works for a major multi-national, I would like to add a major omission. The US taxation of worldwide income of corporations (subpart F) is a major disincentive for US firms to repatriate capital and invest in the US.

Going towards a territorial taxation system like our major competitors would be a step in improving tax competitiveness, investment in the US, and reducing compliance costs.

dngrwill

12/16/10 09:32

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More taxes here to reduce taxes there ... while spending remains at 21% GDP ... !!!!

I have a simpler solution. Get back to the constitution, reduce government spending to 8% GDP, get rid of the current tax structure and impose a smaller flat tax on ALL individuals. Why shouldn't the 'poor' pay their share? Since when did we let the government turn into the mob and steal our money on behalf of another individual?

I can't believe Duncan didn't understand the message we gave our politicians in November!

Wake Up!

Don't Tread on Me

12/16/10 07:27

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When I read in National Review that higher taxes are inevitable, and watch Charles Krauthammer on Fox News essentially saying that extending the Bush tax cuts is irresponsible, I don't know whether to laugh or cry. These are OUR guys, supposed conservatives, advocating the confiscation of yet more money from the people and transferring it to the limitless federal monstrosity. Duncan Currie, again a supposed conservative, argues for a VAT. Sure, he balances it with a decrease in the federal income and corporate tax rates. But does anyone doubt for a moment Congress will eventually use both to increase the overall tax burden. Picture Democrats laughing with incredulous delight as Republicans hand them vast new taxing power in the form of a VAT.

To read Mr. Currie's piece, and to watch Charles Krauthammer on TV, is to understand why we have a Tea Party movement.

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larrytex56

12/16/10 14:24

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Ogrepete

12/16/10 13:58

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Wow.

And I thought the election was over. The "RINO" throwing folks are showing their innocence.

Replacing part of the corporate income tax with a VAT is certainly possible and also, IMO, a good thing, assuming we conservatives keep our eye on the Government to prevent "tax creep."

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