Sorting through a shift toward a consumption tax

Christian Science Monitor ^ | 06/30/03 | David R. Francis

[bedolido]

Conservatives are rejoicing. They see the United States already on a path of fundamental tax changes that will accelerate economic growth. "Stealth tax reform," it has been called. That's because relatively few voters are aware of the significance of the changes in the system proposed by President Bush and incorporated in the three tax-cutting measures passed by a Republican-led Congress since he took office.

"George W. Bush is the first president to actively understand and embrace the fundamental core principles of tax reform," says Ernest Christian, a founder of the Center for Strategic Tax Reform in Washington.

The ultimate tax-reform goal varies somewhat among conservatives.

In general, these reformers see their proposals and the recent tax-cut changes as shifting the system toward taxing consumption, that is, money used by people and companies to buy goods and services, and leaving individual savings and much of corporate profits facing less income taxation. This, their rationale goes, will encourage extra savings and investment, thereby speeding up growth in productivity.

For instance, Grover Norquist, head of Americans for Tax Reform in Washington, would like to see a single-rate tax - a "flat tax" - that taxes income only once. Corporate dividends, for example, would be taxed at either the corporate or individual level, but not both.

"It's a huge political winner today because 70 percent of voters [those actually voting] own corporate shares," he maintains. "So we will keep taking baby steps" in that tax-reform direction.

Michael Graetz, a Yale Law School professor and Treasury tax-policy official under the first President Bush, last fall called for a 10-to-15 percent federal value-added tax, like that in some 120 other nations. This type of sales tax would raise enough revenues to allow families with $100,000 of annual income or less - almost 90 percent of all current filers - to pay no income tax, or even need to file. Those with incomes above that would be taxed at a flat 25 percent rate.

But Mr. Graetz's VAT plan is widely seen as a nonflier in Washington.

"It is not going to happen," says Stan Collender, a budget expert with Fleishman-Hillard Inc. It may be "right academically," but is "incredibly wrong politically." It would be opposed by retailers, as well as by the states and cities that regard sales taxes as their turf.

Even L. Glenn Hubbard, chairman of the Council of Economic Advisers (CEA) under Bush before leaving earlier this year for Columbia University, "doubts very much" that Congress would approve a value-added tax.

Mr. Hubbard devoted a 36-page chapter in the CEA's annual report last winter to a pitch for a consumption tax. And he expects the Bush administration to introduce more "reform" in the months ahead, but won't spell out what.

The tax changes so far include these:

• Marginal income-tax rates have been cut - from 38.6 to 35 percent for the rich, a smaller cut for those with less income.

• The tax on corporate dividends was not eliminated, as proposed by Bush, but slashed to 15 percent along with the tax rate on capital gains.

• The amount that business can write off their taxes in the first year on purchases of plant and equipment has been raised to 50 percent for bigger companies, and by as much as 100 percent for small businesses.

Mr. Christian would like 100 percent depreciation in the first year. He also wants to excuse from taxation export and other foreign-trade income of US multinationals, as many other nations do.

The next likely "baby step" is the revival of the Lifetime Savings Account proposed by Bush last January, and later dropped for fear it would distract from the White House goal of selling its main tax package. The radical measure would allow taxpayers to contribute up to $7,500 a year of after-tax income into an investment account where it could grow untaxed and be withdrawn tax-free later for retirement, education, or other purposes.

"That is coming back," says Chris Edwards, a fiscal expert at the Cato Institute in Washington. He sees it as having political appeal in an election year. And its revenue loss is small in the 10-year window used by Congress in looking at tax bills.

The measure would also move toward a consumption tax by easing the tax burden on money not spent, that is, savings.

Critics of the Bush step-by-step moves are bothered that they tend to benefit mostly the well-to-do who can afford to save more than the middle class or poor.

William Gale, a Brookings Institution tax expert, says the nation is headed toward "a wage tax" system that puts the tax burden on employees, and ignores some dividends, interest, capital gains, and other "nonearned" income. The tax system will be less progressive and worse than either today's system or a more pure consumption-tax system, he argues.

Robert Reischaurer, president of the Urban Institute, complains the developing system will "worsen" an after-tax distribution of income that already is slanted to the top, and especially help "old capital."

An academically "pure" consumption-tax system would tax inheritances. But it is unlikely Bush would push for that, notes Joel Slemrod, a University of Michigan Business School tax expert in Ann Arbor.

[Wright is right!]

"An academically "pure" consumption-tax system would tax inheritances."

And where, zackly, does this author come up with THAT hare-brained notion? Inheritances are not "spending" nor are they "consumption." They are the result of SAVING.

Michael

[RRWCC]

Definition of Tax Reform: We have figured out how to get more out of the middle while making the middle think we are extracting less.

What ever happened to cutting spending?

[kevkrom]

The only danger with the "baby-step" approach is that we're going to wind up with an income tax/VAT hybrid approach. The system needs to be gutted and replaced with a true consumption tax.

[SolidSupplySide]

Michael Graetz, a Yale Law School professor and Treasury tax-policy official under the first President Bush, last fall called for a 10-to-15 percent federal value-added tax, like that in some 120 other nations. This type of sales tax would raise enough revenues to allow families with $100,000 of annual income or less - almost 90 percent of all current filers - to pay no income tax, or even need to file. Those with incomes above that would be taxed at a flat 25 percent rate.

But Mr. Graetz's VAT plan is widely seen as a nonflier in Washington.

Good.

A VAT/Sales Tax would cause a greater economic loss than the reform that Bush is achieving incrementally.

[lelio]

Reduce the income tax and tax imports (be it goods or services) by the same amount.
That would stem the tidal wave of outsourcing everything as it levels the playing field. Think of it as a "foreign" income tax.

[Libertarianize the GOP]

http://www.fairtax.org

[kevkrom]

A VAT/Sales Tax would cause a greater economic loss than the reform that Bush is achieving incrementally.

Be careful to use the right terms. A VAT and a sales tax are two entirely different animals. Econmically, the existing income tax works as a VAT.

What it really boils down to is that, all of the hand-waving aside, only individuals pay taxes (not corporations). A single-stage consumption tax ("sales tax") is the only mechanism that truly captures this concept.

[CGTRWK]

A VAT/Sales Tax would cause a greater economic loss than the reform that Bush is achieving incrementally.

Agree 100%. Nothing will discourage consumer spending quite like a big fat tax tacked on at the point of sale. Furthermore, a consumption tax screws everyone responsible enough to have any savings now.

Plus I really don't like the word VAT. Very Orwellian. Exactly what value is it that's being added? 15 billion dollars a year to subsidize queers with AIDS? 30 billion in farm subsidies to keep my grocery bill up? Yeah, that's really adding alot to my quality of life...

[MattinNJ]

bttt for later read.

[kevkrom]

Agree 100%. Nothing will discourage consumer spending quite like a big fat tax tacked on at the point of sale. Furthermore, a consumption tax screws everyone responsible enough to have any savings now.

As if you aren't paying those same taxes now every time you buy something? A sales tax would at least be an explicit cost that you can see (and get P.O.'ed about because of how much government "services" costs), rather than just burying those taxes into the price through income taxes and VATs...

[CGTRWK]

As if you aren't paying those same taxes now every time you buy something? A sales tax would at least be an explicit cost that you can see (and get P.O.'ed about because of how much government "services" costs), rather than just burying those taxes into the price through income taxes and VATs...

That's just the thing, when you can see the staggering cost of government right there in front of you at the checkout counter, and opt out of it by not buying whatever it is you were gonna buy, consumer spending is going to suffer and drag down the whole economy with it.

I agree that having the cost of government rubbed in people's faces with every purchase is a good point for a VAT. But that's not enough to outweigh the downsides to me.

[Libertarianize the GOP]

Do you think there is any chance that Bush will announce his support for the FairTax during the 2004 race?

Interesting question, I don't know and I don't spend a lot of time analyzing the political angles but I would love to see our current income tax replaced by a consumption tax.

[jennyp]

I agree that having the cost of government rubbed in people's faces with every purchase is a good point for a VAT. But that's not enough to outweigh the downsides to me.

You mean sales tax. A VAT is collected at each step of production, and the end consumer doesn't notice any of that. It's the same way as today, where the companies that make the products are taxed on the profits they made by increasing the value of those products. We as consumers don't see any of that. All we see is "hey, the greedy store has upped the price!"

(Kevkrom: Good point about the corporate income tax essentially being a VAT already! I never thought of that, but it makes perfect sense.)

[Action-America]

It doesn't take a Harvard MBA to realize that the whole point of Dubya's "step-by-step" or "baby-step" approach, is to have us end up with a tax system that includes both a progressive income tax and a consumption tax and is even more convoluted than the current progressive income tax.

Note also, that they refer to their system as a "consumption" tax, even though what they are talking about is essentially, a "VAT", that is levied at every level in the supply chain, rather than only at the point of final retail sale to the consumer.  This will give the government a way to extract even more money from the citizenry, without most voters understanding that they are being taxed at all.

Any attempt at tax reform, that leaves the IRS intact, is only a placebo.  Furthermore, the hidden agenda in such halfhearted actions is probably to prevent true tax reform, rather than enact it.

The National Retail Sales Tax is the only proposal on the legislative table at this time, that truly does qualify as fundamental tax reform.

 

[lewislynn]

Good point about the corporate income tax essentially being a VAT already!

How is corporate income tax "essentially being a VAT" exactly?...

If company (A) sells a product to manufacturer B, manufacturer (B) writes off the cost of procuct (A) from his gross income...there is NO VAT there....If 5 producers are paying 5% of their gross in taxes it's still only 5% of the gross at the end...not 25% like the sales tax shills would like for you to believe.

BTW all businesses paying taxes aren't corporations and one of the reasons for incorporating is for tax advantage.

[William Terrell]

But that's not enough to outweigh the downsides to me.

A NRST was proposed one time before, earlier in last century, and it was rejected mainly because it would penalize the less solvent folks. The current NRST proposal (HR2525) would attempt to solve that problem by letting people who find it hard to buy necessities like food and heating oil, to file a claim for a government set amount to be "refunded" to them, which claim must be filed each month, if I remember correctly.

However the money will have been spent before the claim, and the claim can only be within limits, and like any massive government payoff, will be slow, almost certainly not arriving before the next month's purchases.

Also, there is a provision that social security remain at a level that will be a set portion of the sales tax recieved by the national government, after payoffs to state/federal agencies, retailers and other expenses. If the revenue falls, the NRST percentage will be automatically raised to restore the level, with not a congressman's pinkey soiled by having to pass a bill.

With a 28% to 35%, or even lower, NRST, and repurchased merchandise not taxed, the resulting market in secondhand goods will boom, reducing the level of revenue coming into the national government. This could have a cycling effect.

Yes, downsides. The real winners among the populance would seem to be the employees of a company, particularly a big company, and making a fairly large wage or salary, making employment in such companies very sought after positions, skewing the master/servant (renamed the employer/empolyee) relationship too much toward the master.

These are a few among many more.

[John Locke]

A consumption tax would tax inherited wealth insofar as it is spent. So if Daddy Warbucks leaves $10M to Little Orphan Annie, she pays no tax if she leaves the money invested, but if she splurges on Pokemon toys and designer Bratz dolls then she will pay the consumption tax.

This of course creates a great incentive to hoard inherited wealth rather than spending it, and so over the long term will create more very rich families with tons of old money. As a member of the VRWC, I regard that as a good thing.

[jennyp]

Ah, you may be right. (But then that would mean I could be wrong. So I'm skeptical. :-)