James Pethokoukis

Politics and policy from inside Washington

The reality behind the VAT

Apr 22, 2010 14:27 UTC

Over at the very fine TaxVox blog, Howard Gleckman writes a good explanatory piece on the current VAT debate. But this one  part really struck me:

Our current revenue system has reached its breaking point. To fix our terrible budget problem, we are going to have to cut spending. But we are also going to have to raise more revenue. And for the life of me, I don’t understand why we wouldn’t want to do so in the most efficient way possible. And that may lead us to a consumption tax in one form or another, Senate resolutions notwithstanding.

Me:  That was directed at conservative critics of the VAT.  Now from what I can tell, plenty of conservatives would have no problem with a VAT if it a) replaced the income tax and b) was designed to boost tax revenue by boosting economic growth.  And as far as a way of increasing the tax burden, the budget cuts are going to have to come first. Optimize government, try to quick the pace of GDP growth and then raise taxes if necessary.

COMMENT

The VAT is horrible because it is hidden. The income tax is beautiful because it is seen as it is taken. The VAT and hence the size of government can be increased to extraordinary levels and most people don’t even notice.

One reason America has been able to separate itself from the long-term secular decline of Europe is that our taxes have remained low, because our taxes are seen. In Europe by contrast, massive governments dominate every aspect of life and people end up much less free and much more dependent on their state.

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The latest on Obama and the VAT

Apr 22, 2010 13:51 UTC

OK, here is what President Obama said on CNBC to reporter John Harwood about a value-added tax:

HARWOOD: If reducing consumption is a good idea, could you see the potential for a value-added tax in this country?

OBAMA: You know, I know that there has been a lot of talk around town lately about the value-added tax. That is something that has worked for some countries. It’s something that would be novel for the United States. And before I start saying that this makes sense or that makes sense, I want a better picture of what our options are. And my first priority is to figure out how can we reduce wasteful spending so that, you know, we have a baseline of the core services that we need and the government should provide, and then we decide how do we pay for that. As opposed to figuring out how much money can we raise and then not have to make some tough choices on the spending side.

Me: Well,  I certainly agree with the general principle that we should optimize government and then see how much money we need.  But the important thing here is that a) despite Ways & Means Chair Sander Levin badmouthing the idea and b) 85 Senate votes against the idea, c) the White House won’t rule the idea out. Not all.   I also noticed that  the NYTimes has yet to run a correction on Hardwood’s piece that the WH has run the numbers on how much they think a 5 percent VAT would raise (nearly $300 billion a year). That, despite the WH saying they have not done so. It should also be noted that Obama seems to be qualifying his pledge to not raise middle-class taxes as applying only to income taxes.

COMMENT

“Obama seems to be qualifying his pledge to not raise middle-class taxes as applying only to income taxes.”

He has to, because other wise he’s already broken it for all the smokers who are happily uninsured and like to go tanning.

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Team Obama already running the numbers on a VAT

Apr 19, 2010 12:55 UTC

Talk about burying the lede. This from the NYTimes and my pal John Harwood:

One way to reach that 3 percent [deficit-to-GDP] goal, by the calculations of Mr. Obama’s economic team: a 5 percent value-added tax, which would generate enough revenue to simultaneously permit the reduction in corporate tax rates Republicans favor.

Me. Not only does it look like they are considering a VAT, the only offset would be lower corporate taxes. The whole thing would be a net tax increase, obviously. I mean, that is the whole point, despite all the talk about its efficient, pro-growth effects. A VAT of that size would raise $250-$300 billion a year in new tax revenue.

COMMENT

Not sure why Obama should give a hoot what Republicans want, since the people don’t either. And I don’t like VAT on principle. Still…

Given a choice between that, cutting Defense Pork or asset-stripping Goldman Sachs to achieve realistic budget aims, some fool somewhere’s always gonna be crazy enough to pick VAT.

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5 reasons why the Tea Partiers are right on taxes

Apr 16, 2010 15:28 UTC

Here is the new Washington Consensus: American taxes must be raised dramatically to deal with exploding federal debt since spending can’t/shouldn’t be cut. Only the rubes and radicals of the Tea Party and their Contract from America movement think otherwise. And don’t worry, the economy will be just fine.

Don’t believe it. While you will never hear this in the MSM, there is plenty of academic research supporting the idea that cutting taxes and spending is the ideal economic recipe for growth, jobs incomes and fiscal soundness. (This all assumes that America’s amazing turnaround since 1980 isn’t proof enough.)  Just take a look:

1) Tax cuts boost economic growth more than increased government spending. Cutting spending is a better way to reduce budget deficits than raising taxes. “Large Changes in Fiscal Policy: Taxes Versus Spending” — Alberto Alesina and Silvia Ardagna, October 2009:

We examine the evidence on episodes of large stances in fiscal policy, both in cases of fiscal stimuli and in that of fiscal adjustments in OECD countries from 1970 to 2007. Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments, those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions.

2) Tax cuts boost growth. Tax increases hurt growth, especially if used to finance increased government spending. “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks” — Christina Romer and David H. Romer, July 2007:

In short, tax increases appear to have a very large, sustained, and highly significant negative impact on output. Since most of our exogenous tax changes are in fact reductions, the more intuitive way to express this result is that tax cuts have very large and persistent positive output effects. … The resulting estimates indicate that tax increases are highly contractionary. The effects are strongly significant, highly robust, and much larger than those obtained using broader measures of tax changes. The large effect stems in considerable part from a powerful negative effect of tax increases on investment. We also find that legislated tax increases designed to reduce a persistent budget deficit appear to have much smaller output costs than other tax increases.

3) Cutting corporate taxes boosts growth. “The Effect of Corporate Taxes on Investment and Entrepreneurship” — Simeon Djankov, Tim Ganser, Caralee McLiesh, Rita Ramalho, Andrei Shleifer, January 2008:

We present new data on effective corporate income tax rates in 85 countries in 2004. The data come from a survey, conducted jointly with PricewaterhouseCoopers, of all taxes imposed on “the same” standardized mid-size domestic firm. In a cross-section of countries, our estimates of the effective corporate tax rate have a large adverse impact on aggregate investment, FDI, and entrepreneurial activity. For example, a 10 percent increase in the effective corporate tax rate reduces aggregate investment to GDP ratio by 2 percentage points. Corporate tax rates are also negatively correlated with growth, and positively correlated with the size of the informal economy.

4) Tax rates are reaching dangerous levels where higher rates bring in less money. “The Elasticity of Taxable Income with Respect to Marginal Tax Rates” — Emmanuel Saez, Joel Slemrod and Seth Giertz, May 2009:

Following the supply-side debates of the early 1980s, much attention has been focused on the revenue-maximizing tax rate. A top tax rate above [X] is inefficient because decreasing the tax rate would both increase the utility of the affected taxpayers with income above [Y] and increase government revenue, which can in principle be used to benefit other taxpayers. Using our previous example … the revenue maximizing tax rate would be 55.6%, not much higher than the combined maximum federal, state, Medicare, and typical sales tax rate in the United States of 2008.

5) Cutting corporate taxes boosts wages. “Taxes and Wages” — Kevin Hassett and Aparna Mathur, June 2006:

Corporate taxes are significantly related to wage rates across countries. Our coefficient estimates are large, ranging from 0.83 to almost 1-thus a 1 percent increase in corporate tax rates leads to an almost equivalent decrease in wage rates (in percentage terms). … Higher corporate taxes lead to lower wages. A 1 percent increase in corporate tax rates is associated with nearly a 1 percent drop in wage rates.

There are plenty more, of course. The Tax Foundation lists a dozen recent studies how harmful business taxes are to growth, jobs and wages. Economist Greg Mankiw has determined America is far from a low tax nation. More like in the middle. And let me add this from economist Scott Sumner:

When I started studying economics the US was much richer than Western Europe and Japan, but was also growing more slowly than other developed countries. They were still in the catch-up growth phase from the ravages of WWII. But since Reagan took office the US has been growing faster than most other big developed economies, and at least as fast in per capita terms. They’ve plateaued at about 25% below US levels, when you adjust for PPP. This is the steady state.  …   Why is per capita GDP in Western Europe so much lower than in the US? Mankiw seems to imply that high tax rates may be one of the reasons. … So I think Mankiw is saying that if we adopt the European model, there really isn’t a lot of evidence that we’d end up with any more revenue than we have right now. … Of course the progressives’ great hope is that we’ll end up like France. But Brazil also has high tax rates, how do they know we won’t end up like Brazil?

COMMENT

This guy seems to be confusing economic growth with creating an economic bubble.

The simple reality is that tax increases lead to higher GDP growth and lower unemployment. And cutting taxes lead to lower GDP growth and higher unemployment.

Take a look at the stark reality yourself.

http://img27.imageshack.us/img27/3633/ta xrates.jpg

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Why Henry Blodget is wrong about taxes

Apr 6, 2010 16:06 UTC

Henry Blodget says he’s pretty confident taxes are headed higher to deal with the historic rise in federal spending  and agrees with Northern Trust’s Paul Kasriel that higher rates won’t be an economy killer. Blodget quotes Kasriel:

The economy performed pretty well in the eight years ended 2000 even though the top marginal tax rate was higher in these eight years than it was in the prior eight years. The economy did not perform better because of the increase in the top marginal tax rate. Nevertheless, this increase was not sufficient to derail economic progress. In the eight years ended 2008, the economy performed relatively poorly despite the lower top marginal tax rate.  The economy did not under-perform because of the marginal tax rate cut. Nevertheless, the cut in the tax rate was not sufficient to enhance economic performance. The point of all this is that although tax rates matter, they are not all that matters.

Me: I agree that taxes matter but they are not the only thing that matters. But they do matter a lot.  Back when tax rates rose in the 1990′s, the economy was starting from a position of strength, not weakness. There was already  a powerful, self-sustaining recovery in place. Let me point out this 2009 study that examined the affect of higher marginal tax rates on the rich:

Taxes trigger a host of behavioral responses designed to minimize the burden on the individual. … all such responses are sources of inefficiency, whether they take the form of reduced labor supply, increased charitable contributions, increased expenditures for tax professionals, or a different form of business organization, and thus they add to the burden of taxes from society’s perspective.

Following the supply-side debates of the early 1980s, much attention has been focused on the revenue-maximizing tax rate. A top tax rate above X is inefficient because decreasing the tax rate would both increase the utility of the affected taxpayers with income above X and increase government revenue, which can in principle be used to benefit other taxpayers. … Using our previous … the revenue-maximizing tax rate would be 55.6%, not much higher than the combined maximum federal, state, Medicare, and typical sales tax rate in the United States of 2008.

And this is before the 2011 tax increases and the increase in taxes related to healthcare reform. We are probably now on the wrong side of the Laffer Curve.  Greg Mankiw also makes the case that Americans are not undertaxed compared with the rest of the planet’s advanced economies.

COMMENT

I would also add there were 3 growth drivers during the 1990’s. 1) The initial build-out of the Internet when firms spent billions on fiber, chips, software, webhosting, etc. 2) The Y2K computer conversion increased demand for some of the same equipment plus lots of high-paying software programmers. 3) Now we also found out the Clinton HUD lowered the lending standards for home ownership and set off a housing boom to boot.

The first two aren’t coming back, and who knows about the third.

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Preventing the Great Stagnation

Mar 31, 2010 19:14 UTC

David Gitlitz, chief economist at High View Economics, has a thought or two about my “20-year bust” post:

Gordon is very good in his areas of expertise, but you’re right to point out that there’s nothing predetermined about this. Enacting full bore Obanomics would make even Gordon’s outlook look like a day at the beach. On the other hand, adopting a supply-side, free-market growth strategy would put in place the incentives to reinvigorate entrepreneurship and innovation and put us on track to restore at least the historical trend rate of productivity growth.

Me: Markets have a funny way of driving policy. A high-debt, high-tax, high-regulation economy would not be good for the dollar, bonds or stocks. And while we are on the topic, an interesting post from the great Larry Kudlow on where taxes are heading.

Obama and America’s 20-year bust

Mar 31, 2010 11:51 UTC

It is an alarming, jaw-dropping conclusion. The U.S. standard of living, says superstar Northwestern University economist Robert Gordon in a new paper, is about to experience its slowest growth “over any two-decade interval recorded since the inauguration of George Washington.” That’s right, get ready for twenty years of major-league economic suckage. It is an event that would change America’s material expectations, self-identity and political landscape.  Change in the worst way.

Now it’s not so much that the Great Recession will morph into the Long Recession. More like ease into the Great Stagnation. As Gordon calculates it, the economy will average only 2.4 percent annual real GDP growth over that span vs. 3 percent or so during the previous 20 years. On a per capita basis, the economy will grow at just a 1.5 percent average annual rate vs. 2.17 percent between 1929 and 2007.

That might not seem like much of a difference, but it really is. Over time, the power of compounding would create a huge growth gap measured in the trillions of dollars. To look at it another way, assume you had an annual salary of $100,000. If you received a 1.5 percent raise each year, you would be making $134,000 after 20 years, $153,000 after 40 years. But a 2.17 annual raise would boost your income to $153,000 after 20 years and $236,000 after 40 years.

For Gordon, the culprit is weaker productivity. Productivity, economists like to say, isn’t everything — but in the long run it is almost everything. A nation’s GDP growth is little more than a derivative of how many workers the nation has and how much they produce. And if Gordon  is correct, U.S. productivity is about to weaken. He forecasts that over the next two decades, the metric will grow at just a 1.7 percent annual rate. From 1996-2007, economy-wide productivity averaged just over 2 percent with GDP growing at 3.1 percent.

Gordon’s argument is simple: The productivity surge starting in the 1990s was driven primarily by the Internet, though drastic corporate cost-cutting in the early 2000s helped, too. Going forward, though, Gordon thinks the IT revolution will be marked by diminishing returns. He concludes, for instance, that most of the product innovations since 2000, like flat screen TVs and iPods, have been directed at consumer enjoyment rather than business productivity. (Also not helping are a more protectionist trade policy and a tax code where the penalties on savings and investment are about to skyrocket with rates soaring 60 percent on capital gains and 200 percent on dividends.)

All this dovetails nicely with research showing financial crises are followed by negative, long-term side-effects such as slow economic growth and higher interest rates. Lots of debt, too. Indeed, researchers Carmen Reinhart and Kenneth Rogoff find advanced economies with debt-to-GDP ratios above 90 percent grow more slowly than less-indebted ones. (Japan is the classic example.) America is on track to hit that level in 2020, according to the Congressional Budget Office.

But maybe Gordon is wrong. Productivity has been surprisingly robust during the downturn, helping the overall economy (though not the labor market) weather the storm better than most expected. Maybe nanotechnology or genetic engineering will be the next Internet and ignite further creative destruction. Yet even if Gordon is correct, Americans still control their own economic destiny.

Since the 2008 election, American economic policy has been about wealth preservation (keeping the economy from sliding into a depression) and wealth redistribution (healthcare reform.) Wealth creation? Not so much.  That needs to change. Washington needs to focus on growing the economy and competing with the rest of the G20 nations, including the other member of the G2, China. Every policy — from education to trade to the tax code — needs to be seen through that lens.

America faced a similar turning point a generation ago. During the Jimmy Carter years, the Malthusian, Limits to Growth crowd argued that natural-resource constraints meant Americans would have to lower their economic expectations and accept economic stagnation — or worse. Carter more or less accepted an end to American Exceptionalism, but the 1980 presidential election showed few of his countrymen did. They chose growth economics and the economy grew.

Now they face another choice. Preserve wealth, redistribute wealth or create wealth.  Hopefully, President Barack Obama will choose door #3. Investing more in basic research (not just healthcare) would be a start, as would slashing the corporate tax rate. A new consumption tax would be better for growth, but only if it replaced the current wage and investment income taxes. Real entitlement reform would help avoid the Reinhart-Rogoff scenario. The choices made during the next few years could the difference between America in Decline or the American (21st) Century.

COMMENT

This state of affairs are known to many Americans and in general public.
Because of economic slow down, no clear cut policy on major issues,last two years banks financial crisis, not much appreciated exports from America, more expenditure on Iraq/Afghans areas, some misconception on Mr.Obama!s new health care proposals made his downward rating on his policies,actions etc.,from Americans.
Mr.Obama wants to do more welfare measures to native Americans and to others as early as possible.
Those who attracts by his or speeches may be short lived.
America was in very pretty positions and enjoying their wealth for many centuries.
Now, other nations had started moving towards forward journey and getting favorable results from now and then.
If government wants to build more cash reserve, more expenditure on running and sustaining economic and social growth, creating more infrastructure, then, our college economics speaks in real terms.
There is no other ways, only to get more revenue by regulations, more and more exported industries formation,more productive work, increase their standard of income,then, some taxes to be levied and can be collected from many high,upper classes.
Still,some years to go and to find what happens on American soil by Mr.Obama and his team.
These findings may be a search type for any corrections and bring his ratings to upwards.,

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Becker on on what healthcare reform should look like

Mar 30, 2010 19:28 UTC

An amazing piece of healthcare analysis by the University of Chicago’s Gary Becker. The whole analysis deserves reading, but a few key points:

1) Out-of-pocket spending accounts for only about 12% of total American spending on healthcare, whereas the share of out-of –pocket spending is over 30% in Switzerland, a country considered to have one of the better health delivery systems. Partly because of this major difference, health care takes 11% of Swiss GDP compared to the much higher American percentage. … As far as I can discover, nothing in the new bill really tries to raise the out-of-pocket share, and some changes would reduce it even further.

2) Another desirable reform is to reduce the reliance of the American health system on tax-deductible employer-based insurance since tax deductibility has encouraged low deductibles and low co-payments. … The bill does propose to phase out tax deductibility for the more expensive plans by 2018, but who knows if that will ever be implemented.

3) Health savings accounts (HSAs) have been one of the most important innovations in the health care field during the past decade. … There is little mention of HSAs in the new bill, and certainly no encouragement to their expansion.

4) The American health care delivery system needs greater transparency and easier access to medical information by consumers. The bill takes a valuable step in this direction by encouraging the development of online medical records and medical histories for all individuals, no matter how many doctors they have seen, or how often they have moved.

5) Proponents of the bill claim it will save hundreds of billions of dollars during the next ten years from cuts in Medicaid and Medicare, but it is far from obvious how such cuts will materialize. … . I do not see how the bill will lead to Medicare savings since there is no increase in out of pocket payments by Medicare enrollees, and Congress is likely to continue to override any scheduled cuts in payments to Medicare doctors and others.

6) The only truly efficient way to handle the pre-existing condition issue is to try to develop an insurance system in which young adults, who generally have few serious existing medical conditions, can take out long-term healthcare insurance.

7) Although the impact on the costs to taxpayers of the more than 40 million uninsured persons in the US is usually greatly exaggerated, I do support a requirement that everyone has health insurance that covers medical catastrophes.

Economic guru: US faces its worst two decades in history

Mar 29, 2010 14:04 UTC

Get ready for the Long Recession.

Well, at least a long period of time where it is going to seem like the US economy is kind of sickly. That is the conclusion of productivity guru Robert Gordon in a new paper. He says US living standards now face their slowest two-decade growth rate “since the inauguration of George Washington.” More:

The statistical trend for growth in total economy [labor productivity] ranged from 2.75 percent in early 1962 down to 1.25 percent in late 1979 and recovered to 2.45 percent in 2002. Our results on productivity trends identify a problem in the interpretation of the 2008-09 recession and conclude that at present statistical trends cannot be extended past 2007.

For the longer stretch of history back to 1891, the paper provides numerous corrections to the growth of labor quality and to capital quantity and quality, leading to significant rearrangements of the growth pattern of MFP, generally lowering the unadjusted MFP growth rates during 1928-50 and raising them after 1950. Nevertheless, by far the most rapid MFP growth in U. S. history occurred in 1928-50, a phenomenon that I have previously dubbed the “one big wave.”

The paper approaches the task of forecasting 20 years into the future by extracting relevant precedents from the growth in labor productivity and in MFP over the last seven years, the last 20 years, and the last 116 years. Its conclusion is that over the next 20 years (2007-2027) growth in real potential GDP will be 2.4 percent (the same as in 2000-07), growth in total economy labor productivity will be 1.7 percent, and growth in the more familiar concept of NFPB sector labor productivity will be 2.05 percent. The implied forecast 1.50 percent growth rate of per-capita real GDP falls far short of the historical achievement of 2.17 percent between 1929 and 2007 and represents the slowest growth of the measured American standard of living over any two-decade interval recorded since the inauguration of George Washington.

Me: There is no more basic political and economic issue than a nation’s standard of living. If  Gordon is right, this will dominate US politics as another sign of American decline.

COMMENT

Or Plan B we could just throw the Democrats out of office (which even the “Greatest Generation” wouldn’t do), rip Obama’s poisoned laws out of the ground, and get our economy back to a nice happy 4.5% unemployment rate.

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A Wall Street conspiracy to kill Social Security?

Mar 26, 2010 11:37 UTC

Finally, a Wall Street conspiracy theory without Goldman Sachs at its heart. This one posits that bond rater Moody’s wants to ding the U.S. credit rating so panicky politicos will privatize Social Security. That would sent big bucks to the firm’s big bank clients. If only it were true.

This bit of speculation comes from Dean Baker, a respected Washington think-tank economist, albeit with a liberal bent. Baker suggests that Moody’s increased debt warning of late “could be a reflection of the Wall Street agenda to cut” America’s social insurance safety net. Shifting government pensions into the private sector could entail billions, if not trillions, of retirement dollars flowing into personal portfolios managed by investment firms.

Like most conspiracy theories, this one reveals more about the storyteller than about reality. Baker, like other left-of-center economists such as New York Times columnist Paul Krugman, think Washington too concerned with deficits given the anemic economy. And they lump President Barack Obama into that camp, too. They fret this New Frugality — somewhat laughable give trillion dollar deficits — will be further fed by Obama’s new deficit commission. And they especially worry the panel will recommend trimming back Social Security to preserve its solvency. Add in displeasure that financial reform isn’t tougher on the major players in the financial meltdown, and a juicy tale of corporate collusion emerges.

A better theory: Raters have been intentionally insouciant so as not to incur the wrath of Congress as it fashions new regulations for the firms. U.S. debt-to-GDP may hit 90 percent by 2020, according to the Congressional Budget Office. The CBO also says that Social Security, which accounts for 16 percent of the government’s $46 trillion in long-term liabilities, will in 2010 for the first time pay out more in benefits it takes in from taxes.  That is six year earlier than predicted. The slow economy is the near-term cause. But the event marks a key milestone in the program’s long descent toward insolvency. Benefit cuts and tax hikes seem inevitable. But those will lower an already paltry rate of return, especially for younger workers.

Letting Americans shift at least some of their government-directed savings into the real economy would generate a bigger nest egg.  This is done in Chile and Sweden, for instance. Yes, stocks are risky. But the market ultimately reflect the real economy. If it booms, so will portfolios. And if doesn’t, Social Security is in even deeper trouble. If there isn’t a conspiracy, someone should hatch one.

COMMENT

clinton surplus – thought congress developed the budget in with the President and approved by the senate. So it is the clinton/newt surplus, is it not?

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