When will the other chaussure drop? Now that America has gone French (and German and British) with universal healthcare, expect Washington to eventually propose a European-style, value-added consumption tax to pay for it — as well as the rest of the historic rise in federal spending. But U.S. voters are in a severe anti-tax mood. It might take another financial crisis to give politicians the will and hubris to ignore them.
Here’s how it might all play out:
1) For Washington insiders, it’s a matter of “when” not “if.” Politicians and economists I chat with from the White House to Capitol Hill to the Federal Reserve think a VAT inevitable. Healthcare reform has only hardened that consensus. Spending cuts to pay for expanded coverage may not happen. Either way, the budget numbers scream for action. Annual federal spending as a share of GDP will likely outpace revenue by at least six percentage points for years to come. Trillion-dollar deficits the norm.
2) Just slashing spending is one option. But that would require a radical reshaping of social-insurance schemes as outlined by Rep. Paul Ryan in his recent white paper, “A Roadmap for America’s Future.” The war over healthcare would seem a minor skirmish by comparison. A battle worth fighting, but a coalition of the willing might be small.
3) Maybe a broad income tax increase? So far Washington has shown an appetite for nicking only the rich. And one study suggests the tax burden on wealthy households is approaching — or has perhaps even exceeded — the revenue-maximizing level. That’s right, America is on the wrong side of the Laffer Curve again. Even assuming the rich wouldn’t flee to tax shelters, top income tax rates would need rise to economy-crushing levels to balance the budget.
4) Anyway, it’s smarter to tax consumption broadly rather than work and investment narrowly. Especially in an economy that needs less of the former and more of the latter. And that is what a VAT does. Few doubt its ability to raise massive amount of revenue with fewer disincentives than the current system. But if the economics are clear, the politics are a puzzle in Tea Party America. VAT proponents assume political intransigence without a financial crisis to spur action, just as market chaos helped get the $700 billion bank rescue passed in 2008.
5) Yet there is a reasonable scenario where America would accept a VAT. In fact, it is the only scenario under which we should accept a VAT.
First, Washington would have to demonstrate it could manage the public purse by reforming entitlements in a Ryan-esque manner. A tall order, but a necessary prerequisite or else voters would fear that entire six-point budget gap would be closed by tax hikes via a VAT. So, in the end, government spending needs to be dramatically cut. (Preferably, we would never need to get past this step.;)
Second, a VAT would have to completely overwrite the current complex and inefficient tax code. If not, voters would fear getting hit by both VAT and income tax hikes. A VAT can’t be an add on.
Third, every sales receipt in America would have to indicate the VAT penalty. But politicians love the hidden aspect of a VAT as way of duping voters. To them opaqueness is a feature, not a bug.
Fourth, the intended tax burden should be kept level at first. A pro-growth VAT — one that does away with corporate and investment taxes — might produce more revenue merely by expanding the economic pie.
Still a tough sell. Better skip the part about the French.