Although a value-added tax is gaining steam as the likeliest revenue source to help fill the nation’s yawning fiscal gap, President Barack Obama’s debt commission should consider an alternative: a progressive consumption tax.
[IMGCAP(1)]The virtue of the PCT over the VAT is that it’s simple, transparent and progressive. It would reward and encourage savings. And, politically, it would be an American invention, not a European import.
Instead of paying a largely hidden sales tax (the VAT), under the PCT, citizens would pay taxes on the difference between what they earned and what they saved — that is, on what they spent.
Foes of higher taxes — such as practically every Republican on the commission — likely will insist that mounting deficits be controlled by spending cuts alone.
And many Democrats on the commission — particularly liberals Andy Stern of the Service Employees International Union and Rep. Jan Schakowsky (Ill.) — will want tax increases to cover the gap.
But either path would be a traumatic way to reduce deficits scheduled to total more than $3 trillion over the next five years and $9 trillion over 10 years.
This commission, headed by two moderates — Bill Clinton’s former White House chief of staff, Erskine Bowles, and retired Sen. Alan Simpson (R-Wyo.) — will be a crucial test of whether bipartisan solutions can be found to the nation’s serious problems.
Hopefully, the commission will agree that both spending cuts and tax increases — plus reform of both entitlement programs and the tax system — are the way to contain a debt burden.
On the revenue side, a VAT is now the leading proposal, advocated by Speaker Nancy Pelosi (D-Calif.), former White House Chief of Staff John Podesta and — significantly — former Federal Reserve Chairman Paul Volcker.
It’s also recommended as the least-bad alternative by some Republican economists, notably Greg Mankiw, chairman of the Council of Economic Advisers under former President George W. Bush.
A VAT is essentially a sales tax, except that it’s charged at each stage in the development of a product instead of when the product is sold.
As Shawn Tully wrote for CNNMoney.com, “the genius of the VAT is that, while the consumer pays it, the actual cash is mostly collected from producers before it reaches the retailer.
“Since the VAT is essentially a hidden charge embedded in the price of goods and services, raising the VAT doesn’t arouse the uproar caused by increasing income taxes.”
The progressive consumption tax was first proposed in 2004 by Maya MacGuineas, president of the Committee for a Responsible Federal Budget, as an alternative to regressive payroll taxes and later as replacement for the income tax.
Now, she’s advocating it in place of the VAT, which she says is also inherently regressive because poorer people spend a greater percentage of their incomes than rich people.
And, efforts to make it more progressive by exempting food, medicine and children’s clothing will raise prices on those favored items.
The PCT works like this: At tax time, a person states his or her income, subtracts the amount that he or she has saved and pays tax on the difference.
As opposed to the VAT, taxpayers would know exactly what they were paying and why — and would be encouraged to save more.
The rate of tax on consumption would be based on income — perhaps zero for poor people, 5 percent for middle-income earners and 10 percent for those more than $100,000 a year. Revenue needs also would determine the rates.
Transparency should also make the PCT attractive to Republicans, who fear that a VAT would be raised frequently to pay for increased spending.
Conservatives rail that Obama and his fellow Democrats are determined to make the United States into a “European-style social welfare state.”
First introduced in France in 1954, VATs in the range of 20 percent are now universal in European countries and also Mexico, Canada, Australia and New Zealand.
A progressive consumption tax would be an all-American alternative designed to close the deficit gap and incentivize chronically low savings and investment.
MacGuineas, in an interview, stressed that the PCT should not by any means be the commission’s sole means of bringing deficits under control.
She favors income tax reform — lowering rates and broadening the base of taxes by eliminating as many special breaks as possible.
Breaks — technically known as “tax expenditures” — cost the treasury an astronomical $1 trillion, but they include such popular items as the mortgage interest deduction and the exclusion of taxes on employer-provided health insurance.
MacGuineas also favors slowing the growth of Social Security and Medicare benefit increases by such means as raising the retirement age and indexing it to longevity and means-testing Medicare.
Just as Congress and Bush and Obama have failed to control the national debt, there’s every reason to fear that ideology will prevent the commission from reaching agreement.
But every commissioner needs to consider the warning: The debt is so big that, if it’s not contained, it will ruin America’s economy and undermine its world leadership.