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Door to a Consumption Tax Remains Closed, for Now

As the economy has slumped and budget deficits have skyrocketed, lawmakers from both parties have expressed new interest in stabilizing the national debt and restructuring the tax code to make it more conducive to economic growth. That’s led some to give serious consideration to policies that were once thought unthinkable.

There is, however, something that remains missing from debates in the legislative arena.

For all the dire warnings about the debt and criticism of the tax system, policymakers still don’t seem ready to entertain the thought of a national consumption tax. It’s a measure that, according to many budget experts and economists, will almost certainly need to be adopted at some point if the country is to preserve some semblance of its social safety net and remain an economic powerhouse.

And so for some, the time seems right for a consumption tax. Across the country, Republican governors are considering or have already adopted legislation that would increase sales taxes to pay for lower income taxes or new infrastructure projects.

Dave Camp, the chairman of the tax-writing House Ways and Means Committee, who has launched the most ambitious effort to rewrite the nation’s tax laws since Congress overhauled the tax code in 1986, has not entirely dismissed the ideas behind consumption taxes, although the Michigan Republican is hardly a backer. According to proponents, “taxing consumption rather than income could have important economic benefits, and so as part of our efforts to reform the tax code, the committee needs to examine those proposals,” Camp said at a hearing on consumption taxation in July 2011.

However, in a meeting with reporters at the end of last month, Camp was asked whether he would include a consumption tax in the legislation that he plans to introduce by the end of 2013. Though usually careful to leave room to maneuver, Camp didn’t leave any doubts with his answer: “No.”

In contrast to many areas of tax policy, the issues surrounding a consumption tax are relatively simple. Economists like the taxation of consumption rather than income, because it encourages savings and investment.

According to a 2007 Treasury Department study, taxing businesses on their purchases instead of their profits would “ultimately increase the size of the economy by roughly 2 percent to 2.5 percent.”

Yet the notion of a consumption tax at the national level has traditionally been met on Capitol Hill with scorn, if not outright derision.

Among Republicans, the fear has been that a consumption tax would turn out to be a money machine, putting an end to their larger goal of squeezing down the size of government. Democrats have rejected the idea on the grounds that it would impose more of a burden on low- and middle-income earners than those at the top of the income distribution.

And for Republicans, in particular, consumption taxes have earned a bad name because of their association with European value-added taxes, which are essentially sales taxes collected at each stage of the production process but also carry the air of European values viewed with suspicion in much of the United States.

In fact, value-added taxes have become ubiquitous around the world, enabling governments to support large social-welfare programs and attract investment by lowering their corporate tax rates.

Of the 34 developed countries that belong to the Organization for Economic Cooperation and Development, the U.S. is the only country without a value-added tax at the national level. Even including state and local governments, the U.S. raises much less revenue through consumption taxes than other countries. The U.S. is also taxed less heavily overall, and it has to borrow more to finance its government than most other countries in its peer group.

To many economists, the U.S. is simply living on borrowed time before the simple mathematics of taxation brings the country around to the rest of the world. Experts say the U.S. might be able to last another few years, or even a couple of decades, without adopting a national consumption tax, but eventually an aging population and rising health care costs will force policymakers to raise taxes in the least economically harmful way possible.

One reason investors maintain their “confidence in the U.S. is that, for all the politics back and forth and for all of our complaining about our taxes, the actual total share of taxes in the U.S. economy is relatively low by international standards,” Adam Posen, president of the Peterson Institute for International Economics, said in an interview. “There is this sense that as long as things don’t get totally out of hand, if push came to shove, the U.S. could overnight impose a national sales tax.”

Regardless of whether adopting a consumption tax is necessary, it certainly would make life easier for lawmakers as they strain to find a way to both reduce the deficit and lower the corporate tax rate, which, at 35 percent, remains the highest in the developed world.

As it stands, Camp and others are intent on paying for rate reductions for businesses and individuals by eliminating or scaling back various credits, deductions and exclusions. According to many economists, removing economic distortions caused by tax preferences is a worthy goal. Still, there are some tax breaks that even economists would like to preserve in some form. And even if those are removed it would be difficult to find enough revenue within the corporate tax system to reduce the corporate rate as much as lawmakers want, to 25 percent or 28 percent.

“You can cry all day about how you hate the income tax and the corporate tax, but you have to have a substitute,” said Martin Sullivan, a columnist for Tax Notes magazine and former Treasury Department economist.

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