Friday, May 29, 2009

Is the Value Added Tax the Solution to the Nation’s Debt Problem?

As of today, the U.S. national debt is over $11 trillion dollars.  The Congressional Budget Office (CBO) estimates that the  budget deficit will be $1.8 trillion in 2009 and $1.3 trillion in 2010.  These deficit figures are added to the national debt, which means that in 2010, the national debt will be over $14 trillion.  Let me repeat that, this country currently owes somebody $11 trillion and will owe somebody over $14 trillion!  Who is that somebody?  As of March, we owe China $767.9 billion and Japan is due $686.7 billion.  According to this chart, 29% of the debt is owned by foreign creditors, 31% by the American private sector, and the rest is owned by the U.S. Government. 

Debt of this magnitude cannot exist without consequences.  There is concern that while our AAA credit rating is currently intact, it may be in jeopardy.  At the same time, our investors are getting nervous.  China, as our largest debtor, continues to voice concerns, calling for the “creation of a new currency to replace the U.S. dollar as the world's standard.”  (Relax Bachmann)  Talk like this is not good, not just for our nation’s economic prospects, but for the nation’s confidence in general. 

There is no doubt that these are daunting figures.  It’s hard to feel better about it when you consider the President’s FY 2010 budget.  Disclosure, I have argued in favor of, and still believe in, the President’s budget.  Health care and energy reform, as well as infrastructure upgrades are long over due.  Investments in all three areas will have positive, long term effects for the strength and prosperity of this country.  That said, these things don’t come cheap.  Somebody has to pay for it and I for one would rather pay taxes on tangible things, like roads, schools, and health insurance, then things that vanish at the push of a button, like, for example, bombs and bullets expended in far away lands.

This is our dilemma.  We, as a country, want good roads, police and fire protection, a strong military, solid education for our children, health care, social security, etc.  We just don’t want to pay for it.  Meanwhile, Government expenses exceed revenues, which creates a deficit and is, in turn, added to the national debt.  We can argue that Government spending is out of control all we want, but the truth is, when the Government can’t meet expenses, police, fire, and teachers get fired.  Solders go into battle with substandard armor.  You start noticing more potholes and they don’t plow in the winter like they used to.  The local park doesn’t get mowed as often.  In response, we cry about it.  This nation has grown accustom to expect things from the Government whether they like to admit it or not.  With expenses going up, and the possibility of bigger deficits, the reality is that our current tax structure cannot raise the amount of money necessary to sustain these expectations. 

One possible solution is the Value Added Tax (VAT).  VAT has been billed as a national sales tax.  However, unlike standard sales taxes that tax once at the register, VAT is assessed at every point in a products life.  For example, a dowel rod maker is taxed on the wood he buys.  The producer sells the dowel to a distributer, who is taxed.  The distributer sells it to a retailer, who is taxed and the retailer sells it to the consumer, who is taxed. 

This week, the Washington Post ran a story on this tax scheme:

Enter the VAT, one of the world's most popular taxes, in use in more than 130 countries. Among industrialized nations, rates range from 5 percent in Japan to 25 percent in Hungary and in parts of Scandinavia. A 21 percent VAT has permitted Ireland to attract investment by lowering its corporate tax rate.

The VAT has advantages: Because producers, wholesalers and retailers are each required to record their transactions and pay a portion of the VAT, the tax is hard to dodge. It punishes spending rather than savings, which the administration hopes to encourage. And the threat of a VAT could pull the country out of recession, some economists argue, by hurrying consumers to the mall before the tax hits.

What would it cost? (Brother of White House chief of staff Rahm Emanuel and author of the 2008 book "Health Care, Guaranteed” Ezekiel) Emanuel argues in his book that a 10 percent VAT would pay for every American not entitled to Medicare or Medicaid to enroll in a health plan with no deductibles and minimal copayments. In his 2008 book, "100 Million Unnecessary Returns," Yale law professor Michael J. Graetz estimates that a VAT of 10 to 14 percent would raise enough money to exempt families earning less than $100,000 -- about 90 percent of households -- from the income tax and would lower rates for everyone else.

And in a paper published last month in the Virginia Tax Review, (co-director of the Tax Policy Center, Leonard) Burman suggests that a 25 percent VAT could do it all: Pay for health-care reform, balance the federal budget and exempt millions of families from the income tax while slashing the top rate to 25 percent. A gallon of milk would jump from $3.69 to $4.61, and a $5,000 bathroom renovation would suddenly cost $6,250, but the nation's debt would stabilize and everybody could see a doctor.

Of course, not everybody is in favor of a tax like this.  Daniel J. Mitchell, Ph.D. in an essay for the Heritage Foundation argues that VAT would most certainly increase Government spending, slow the economy, create higher income taxes, and create “heavy administrative costs.”  He concludes:

Enacting a value-added tax would be a costly mistake for American consumers and workers. Once adopted, the VAT would prove irresistible to politicians eagerly looking for money to pay for new programs. The VAT would also undermine entitlement reform because politicians could gradually increase the tax to finance promised benefits.

The tax rate would doubtlessly climb, financing a surge of new federal spending. The result would be a stagnating economy, higher budget deficits, and fewer jobs for American workers. The value-added tax may have some attractive theoretical qualities compared to taxes on income and produc­tion, but in the real world, it would simply be another burden on an already overtaxed economy.

Mitchell also says:

The only condition that would make a VAT acceptable is complete repeal of all income taxes and a constitutional amendment that prohibits Congress from re-imposing taxes on any type of income. But this is not a realistic option, which is why the VAT should be stopped.

Obviously, there are a lot of pros and cons to a plan like this.  Nobody likes to pay higher prices.  But, I would be willing to pay extra if I got health care and economic stability.  I also like the idea of transparency in the sense that every step of the line knows exactly what their tax rate is.  Another bonus is that companies can’t open off-shore accounts to avoid paying taxes.  Everybody pays their fair share.  In the end, it’ll make people think before buying something.  Frankly, you don’t have to pay taxes if you don’t want to.

Even though much of the world uses this tax scheme, I understand that this is a completely new and foreign idea to us.   I just heard about it for the first time yesterday.  We say we want change, but this country doesn’t exactly embrace it.  I understand that we wouldn’t be in this situation if our Government acted responsibly in the first place.  Also, an economy that is driven by spending cannot grow when people save.  It would be up to the Government to spend in order to keep the economy moving.  Frankly, I’m not completely sold.  However, upon first analysis of this plan, with all the things this country needs to do to get it’s financial footing firmly in place, this could be an answer.

Many thanks to my friend JoeDitto, who turned me onto the Washington Post story.

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