Bruce Bartlett has written a report for the New America Foundation calling for tax reformers to embrace a VAT, and he praises Michael Graetz’s Competitive Tax Plan (CTP):
In my opinion, the greatest potential to break the tax reform gridlock is to get away from the model of cutting popular tax preferences in order to pay for rate reductions. That is the political equivalent of World War I-style trench warfare. I think it makes more sense to adopt a different approach, one more akin to Douglas MacArthur’s strategy of leapfrogging Japanese strongholds in the Pacific during World War II, leaving them impotent.
The tax equivalent of MacArthur’s strategy would be to leave in place all the existing deductions and credits, but make them irrelevant for most people. Prof. Michael Graetz of Columbia University has devised exactly such a plan.12 He would institute an exemption of $100,000 for married couples ($50,000 for singles, $75,000 for heads of households). All the existing deductions and credits would remain in place and could still be used by those with incomes above $100,000, but for the vast bulk of taxpayers they would become irrelevant because they would have no taxable income against which to take them. About 100 million of the 140 million people now required to file federal income tax returns would no longer have to do so.
Graetz would replace the lost revenue with a value-added tax (more below) combined with a rebate mechanism to relieve the regressivity on those with low incomes and also replace refundable tax credits for the poor. A recent analysis of the Graetz plan by the Tax Policy Center concluded that it could be done in a deficit-neutral manner with a VAT rate of 12.4 percent – well below the rates that prevail in Europe.
Bartlett’s analysis is devoted in large part to criticizing conservative critics of the VAT and of higher taxes more broadly, and my sense is that many of his criticisms miss the mark. For example, I don’t think he gives conservatives who believe that low revenue levels restrain spending growth their due. The key question is whether the 2001-2003 tax cuts restrained the growth of federal spending relative to a counterfactual scenario in which the Clinton tax code had remained in place. The Niskanen thesis — that tax cuts effectively reduce the perceived cost of federal expenditures, thus making increases in federal expenditures more attractive — is an interesting and plausible one, but if true it suggests that the problem is not tax cuts as such, but rather the relatively progressive distribution of the federal income tax burden and whether or not workers who pay Social Security payroll tax see it as a form of forced savings. Another view is that concerns about deficits contribute to spending restraint, and that higher revenue levels during the 2000s would have encouraged even higher spending growth. This view is not necessarily correct, of course. But Bartlett does not disprove it, and it is not clear to me that it is less plausible than the Niskanen thesis.
Bartlett derides conservatives who are concerned about the VAT in light of European precedents, yet there is widespread agreement that European VATs, which have to adhere to the European Union’s Sixth VAT Directive, are economically problematic. In contrast, modern VATs, like the GST employed by Canada, Australia, and Singapore, are considered far less harmful. To make the case for the VAT, advocates would be well advised not to accuse opponents of irrational dogmatism, but rather to point to relatively successful implementations of the VAT, like the Australian GST, which has not increased since its inception. The Canadian GST, meanwhile, has been cut twice, a fact that should alleviate concerns about a VAT that only moves in one direction. Moreover, Canada has exhibited more spending restraint than the U.S. in the years since the creation of its GST, which undermines yet another objection.
I do, however, agree with Bartlett on the virtues of Michael Graetz’s CTP, which I’ve written about for Reuters. Part of the reason is that the CTP addresses a core concern raised by the Niskanen thesis. My take on it read as follows:
Conservatives hate the idea of new taxes. But imagine if every time you bought a cup of coffee, it said on the receipt that you had also just paid a 12.3 percent consumption tax to the federal government. Instead of paying your taxes once a year, you would pay taxes every time you made a purchase. What better way to remind people of all of the money government spends, and all of the money government spends foolishly, than to make them pay for government several times a day?
Yet the CTP preserves progressivity:
One concern is that even with this radical shrinking of the income tax, poor families that spend the bulk of their income would pay more under a consumption tax. That is why the CTP includes a generous per-worker and per-child rebate that would be used to offset payroll taxes. These rebates would also serve as a replacement for the earned-income tax credit, which is the chief reason tens of millions of low-income households have to go through the hassle of filing income tax returns. The end result is that the tax burden under the CTP would be exactly as progressive as it is under today’s tax rules.
This does not change the fact that the VAT would be a very visible part of daily consumption under the CTP, which could have an impact on how people perceive the cost of government.
Politically, I think the VAT is deeply problematic, not just due to conservative objections but because the wider American public would likely balk at a substantial new consumption tax. The genius of CTP is that it offers the American public an attractive swap. In the near term, I tend to think that Stein-style tax reform is the best way forward, but the CTP has many virtues and it deserves to be a part of the tax reform conversation.