VAT: Now There's a Good Idea

You don't need me to tell you that America's finances are on an unsustainable trajectory. Revenues have plunged to their lowest levels in decades, as a percentage of GDP. Spending has soared in the recession so that we're projected to run a $1.7 trillion deficit. For a while I've argued that the solution should begin with both spending reforms and new taxes. One new tax I can get behind in the value added tax.

This afternoon I'm attending a discussion about the VAT and its economic and political viability, so I won't be around to blog much. But I wanted to quickly share my VAT take before I take off. (If you want to know more about how it would be collected, go here. Megan added her cents here. Here's a piece I wrote about why I think liberals and conservatives can find room to agree on the tax, and here's how Paul Ryan's plan manages to turn a new VAT into a de facto tax cut).

Liberals and conservatives sometimes say they agree to disagree. But on the institution of a new value added tax, I think you're seeing increasing evidence that they agree, but disagree that they agree. Bruce Bartlett, Paul Ryan, Robert Hall and Alvin Rabushka, Jerry Brown, Jim DeMint, Arthur Laffer, Greg Mankiw: there are a lot of conservatives who have come out in support of a VAT or something like it. Meanwhile, every moderate and left of moderate tax expert I've spoken to or heard speak recently, from Brookings scholars to Center for American Progress President John Podesta, have been enthusiastic about a VAT. The difference between the two sides I think is where they see the utility. Liberals want the VAT to protect spending programs. Conservatives want the VAT to provide cover for tax cuts -- lower marginal rates in federal taxes, scaling down of the corporate income tax, and so on. There's the great Larry Summers line, about how liberals think the tax is too regressive and conservatives think it's too effective and when they switch reasons, that's when we'll have a VAT. I think that's about right, but I also think that the only way to sell the VAT to both parties and both parties' constituents is to acknowledge those differences by including rebates for low-income families and to institute the VAT in exchange for say cutting the corporate income tax.

I know that some conservatives want marginal tax rate cuts to be on the table, but I don't know that I want to make cutting top income rates a part of the deal. First of all, there's a lot of wealth in the top ten percent, and historically we're not taxing very much of it. The top ten percent of income earners are taking in about 50 percent of income, which is higher than any time since the 1920s. At the same time the effective marginal taxes for this bracket have fallen so that the difference in ETR between the middle 20 percent and the top one percent is the smallest in the last fifty years, about the same as in the 1980s. And yet, in the 1980s about 35 percent of pre-tax income went to the top ten percent. If we're going to make a deal for the VAT, I'd prefer to see corporate taxes cut (along with corporate tax exemptions) to encourage companies to stop stashing cash overseas to avoid the tax, and invest that money in the United States.