Dadash, Uri & William Shaw, “Competitiveness: The Great American Distraction,”, 06/28/11

“Insofar as the US structural current-account deficit reflects inadequate savings – as it clearly does – reducing it is desirable. Doing so efficiently requires that policymakers focus on fiscal reforms that not only reduce the budget deficit directly but also make public spending more effective and nudge the private sector toward producing more exports and reducing imports.

Three types of tax reforms clearly meet these criteria: increased gasoline taxes, a value-added tax, and a phased-in elimination of the mortgage interest deduction.

The US has held its federal gasoline tax at 18.4 cents per gallon since 1994, while other OECD countries have instituted much higher rates. Raising the US gas tax would directly improve the fiscal deficit – raising the tax to only half the OECD average could generate approximately 1% of GDP – and it would help reduce the current-account balance, as oil imports fall. Because the disposable income of consumers would decline, other imports and consumption could decrease as well. Over time, renewable energy sources, alternative means of commuting (including telecommuting), changes in residence or work location, and more efficient cars will mitigate the effect of the initial rise in gasoline prices. The gain in tax revenues will also be smaller as Americans adapt by consuming less gasoline.

A value-added tax (VAT) could also reduce the fiscal and current-account deficits. The CBO estimates that applying a 5% VAT to most goods and services in 2013 would raise $180 billion (1.2% of GDP) that year and $2.5 trillion through 2021 (1.4% of GDP over the period) (CBO 2011). Meanwhile, charging VAT on imports while rebating VAT payments to exporters, a universal practice, would strongly tilt incentives in favor of exporters. At the same time, introducing the VAT could increase the efficiency of the tax system (Hufbauer 2011) and would require limited administrative resources for enforcement, as firms purchasing inputs have an incentive to ensure that sellers fully state their VAT payments. Finally, a VAT could increase household savings by taxing all consumption goods and allowing households to earn interest on savings free of VAT.

The mortgage interest tax deduction, on the other hand, must be gradually eliminated to reduce the deficit. It will cost an estimated $100 billion in 2011 and artificially encourages spending on and investment in real estate, a highly volatile sector. Eliminating the subsidy would help direct savings to more stable assets, reduce individuals’ reliance on household equity to finance consumption during booms, and improve income distribution (subsidizing home purchases disproportionally benefits the rich, who typically buy houses, over the poor, who typically rent). It would also free resources for investment in internationally-competing sectors.”