Stimulus Comparison: Extended Bush Tax Cuts vs. Domenici-Rivlin Plan

The exact numbers in the compromise extention of the Bush tax cuts are not yet available, but CNNMoney is reporting early Treasury estimates place it at $458 billion over two years. The overall compromise adjustment including the 2% Social Security cut, business tax breaks, and estate tax deductions should total between $700 to $800 billion in tax relief. Deficit hawks are reportedly OK with the implied increase in short-term debt so long as it is tied to a long-term deficit reduction plan.

Is this a plus or a minus for the economy? Previously, I have observed that both sides are Keynesians, now. For Congress, a decision not to extend the Bush tax cuts would come with the political risk of blame for a potential double-dip recession, i.e., extending an existing tax cut is not a true stimulus, but eclipsing the tax cut could hinder economic growth. We need more stimulus because we fear further contraction.

For stimulus size comparison, in 2011, Domenici-Rivlin projected the value of a payroll tax holiday to be $481 billion. The D-R plan would commence in 2012 with a payroll tax holiday stimulus paired with a Deficit Reduction Sales Tax (DRST), a VAT. In 2012, the D-R plan would net around $375 billion stimulus from the payroll tax holiday after the DRST (which would raise $105 billion), but D-R had contemplated that the Bush tax cuts would expire. So, the Bush tax cut compromise, if it comes about, would result in two to three times the first year stimulus of D-R.

Will that be enough stimulus to revive the economy? If throwing money at the economy is enough, then yes. If we need direction in spending that money, which I feel we do (on alternative energy), then we need an industrial policy as described in my last post.

Thomas L. Friedman, “Still Digging,” The New York Times, 12/08/10

Tom Friedman admonishes, “We don’t seem to realize: We’re in a hole and still digging. Our educational attainment levels are stagnating; our infrastructure is fraying. We don’t have enough smart incentives to foster both innovation and manufacturing…” Of course superior education is necessary to remain competitive, and we must fix it for the long-term. However, the focus in the short-term must be jobs and economic growth.

Historically, with the notable exception of the internet bubble, to climb out of recession we have needed growth in one of two core industries, automobiles or housing. Today, automobiles are a smaller portion of our economy, with much of that industry comprised of imported cars and outsourced parts. The housing market is sitting on a huge inventory, and heightened foreclosures threaten further price decline. Infrastructure construction could certainly help today.

What then? An industrial policy for alternative energy with strong incentives for innovation and domestic manufacturing could put America back to work in the short-term while working to lessen our demand for imported oil.

Congress should create a matching Feed-In-Tariff for state utilities. FIT’s have been successful in driving demand in the countries using them; the German FIT has made them the number one installed base for solar panels, and the recent Ontario FIT is driving installation there. Congress can also ease the adoption of state and local PACE bonds (Property Assessed Clean Energy Bonds) by forcing Fanny and Freddy to accept these bonds as a first lien against properties, perhaps at some cap of installation cost to value. Most states have as their RPS targets (Renewable Portfolio Standards) about 25% of energy from renewables within three to four years time. However, these targets are moot without the incentives of FIT’s and PACE bonds.

The implementation of a VAT as part of tax reform and deficit reduction will make domestic production, including solar, more competitive, but a stronger incentive is needed to assure home-grown manufacturing jobs. My suggestion would be to restrict the protection of a U.S. Patent to solar equipment that is at least 80% domestic value-added in manufacturing.

Deficit Commission: Dodo or Phoenix?

One can only imagine the inner working meetings of the Simpson-Bowles commission. Perhaps the inside story of the commission deliberations will become the subject of a new book. Our complex tax code has so many tax preferences representing as many or more political constituencies, that achieving a consensus on what budgets to cut and which taxes to increase was predictably impossible. Remember Sen. Russell Long’s ditty: “Don’t tax you, don’t tax me, tax the fellow behind the tree.”? One person’s deduction is another person’s loophole. If oxen must be gored, politicians will tremble./p>

Alan Simpson has found his metaphor in the Dodo bird. A clear path to fiscal responsibility must be outlined or the global currency markets will take the dollar down, and when it happens it will be fast and crippling. But, the fix dare not be short-term, as we all fear a double-dip contraction.

Politicians may not admit it, but they’re all Keynesians, now. Republicans want the tax cuts continued for everyone. Democrats want extension of unemployment benefits. And, while both sides posture that this deficit spending must be paid for, neither side will pay for these expenditures with tax increases. Both sides are de facto favoring short-term stimulus.

Keynes warned about the complacency of economists who feared the risk of short-term stimulus and believed that free markets would work things out in the long run: “In the long run, we’re all dead.” Dodo birds?

I admire the Domenici-Rivlin proposal because it includes the short-term stimulus of a payroll tax holiday backed up by a medium-term increase in revenues via a VAT tax. But, my dream was not of Dodo birds, but of the Phoenix, as metaphor for a revitalized America through sweeping tax reform

The economy is seriously crippled. Paul Kennedy clarified in “The Rise and Fall of Great Powers,” that a country must have a strong economy to support the projection of military power internationally. We are bleeding borrowed capital for our military campaigns. Our economy has been hollowed out, riddled by policies derived from the false perspective that expanded world trade based on comparative advantage was not a zero sum game, and that all economies would grow together. The truth is the American labor force has been decimated by these policies.

We now have a virtual rentier society, where the upper class gets richer collecting its dividends and capital gains from the spreads achieved by outsourcing production and jobs for the middle class. How many CEO’s have already retired with their stock options inflated by their having outsourced manufacturing? How many more hold their employees captive to a lower wage with the threat of shipping their jobs to India or China?

America needs a fresh start. The ideal tax system would replace all revenue sources with a VAT tax coupled balanced by a flat income tax with a high deduction threshold, the concept recently revived by Gov. Mitch Daniels. No tax preferences. No lobbying for loopholes. There are three variables to adjust to achieve an equitable balance.

The VAT would be protectionist in the short-term, since the U.S. would be the last of our trading partners to have implemented one, i.e., cheaper exports and more expensive imports. VAT is the tax for the era of globalization, i.e., the border-adjustable tax, subtracted from exports and added to imports without prejudice. Again, all our trading partners use a VAT as a component of their tax revenues to our competitive disadvantage. There would be no retaliation.

Bold leadership is needed from the President. It would have been useful had the Simpson-Bowles commission asked OMB to run the numbers on the distribution of the tax burden of this revolutionary sweeping tax reform.

(Gov. Daniels) Herman Kahn on Tax Reform & VAT

It was smart marketing for Domenici/Rivlin to label their VAT a DRST (deficit reduction sales tax), and as a result there has not been much outcry about the VAT component.

Contrast that response with the well-publicized criticism that followed Indiana Gov. Mitch Daniels’ endorsement of sweeping tax reform including a VAT. Gov. Daniels, on the occasion of accepting the Hudson Institute’s Herman Kahn Award, Gov. Daniels had quoteed from Kahn’s 1982 book, “The Coming Boom.” Herman Kahn was co-founder and Director of the Hudson Institute, a conservative think-tank, so it is somewhat curious that the critical response to Gov. Daniels’ endorsement of Kahn’s tax reform proposal came almost entirely from conservatives.

Of course, the makeup of our economy has changed in the eighteen years since Kahn’s book was published, but the principle should still apply. It would be instructive to have OMB run the numbers based on different percentages and proportions.

NRF Distorts Domenici-Rivlin Sales Tax

The National Retail Federation has it in for consumption taxes and wrongly opposes the Domenici-Rivlin plan, “Restoring America’s Future” from the Bipartisan Policy Center. NRF fears the short-term losses that might occur from an increase in prices. Fair enough. But, the Ernst & Young study they funded looks only to the effect of an ADD-ON value added tax, and that is not what the Domenici-Rivlin deficit reduction package is all about. (E&Y cannot be faulted; they were given the assignment to look only at an add-on VAT and not a VAT substitute for other taxes.)

First and foremost, D-R is intended to get the economy on a firm footing for growth, and they do this with an initial stimulus for jobs that puts money in the hands of consumers. NRF should really like that. The Deficit Reduction Sales Tax proposed in D-R is 3% in the first year, and rises to 6.5% thereafter, but it is offset in the first year by a payroll tax holiday for both employers and employees (combined 12.4%). Employers will have a reduced burden for employment, and that should help stimulate jobs. Employees will have extra cash in their pockets which when spent will be an off-budget stimulus to the economy. will be a boost to the economy and retail sales.

NRF is simply wrong-headed on this. The payroll tax cut and increase in consumer income in the Domenici-Rivlin plan will be good for retail business, jobs, and the economy.

Domenici-Rivlin: Payroll Tax Holiday to Reduce Debt

Today, the Bipartisan Policy Center released its tax proposal to reduce the deficit and debt and put the country on a competitive footing for growth. This report, chaired by Pete Domenici and Alice Rivlin comes on the heels of the Simpson-Bowles recommendation of last week. A month ago, Gov. Mitch Daniels floated the concept of simplified sweeping tax reform with a VAT balanced by a flat income tax with a high deductible threshold. Could it be we are finally about to have the serious debate on tax policy that the country needs?
Last February, Rivlin testified to the Senate Budget Committee that: “…(O)ur tax system is extremely inefficient and complex. Part of the gap should be closed by reforming the federal tax system so that it produces more revenue with less drag on economic growth.”

Yesterday, ABC (Reuters) reported at the Wall Street Journal CEO Council conference in Washington that Rivlin hinted at the proposal being released today: “”We need a broad-based consumption tax. That is not politically popular, but at some point we are going to have to do it.”

In their joint Op/Ed in The Washington Post, today, Rivlin-Domenici propose: “To ensure a more robust recovery, we propose a one-year “payroll tax holiday” for 2011, suspending Social Security payroll taxes for employers and employees.” The proposal cuts corporate and individual tax rates and adds a 6.5 percent “debt-reduction sales tax.”

“…Restraining the debt can give us a leaner, more-effective government, a more efficient health system and a far simpler tax system more favorable to economic growth. Moreover, we can put the budget on a sustainable path without threatening the fragile recovery.”

This is a smart tax approach…reducing tax rates will cushion the introduction of the sales tax and the elimination of tax expenditures. The reduction in the employee portion of the payroll tax would more than offset the sales tax, and should make the new tax base marketable to the public and therefore politically viable.  President Obama would be well advised to back it.

Bowles-Simpson & Tax Reform, 11/11/10

Erskine Bowles and Alan Simpson have released their “trial balloon” knock-down draft proposition for deficit reduction and it includes some tinkering with tax reform, and calls on “Finance and Ways & Means Committees and Treasury to develop and enact comprehensive tax reform by end of 2012.”

The Co-chairs of the Deficit Commission did not suggest a VAT.  That was expected, since PERAB (President’s Economic Recovery Advisory Board) had already taken value added tax off the table.  But, they did suggest flattening the tax code, by lowering income tax rates and at the same time broadening the base by removing the tax expenditures for mortgage interest deductions and employer provided healthcare.  They also suggested eliminating the AMT.  Overall, in addition to the significant cuts in expenditures, they have raised revenues as well.

No matter what is ultimately decided, or not, by the necessary 14 of 18 Commission members, any notion of sweeping tax reform including a VAT will have to wait for the 2012 presidential campaign and the possibility of a champion and meaningful debate on the issue.

Unfortunate as it may be for the competitive positioning of the U.S. economy in this era of globalization, analytical consideration of VAT will again have to wait for another day.

AARP Gets the VAT, 11/04/10

Jim Toedtman, Editor of AARP Bulletin, decries our lack of thoughtful discussion of taxes in relation to our deficit (“The Great Tax Debate That Wasn’t,” November): ”In our global economy, shouldn’t we consider the value-added tax already in place in virtually every other industrialized nation?  How many more companies must move their operations overseas to escape our 35 percent corporate tax rate before we alter that tax strategy.”

AARP, one of the largest NGO’s, claims 40 million over-50 citizens, many of whom are on fixed retirement income.  You might think that Toedtman’s membership should fear the impact of a VAT because vocal knee-jerk opposition to VAT portrays it as an “add-on” tax, which it does not have to be.  Recently, the National Retail Foundation commissioned Ernst & Young to produce a study that shows the result of a 10% “add-on” VAT to be a loss of 850,000 jobs.  Big surprise.  The study intentionally skipped any comparison to an equivalent increase in personal income taxes. The study did not examine VAT substitution for other taxes, either.

Toedtman, along with Andy Stern (past president of SEIU and a member of the President’s Budget Deficit Reduction Commission), President Clinton, and Warren Buffett, Fareed Zakaria, (fmr.) Senator Hollings, and others have endorsed VAT because value added taxes would be good for business and labor alike.   Multi-nationals game the current corporate tax which affords the sheltering of income in lower-taxed countries, but a revenue-neutral VAT replacement for the Corporate Income Tax would eliminate that incentive and capital would be repatriated.

So who would really be hurt by the VAT?  Just think.  If a VAT were implemented with no tax preferences, then corporations who successfully work the Congress would not be able to get special loopholes.  With no incentive to jockey for loopholes, what would happen to the lobbying industry?  The revolving door for Congressmen joining lobbying firms would close.  As the late David Brinkley had wryly observed about the VAT, “Who would take Congressmen to lunch?”

“Divide on Deficit and VAT,” New York Times, 10/25/10

The big question is whether the Deficit Reduction Commission will have the courage to recommend a value added tax, not as an add-on tax, but as a revenue-neutral replacement for the Corporate Income Tax. Knee-jerk opposition can be expected by those who fear the VAT would be implemented as an add-on tax, but that assumption is not a given for consideration of the VAT.

NO advocate of VAT should encourage introducing an “add-on” tax while the economy is so vulnerable. In fact, as Canada did, and Japan before her, it probably should be introduced with a tax cut! The economy needs stimulus now. Later, after the economy recovers and after all practical spending cuts are made, if we still have to raise taxes, better a consumption tax than an increase in income taxes.

But a strong argument can be made for VAT as a “revenue neutral” replacement for the Corporate Income Tax. It would be stimulative: eliminate a major competitive disadvantage in world trade (because VAT is subtracted from exports and added to imports); incentivize the return of U.S. multinationals’ capital parked abroad in lower-taxed countries; eliminate double-taxation of dividends. A broad-based VAT with no tax preferences would end lobbying for loopholes.

NRF Study Wrong - VAT Not an Add-On, 10/14/10

Ernst & Young releases, today, its report on “The Macroeconomic Effects of an Add-On Value Added Tax,” prepared for the National Retail Foundation (NRF).

The point of contention in this report is the assumption of using a VAT to increase (“add-on”) taxes.  The conclusion of the E&Y report is obvious:  increasing prices by 10 percent will result in a reduction in consumer purchases.

No advocate of a VAT would encourage introducing an “add-on” tax while the economy is so vulnerable.  But, a strong argument can be made for introducing a VAT as a revenue-neutral replacement for other taxes.  Later, after the economy recovers, and after all practical cuts in spending are addressed, there will likely still be a need to raise taxes;  at that point only, the VAT would then be in place, as a preferred alternative to increasing income taxes.

The economic stimulus of a VAT as a revenue-neutral replacement of the Corporate Income Tax:

-  American business and labor would be more competitive in international trade.  Under GATT rules the VAT is subtracted from exports and applied to imports, thus removing the burden of government from the price/value comparison.

- Eliminates the incentive for multi-nationals to use transfer pricing to shift profits to lower-taxed countries.  This would bring capital back to the U.S. for reinvestment here, and would make the U.S. the strongest magnet for foreign corporate investment.

- Ends the double-taxation of dividends.

- Eliminates the lobbying for loopholes with a broad-based VAT without preferences.

-  An off-budget stimulus, as the knowledge of a date-certain implementation of a VAT  as consumers would speed-up purchases to avoid the tax.