Adding a VAT

Josh Barro has a piece in favor of a Value Added Tax in Bloomberg. A VAT is a tax levied on business sales minus their inputs or costs, so all companies ‘adding value’ along the production chain pay the tax, but it is collected at the sale of the final consumer good. If you buy a sweater for $50 and the VAT is 10%, $5 of the $50 is the VAT.

In my book Balancing the Budget is a Progressive Priority, I didn’t suggest that we add a VAT, but I do think that it will take a substantial increase in tax revenue as a percent of GDP to ever have a balanced budget again. I suggest 21% of GDP, which is about 3 percentage points higher than the 40 year average, a level that is doable, but won’t be easy. Would a VAT be useful to consider? A key question, and a few thoughts.

  • Is the VAT viewed as a supplement to our current system of taxation (payroll taxes, personal and corporate income, excise taxes) or a replacement of some portion? I asked Josh Barro via twitter for his views, and he said he viewed the VAT as supplementing our current federal taxation regime, shown below. Individual income taxes and payroll taxes are the largest source of federal revenue, with corporate and excise taxes being much smaller (in percent of GDP terms).

Barro notes how difficult tax reform that increases revenue will be, whether it is in the individual or corporate income tax, because as much as people claim to support it in theory, most deductions and exemptions benefit those who are powerful. So, one strong positive of the VAT is that it could raise a substantial amount of revenue, and would not be as noticeable and its burden would be spread across all consumers. A negative is that it is a regressive tax (lower income have larger percentage of their income subjected to the tax).

I have suggested ending the corporate income tax, and treating dividends and capital gains as normal income, while raising the top personal income tax rate and thereby making it more progressive. I stand by the notion that the most important tax reform decision is determining what proportion of GDP will be collected in taxes. Within that overall level of taxation, distributional impacts are important. Currently, we have a regressive payroll tax and a progressive income tax as the two largest revenue raisers, so it could raise concerns to add another large regressive revenue raiser. Josh Barro has a follow up post in which he argues distributional/fairness concerns about the VAT are not as big a worry so long as you are not adding a VAT and doing nothing else. This argument makes sense at some level, but I haven’t read all the underlying work he cites, and Michael Linden is lots more skeptical on twitter about this and points to this document (that I need to read).

Whatever we concluded, this strikes me as the type of discussion we should be having; what level of tax will be collected to finance a plausible level of spending? Within that, what mix of taxes will be used? The hardest part of all this is imagining that our dysfunctional political system could ever have a reasoned discussion of these issues. That is demoralizing.

Stephen Parente’s Grand Bargain

Steve writes in politico his health policy grand bargain that he says would reduce spending by around $4 Trillion over 10 years and let both sides declare victory.

  • End the tax preference of employer paid insurance
  • Transition Medicare to defined contribution program for those under age 54
  • Block grant Medicaid
  • Adjust several aspects of the ACA (lessen subsidy triggers, end taxes imposed on device makers, etc.)

I wholeheartedly endorse his first suggestion. He correctly notes that while Republicans have long talked about reforming the tax treatment of employer paid insurance, the Democrats actually did it via the tax on high cost plans that is delayed until 2018 in the ACA. Ending or even capping the tax preference afforded to employer provided insurance and doing so earlier is easily the most consequential thing we could do to address health care costs in the private portion of the system. And it is a flexible policy that will improve the ability of the ACA framework to address costs that would also work as intended regardless of the direction that health reform takes. I wrote about doing so here and here and have done so bazillion times on the blog.

And my version of what the grand bargain would look like is here. Stepehen and I would likely quibble forever about many parts of what we have suggested as the middle ground ‘way forward’. But not about changing the tax treatment of employer paid health insurance. Here is what I wrote in March, 2010 just after the passage of the ACA:

The most bipartisan cost-control approach among health policy experts is ending, or limiting this subsidy. Democratic politicians are slower to convert, but I suspect some of the Republican support is strong because it is easy to be for something that seems impossible. The commission could help change that sense. [I was talking about the Fiscal Commission]

Capping or ending the tax exclusion would greatly improve the cost-saving potential of the newly passed reform. And such a policy is flexible, and would work well alongside any imaginable change (either to the right or left) to the framework enacted by the Senate bill.

update: Igor Volsky writes with a good point that it would probably be better to wait until 2014 to cap/end the tax preference for employer paid insurance when exchanges will exist to provide more insurance options.

Should charitable contributions be tax deductible?

CBO outlines 11 options for reforming the tax treatment of charitable contributions, 9 of which are designed to lessen the revenue lost from how the current tax code treats such contributions. The tax subsidy in 2006, the year CBO used for their detailed simulations, was 40.9 Billion on total contributions of 203 Billion.  CBO also estimates the impact of two policies (options 3 and 6) that would expand the tax benefits of charitable giving, by extending them to taxpayers who do not itemize deductions. Table 3 provides the essential overview:

The bottom line of this detailed analysis is that for the 9 options simulated that would lessen the current tax preference provided to charitable giving, CBO finds that the deficit reduction achieved is larger than the subsequent reduction in charitable giving. None of these reforms would eradicate our budget deficit by any stretch, but they would be a move toward balance, and charitable contributions would not decline by that much.

In the budget talks that are ongoing, tax reform may be the only politically possible way in which to raise revenue. While most everyone says they want to reduce the deficit, and many say that we need tax reform, once you get down to ending specific subsidies in the tax code, most people head for the hills (well, not that tax preference….). It is unimaginable to me that a reduction in the tax preference of charitable giving could pass both Houses of Congress as a stand alone measure. As part of a larger package, then maybe. That is why a bigger tax reform deal seems more likely to me than a small one, though I wouldn’t bet the farm on either.