I've already commented on the proposal from the Chairmen of President Obama's Fiscal Commission (including a very clever cartoon, if it's okay to pat myself on the back).
Now we have a similar proposal from the so-called Debt Reduction Task Force. Chaired by former Senator Pete Domenici and Clinton Administration Budget Director Alice Rivlin, the Task Force proposed a series of big tax increases to finance bigger government. I have five observations.
Notwithstanding a claim of $2.68 trillion of "spending cuts" during the 2012-2020 period, government gets a lot bigger during the decade. All of the supposed "cuts" are measured against an artificial baseline that assumes bigger government. In other words, the report is completely misleading in that spending increases get portrayed as spending cuts simply because government could be growing even faster. Interestingly, nowhere in the report does it show what total spending is today and what it will be in 10 years, presumably because the authors realized that the fiction of spending cuts would be hard to maintain if people could see real-world numbers showing the actual size of government now and in the future.
This chart shows what it would actually take to balance the budget over the next 10 years -- and these numbers assume all of the tax cuts are made permanent and that the alternative minimum tax is extended.
- The Task Force proposes a value-added tax, which is estimated to generate more than $3 trillion between 2012 and 2020. They call this new tax a "debt reduction sales tax" and I can just imagine the members giggling as they came up with this term. They may think the American people are a bunch of yokels who will get tricked by this language, but one can only wonder why they think making our tax system more like those in Europe will lead to anything other than more spending and less growth.
- The Task Force proposes to dramatically increase the scope of the Social Security payroll tax. Since this is something Obama called for in the campaign and also something endorsed by the President's Fiscal Commission, this proposed tax hike should be viewed as a real threat. I've explained elsewhere why this is bad tax policy, bad fiscal policy, bad entitlement policy, and bad Social Security policy.
- To add "stimulus" to the package, the Task Force proposes a one-year payroll tax holiday. The good news is that they didn't call for more spending. The bad news is that temporary tax cuts have very little pro-growth impact, especially if a tax cut will only last for one year. Unfortunately, the Task Force relied on the Congressional Budget Office, which blindly claimed that this gimmicky proposal will create between 2.5 million-7.0 million jobs. But since these are the geniuses who recently argued that higher tax rates boost growth and also claimed that Obama's faux stimulus created jobs, those numbers have very little credibility.
- While the Task Force's recommendations are unpalatable and misleading, there is a meaningful distinction between this plan and the Obama Administration's fiscal policy. The Task Force assumes that government should get even bigger than it is today, but the Obama Administration wants government to grow at a much faster rate. The Task Force endorses massive tax hikes, but generally tries to avoid marginal tax rate increases that have especially large negative supply-side consequences. The Obama White House, by contrast, is fixated on a class-warfare approach to fiscal policy. One way of characterizing the different approaches is that the Task Force represents the responsible left while the Obama Administration represents the ideological left.
We’ve been spending too much time on elections, so let’s get back to pointing out inane, foolish, and destructive government policies. Our latest example comes from the United Kingdom, where politicians are pushing airline ticket taxes to punitive levels and harming the tourism industry. But the real lesson from this story is that it is very dangerous to give politicians a new revenue source.
The airline ticket tax was first imposed by a (supposedly) Conservative Party government in 1994 at a maximum rate of 10 pounds. During the Blair/Brown Labor Party reign, the tax was boosted to a maximum rate of 50 pounds. Now, the new government, led by ostensible Conservative David Cameron, is pushing the maximum tax up to 75 pounds (more than $120) per ticket.
Here’s an excerpt from the story in the Telegraph.
Families are avoiding holidays in Egypt and the Caribbean because of the high cost of air taxes — even before the hike in passenger duty that comes into place on Monday.
…The duty, which is paid by all travellers on leaving Britain and added automatically to the price when a ticket is booked, is to increase by 50 per cent to some destinations. It is the second significant rise in two years, and figures show that previous hikes have already influenced people’s choice of holiday destinations.
…Bob Atkinson, travel expert at Travelsupermarket.com, said: “Families looking to book for this winter and summer next year will be faced with tax rises of up to 54 per cent on their family holidays. This tax rise is completely out of line with inflation and bears no relation to the original purpose of the tax.”
…The tax was introduced in 1994 at the rate of £10 on long‐haul flights, but increased by the previous Government, which said it was a necessary “green measure”.
…The increases mean a family of four flying to the Caribbean will pay £300 in duty compared with the old rate of £200 or £160 last year. Willie Walsh, the chief executive of British Airways, has branded the higher taxes a “disaster”. Earlier this month, he called the duty a “disgrace”.
No wonder families are choosing not to travel. But, more important, imagine what American politicians will do if they ever succeed in imposing a value‐added tax. The rate initially will be low (just as the original income tax had a top rate of just 7 percent), but nobody should delude themselves into thinking the rate won’t quickly climb as greedy politicians get hooked on a new form of revenue to feed their spending addictions.
Governor Mitch Daniels of Indiana has triggered a spat among policy wonks with his recent comments expressing sympathy for a value‐added tax (VAT). Kevin Williamson of National Review is arguing that a VAT will probably be necessary because there is no hope of restraining spending. Ryan Ellis of Americans for Tax Reform jumped on Williamson for his “apostasy,” arguing that a VAT would be bad news for taxpayers. From a policy perspective, I’m very much against a VAT because it will finance bigger government, as explained in this video.
That being said, Kevin Williamson makes a good point when he says that some supply‐siders have neglected the spending side of the fiscal ledger. And it certainly is true that Republicans don’t seem very interested in curtailing the growth of government. But does this mean, as Williamson argues, but that our choices are limited to 1) a 36 percent spending cut, 2) catastrophic deficits and debt, or 3) a European‐style value‐added tax.
I actually think it would be a great idea to reduce the budget by 36 percent. That would bring the burden of federal spending back down to where it was in 2003. Notwithstanding the screams from various interest groups that this would generate, nobody was starving in the streets when the budget was $2.3 trillion rather than today’s $3.5 trillion. But Kevin is unfortunately correct in noting that this type of fiscal reform won’t happen.
Kevin is wrong, however, in saying that we therefore have to choose between either Greek‐style deficits or a VAT. According to the Congressional Budget Office, tax revenues over the next 10 years will increase by an average of about 7.3 percent each year — and that’s assuming the tax cuts are made permanent and the AMT is adjusted for inflation. Reducing red ink simply requires that politicians exercise a tiny bit of restraint so that spending grows by a lesser amount. This video walks through the numbers and shows how quickly the budget could be balanced with varying levels of spending discipline.
By the way, it’s worth pointing out that the VAT has not prevented gigantic deficits in nations such as Greece, Japan, Ireland, Spain, England, etc, etc. Politicians in those nations implemented VATs, usually with promises that the money would be used to reduce other taxes and/or lower red ink, but all that happened was more spending and bigger government (this cartoon makes the point in a rather amusing fashion). In other words, Milton Friedman was right when he wrote that, “In the long run government will spend whatever the tax system will raise, plus as much more as it can get away with.”
There’s a wise old saying about “don’t bite the hand that feeds you.” But perhaps we need a new saying along the lines of “don’t subsidize the foot that kicks you.” Here’s a good example: American taxpayers finance the biggest share of the budget for the Organization for Economic Cooperation and Development, which is an international bureaucracy based in Paris. The OECD is not as costly as the United Nations, but it still soaks up about $100 million of American tax dollars each year. And what do we get in exchange for all this money? Sadly, the answer is lots of bad policy. The bureaucrats (who, by the way, get tax‐free salaries) just released their “Economic Survey of the United States, 2010″ and it contains a wide range of statist analysis and big‐government recommendations.
The Survey endorses Obama’s failed Keynesian spending bill and the Fed’s easy‐money policy, stating, “The substantial fiscal and monetary stimulus successfully turned the economy around.” If 9.6 percent unemployment and economic stagnation is the OECD’s idea of success, I’d hate to see what they consider a failure. Then again, the OECD is based in Paris, so even America’s anemic economy may seem vibrant from that perspective.
The Survey also targets some very prominent tax loopholes, asserting that, “The mortgage interest deduction should be reduced or eliminated” and “the government should reduce further this [health care exclusion] tax expenditure.” If the entire tax code was being ripped up and replaced with a simple and fair flat tax, these would be good policies. Unfortunately (but predictably), the OECD supports these policies as a means of increasing the overall tax burden and giving politicians more money to spend.
Speaking of tax increases, the OECD is in love with higher taxes. The Paris‐based bureaucrats endorse Obama’s soak‐the‐rich tax agenda, including higher income tax rates, higher capital gains tax rates, more double taxation of dividends, and a reinstated death tax. Perhaps because they don’t pay tax and are clueless about how the real world operates, the bureaucrats state that “…the Administration’s fiscal plan is ambitious…and should therefore be implemented in full.”
But even that’s not enough. The OECD then puts together a menu of additional taxes and even gives political advice on how to get away with foisting these harsh burdens on innocent American taxpayers. According to the Survey, “A variety of options is available to raise tax revenue, some of which are discussed below. Combined, they have the potential to raise considerably more revenue… The advantage of relying on a package of measures is that the increase in taxation faced by individual groups is more limited than otherwise, reducing incentives to mobilise to oppose the tax increase.”
The biggest kick in the teeth, though, is the OECD’s support for a value‐added tax. The bureaucrats wrote that, “Raising consumption taxes, notably by introducing a federal value‐added tax (VAT), could therefore be another approach… A national VAT would be easier to enforce than other taxes, as each firm in the production chain pays only a fraction of the tax and must report the sales of other firms.”
But just in case you think the OECD is myopically focused on tax increases, you’ll be happy to know it is a full‐service generator of bad ideas. The Paris‐based bureaucracy also is a rabid supporter of the global‐warming/climate‐change/whatever‐they’re‐calling‐it‐now agenda. There’s an entire chapter in the survey on the issue, but the key passages is, “The current Administration is endeavouring to establish a comprehensive climate‐change policy, the main planks of which are pricing GHG emissions and supporting the development of innovative technologies to reduce GHG emissions. As discussed above and emphasized in the OECD (2009), this is the right approach… Congress should pass comprehensive climate‐change legislation.”
You won’t be surprised to learn that the OECD’s reflexive support for higher taxes appears even in this section. The bureaucrats urge that “such regulation should be complemented by increases in gasoline and other fossil‐fuel taxes.”
If you’re still not convinced the OECD is a giant waste of money for American taxpayers, I suggest you watch this video released by the Center for Freedom and Prosperity about two months ago. It’s a damning indictment of the OECD’s statist agenda (and this was before the bureaucrats released the horrid new “Economic Survey of the United States”).
The biggest long‐term threat to fiscal responsibility is a value‐added tax, as I’ve explained here, here, here, here, and here. So I’m delighted to see a growing amount of research showing that a VAT is bad news. Jim Powell has an excellent column at Investor’s Business Daily that makes a rather obvious point about the wisdom (or lack thereof) of copying the tax policy of nations that are teetering on the edge of fiscal collapse (this cartoon has the same message in a more amusing fashion).
Drums are beating in Washington for a value‐added tax in addition to the “stimulus” taxes, health care taxes, energy taxes and other taxes President Obama has imposed and wants to impose on hard‐pressed taxpayers. Supposedly a value‐added tax is a magic elixir for curing budget deficits and excessive debt. Quack remedy would be more like it. If it worked, you’d observe that countries with a VAT had budget surpluses and no debt problems. But almost every country that has a VAT is plagued with budget deficits and excessive debt. … No surprise that the worst financial basket cases all have a VAT. Iceland has the highest VAT rates, but this didn’t prevent its financial crisis and the near bankruptcy of its government. Italy’s VAT rates are almost as high, and its debt exceeds its GDP. Financial crises are looming in Spain and Portugal, and of course they have a VAT. Greece has a VAT, too, and when politicians ran out of money to pay government employees for more than a year’s worth of work every year, they rioted in the streets. Great Britain has a VAT, and its government finances are in the worst shape since World War II — its budget deficit is expected to be bigger than that of Greece. Moreover, the OECD has acknowledged that “(VAT) tax and transfer wedges have discouraged firms from offering employment and individuals from taking it, reduced employment and increased inequality.”
And a new study by Douglas Holtz‐Eakin and Cameron Smith finds evidence that a VAT would lead to bigger government.
VATs provide a significant amount of revenue. …But do these significant revenues cause government spending to grow larger? Or is it the case that adoption of a VAT is evidence of the desire for a larger government so that the causal arrow runs from a taste for Leviathan to a VAT, and not the reverse? …we find a statistically significant dynamic relationship between the rate of VAT taxation and the size of government. Although no single study is definitive, this is the first rigorous evidence that a VAT causes government to grow larger. …countries that adopted a VAT did in fact experience, on average, a 29 percent increase in the size of government. …The estimated coefficient of 0.262 indicates that adopting a VAT is associated with larger government. This estimate is statistically significant. …our results shift the burden of proof to those who deny that VATs fuel increases in the size of the public sector.
This study jumps into a long‐running chicken‐or‐egg debate in the academic literature about whether higher taxes lead to higher spending or whether higher spending leads to higher taxes. This causality debate is interesting, but I’m not sure it really matters. A VAT is a terrible idea if it triggers bigger government, and a VAT is a bad idea if it merely finances bigger government. But I suspect this study is correct. The key thing to remember is that Milton Friedman was right when he warned that “In the long run government will spend whatever the tax system will raise, plus as much more as it can get away with.” This means that a VAT will allow more government spending and no reduction in deficits and debt, which is exactly what we see in Europe (and as Jim Powell noted in his column). Last but not least, this video summarizes the best arguments against a VAT.
In a very predictable editorial this morning, the New York Times pontificated in favor of higher taxes. Compared to Paul Krugman’s rant earlier in the week, which featured the laughable assertion that letting people keep more of the money they earn is akin to sending them a check from the government, the piece seemed rational. But that is damning with faint praise. There are several points in the editorial that deserve some unfriendly commentary.
First, let’s give the editors credit for being somewhat honest about their bad intentions. Unlike other statists, they openly admit that they want higher taxes on the middle class, stating that “more Americans — and not just the rich — are going to have to pay more taxes.” This is a noteworthy admission, though it doesn’t reveal the real strategy on the left.
Most advocates of big government understand that it will be impossible to turn America into a European‐style welfare state without a value‐added tax, but they don’t want to publicly associate themselves with that view until the political environment is more conducive to success. Most important, they realize that it will be very difficult to impose a VAT without seducing some gullible Republicans into giving them political cover. And one way of getting GOPers to sign up for a VAT is by convincing them that they have to choose a VAT if they don’t want a return to the confiscatory 70 percent tax rates of the 1960s and 1970s. Any moves in that direction, such as raising the top tax rate from 35 percent to 39.6 percent next January, are part of this long‐term strategy to pressure Republicans (as well as naive members of the business community) into a VAT trap.
Shifting to other assertions, the editorial claims that “more revenue will be needed in years to come to keep rebuilding the economy.” That’s obviously a novel assertion, and the editors never bother to explain how and why more tax revenue will lead to a stronger economy. Are the folks at the New York Times not aware that both economic growth and living standards are lower in European nations that have imposed higher tax burdens? Heck, even the Keynesians agree (albeit for flawed reasons) that higher taxes stunt growth.
The editorial also asserts that, “Since 2002, the federal budget has been chronically short of revenue.” I suppose if revenues are compared to the spending desires of politicians, then tax collections are — and always will be — inadequate. The same is true in Greece, France, and Sweden. It doesn’t matter whether revenues are 20 percent of GDP or 50 percent of GDP. The political class always wants more.
But let’s actually use an objective measure to determine whether revenues are “chronically short.” The Democrat‐controlled Congressional Budget Office stated in its newly‐released update to the Economic and Budget Outlook that federal tax revenues historically have averaged 18 percent of GDP. They are below that level now because of the economic downturn, but CBO projects that revenues will climb above that level in a few years — even if all of the 2001 and 2003 tax cuts are made permanent. Moreover, OMB’s historical data shows that revenues were actually above the long‐run average in 2006 and 2007, so even the “since 2002” part of the assertion in the editorial is incorrect.
On the issue of temporary tax relief for the non‐rich, the editorial is right but for the wrong reason. The editors rely on the Keynesian rationale, writing that, “low‑, middle– and upper‐middle‐income taxpayers…tend to spend most of their income and the economy needs consumer spending” whereas “Tax cuts for the rich can safely be allowed to expire because wealthy taxpayers tend to save rather than spend their tax savings.”
I’ve debunked Keynesian analysis so often that I feel that I deserve some sort of lifetime exemption from dealing with this nonsense, but I’ll give it another try. Borrowing money from some people in the economy and giving it to some other people in the economy is not a recipe for better economic performance. Economic growth means we are increasing national income. Keynesian policy simply changes who is spending national income, guided by a myopic belief that consumer spending somehow is better than investment spending. The Keynesian approach didn’t work for Hoover and Roosevelt in the 1930s, it didn’t work for Japan in the 1990s, and it hasn’t worked for Obama.
And it doesn’t matter if the Keynesian stimulus is in the form of tax rebates. Gerald Ford’s rebate in the 1970s was a flop, and George W. Bush’s 2001 rebate also failed to boost growth. Tax cuts can lead to more national income, but only if marginal tax rates on productive behavior are reduced so that people have more incentive to work, save, and invest. This is an argument for extending the lower tax rates for all income classes, but it’s important to point out that the economic benefits will be much greater if the lower tax rates are made permanent.
Last but not least, the editorial asserts that, “The revenue from letting [tax cuts for the rich] expire — nearly $40 billion next year — would be better spent on job‐creating measures.” Not surprisingly, there is no effort to justify this claim. They could have cited the infamous White House study claiming that the so‐called stimulus would keep unemployment under 8 percent, but even people at the New York Times presumably understand that might not be very convincing since the actual unemployment rate is two percentage points higher than what the Obama Administration claimed it would be at this point.
As the chart below indicates, the United Kingdom has a large budget deficit solely because government spending has increased to record levels (OECD data). Unfortunately, the new Tory-Liberal coalition government has decided that taxpayers should be punished for all the over-spending that occurred when the Labor government was in charge.
The Telegraph reports that the top capital gains rate will jump to 28 percent, up from 18 percent (the new government foolishly thinks this will result in more revenue). But the biggest change is that the value-added tax will increase to 20 percent. According to Business Week, the Chancellor of the Exchequer (the British equivalent of Treasury Secretary) actually bragged that the VAT increase was good since it would generate "13 billion pounds we don’t have to find from extra spending cuts." Here are some further details from Business Week about the disappointing fiscal news from London.
British Chancellor of the Exchequer George Osborne increased the value-added tax rate to 20 percent from 17.5 percent in the first permanent change to the levy on sales of goods and services in almost two decades. “The years of debt and spending make this unavoidable,” Osborne told Parliament in London in his emergency budget today as he announced a package of spending cuts and tax increases to cut the U.K.’s record deficit. ...“We understand that the budget deficit needs to be tackled but we think the focus needs to be cutting public spending over tax rises,” Krishan Rama, a spokesman for the industry lobby group, the British Retail Consortium, said in a telephone interview yesterday. ...VAT has remained at 17.5 percent in every year except one since 1991, when John Major’s Conservative administration raised the rate from 15 percent to help plug a deficit.
The one tiny glimmer of good news from the budget is that the corporate tax rate is being reduced from 28 percent to 24 percent, which is probably a reflection of the strong and virtuous tax competition that is forcing greedy governments to lower tax rates in order to attract and/or retain business activity. There also is a two-year pay freeze for government bureaucrats, but this is hardly good news since a 30-percent pay cut is needed to bring compensation down to private sector levels.