VAT’s Under Discussion  (Mar. 23)

Mike & Co. –

In a stark departure from political history since Reagan and Goldwater, the Republican Party this year has struggled to come up with a unified tax message. Perhaps more odd, still, are the abrupt change in tone surrounding the tax debate, from the traditionally robustly pronounced to a muted, tentative, and confused message.

From Presidential debates to the House of Representatives, GOP members are trying to sell their colleagues on some form of a VAT tax, the same tax that Grover Norquist joked was “French for ‘big government.’”

Ways Means joined in on the cacophony  yesterday.  What bills and trends are worth spotting here and what are their implications for Democrats?  More below.

Best,

Dana

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VAT Tax, Flat Tax, No Tax?

The House Ways and Means Tax Policy subcommittee held a hearing yesterday to explore three proposals by GOP Representatives to push the country toward a consumption-based tax code. The three proposals include:

  •  a “cash flow” plan (H.R. 4377) California Rep. Devin Nunes, currently the third-ranking Republican on Ways and Means, which would abolish the IRS, income taxes, capital gains taxes, and more
  •  a flat tax plan (H.R. 1040) from Rep. Michael Burgess of Texas to tax businesses and individuals at 17 percent
  • a Fair Tax (H.R. 25) from Rep. Rob Woodall of Georgia, to abolish the IRS and create a national sales tax in place of income tax

Why was this hearing important, even for Democrats?  It signals further pressure within the GOP to shift away from established income and payroll taxes and toward alternatives like VATs.  Notably, Sen.  Cruz has propose a “not” VAT tax, while former candidates Bush and Rubio both supported cash-flow consumption taxes in their campaigns.

Yesterday’s proposals are also novel because they pitch GOP against a special interest that is normally an ally – business.  In order to take advantage of dynamic scoring methods and to prevent de facto negative tax rates, these proposals replace deductions on interest payments with deductions on investment.  This is a boon for capital-heavy industries like manufacturing, but has businesses in financial services and real estate seeing red.  Some suggest that conservatives are advocating these taxes because they are easier to raise than income or property taxes in the long run.

Economics Driven by Dynamic Models

If tax writers kept both investment and interest deductions they would essentially be paying companies to purchase machinery.  Instead, Congress has decided to embrace the investment write off provision because it offers the best bang for the buck in dynamic tax models.  Dynamic modeling, a sweetheart of conservatives and often seen in analyses by AEI and the Tax Foundation, considers the economic effects of changes to the tax code.  That doesn’t mean that all “pro-growth” changes are equal, however – the Tax Foundation’s model places greater emphasis on the immediate deduction of investments, for example.

What’s the difference in the end?  The latter groups tend to fund their operations through loans, meaning the interest deduction has a far greater effect on their tax bill than the ability to expense investments, even if that expense can be made all at once.  Manufacturers are required to make huge investments in machinery and other physical property which pay off only gradually – an upfront expensing of that investment should help match expenditures to income.

Just because a tax plan scores well on a dynamic model doesn’t mean it is good economics, however.  Economists on both sides have expressed doubts about the level of economic impact certain models predict, and others have stressed that the type of economic growth we experience is as important as the rate of growth.

A VAT Obsession

A VAT is, at its simplest, a “multi-stage” sales tax where taxes are collected at each stage of production process.  Its full name, Value Added Tax, is indicative of this nature – at each point that value is added to a product, a tax is levied.  The tax has been a mainstay of revenue generation in Europe for generations.

Though GOP has become increasingly enamored with VAT taxes of late, there remains some disagreement regarding what exactly a VAT tax should look like or whether one concept is a true VAT.

But the concept has gained a lot of traction within GOP circles because the tax system is considered more equitable than taxing income – a person’s tax burden is determined by how much they consume rather than how much they earn.  Some see a VAT tax as a simpler alternative to an income tax system, but there may be some catches to that understanding.

There are a number of ways to accomplish a VAT tax, including the imposition of a national sales tax (which is not a tax on added value, like a VAT, but a simple tax on consumption) – HR 25 does this.  Rubio’s “X Tax” is a variation on a VAT as well, which is includes wage deductions for businesses and progressive levels for workers.

Democratic Demurral

Democrats have not felt the call of the VAT tax, in keeping with the long-held belief within the party that “flat taxes” are inevitably regressive.  The grand Republican dream of eliminating all taxes in favor of a single flat, or VAT, tax would be too unpalatable for the Democrats.  If the party ever supports such a tax, it would have to be as part of a reform that maintains liberal favorites like capital gains, estate, or progressive income taxes.

Politics Trump Governance

Yesterday’s hearing was also important because it showed the future of GOP tax orthodoxy is moving rapidly toward consumption tax codes.  While the calls to abolish the IRS and have states administer these programs are easily dismissed as farce, observers should not dismiss the overarching themes seen here.

Pieces of the proposals mentioned in the hearing, such as eliminating the interest deduction, could already gain bipartisan support in Congress.  The trick here would be to agree on the relative levels of change – assuming that legislators are content with partial, rather than comprehensive, reform.

Congress is sure to continue moving toward bipartisan comprehensive tax reform, however slowly.  Assuming that proposals moving forward emphasize consumption tax systems, compromise might be found in a small VAT tax that has a specific funding requirement and is progressive in the sense that certain goods are exempt (most already exempt financial services, so that’s not a big stretch, admittedly) or weighted with equitable outcomes in mind.

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