Reactions to the President's Advisory Panel on Tax Reform

Recently, while surfing the net in search of a real job having to do with tax reform from a Value Added Tax (VAT) perspective, I found both comments attacking the use of a VAT, as well as a copy of the VAT analysis from the final report of the President's Advisory Panel on Tax Reform. (Frequent readers know that I contributed analysis to this effort, which is provided on my Geocities page.

Overall, I am encouraged by the Panel’s treatment of this topic. Their overall approach is similar to mine – combining a VAT and a simplified income tax. Due to the scope of their assignment, they were not allowed to consider the replacement of Payroll Tax revenue with the VAT, even though this would be the most natural use of such a tax. Payroll taxes function essentially as a hidden VAT as they add to the cost of labor at a fairly uniform rate, with the exception that the contribution to disability, retirement and survivors insurance is capped. Additionally, in order to keep rates on both taxes low, the Panel “split the difference” by assuming a 15% VAT and a 15% high income tax rate (with a lower 5% rate for lower incomes). Work and family size credits were also assigned to the simplified income tax. This results in a system with three tax systems – consumption, payroll and income. In the end, this proposal was not adopted because fiscal conservatives on the panel believed that the VAT would make it to easy to raise revenue.

This echoes the comments of the Hoover Institute, Citizens for Tax Reform and the Heritage Foundation. These denizens of the right favor a flat tax or the Fair Tax, largely because they wish to have every citizen pay taxes in as obvious method as possible (including by eliminating withholding and requiring the submission of a monthly tax payment by every citizen), believing that this will lead taxpayers to demand less government services. They also fear that an income tax will still be included in any VAT scheme (Grover Norquist considers this the worst possible scenario), which exactly what the Panel’s analysis showed. I proposed such a scheme as well, as has prominent Yale Law Professor and former George H.W. Bush official Michael J. Graetz , although I would institute a higher VAT and lower residual income tax rate.

What I am proposing would not be as horrible as Grover Norquist and company make it out to be. I would divide the VAT into a transparent tax to fund government services and a hidden component to directly fund transfers to larger or poorer families, remedial education services to adults, disability and health care costs (employee and retiree) and education funding contributions to parents, public schools or private schools. The hidden VAT costs could be directed to non-governmental providers or to governmental providers, at the choice of the firm’s employees and shareholders. The hidden portion of the tax would be administered by the states and federal – and possibly matching local – funding of these spending priorities would be supplanted by the new tax structure. The remaining federal income tax would be enacted at a lower rate and would be set aside to pay for net interest on the debt, foreign aid and debt forgiveness, overseas military operations – including the wars in Iraq and Afghanistan, transfer costs in privatizing retirement insurance and repayment of the Social Security Trust Fund, repayment of the debt held by the public and the transition to hard currency from the Federal Reserve System. When international commitments can be fully funded by customs duties and tariffs and all real and contingent obligations are exhausted, the income tax would sunset until needed to fund armed conflict.