Responding to Gale and Harris on the VAT

William Gale and Benjamin Harris of Brookings have a paper out proposing a 10% VAT for use in deficit reduction. They give the right arguments as to why the VAT is a good idea. I agree that we need a VAT but disagree with Gale and Harris on why.

The VAT should be walled off to fund discretionary spending and should likely be higher than 10% to do so. It should be a replacement for income taxes for lower income families (combined with a business income tax to replace health care and corporate profits taxes and fund health and child tax expenditures).

Income tax increases are necessary to fund the medium term debt explosion, which is caused primarily by the need to make good on the IOUs given to the Baby Boomers and Gen Xers for higher payroll taxes to build a Trust Fund. This trust fund ended up funding general government as an alternative to revoking the Reagan tax cuts in whole or in part and funding raising retirement costs from the general fund in the 1980s. A VAT would impact retirees harder than raising income tax, so it would be unfair to those of us who essentially paid a VAT with profits excluded to hit us with another one.

Solutions for the Fed to consider

Ed Andrews of The Fiscal Times (as well as everyone else) reports that yesterday, Federal Reserve Chair Ben Bernanke testified before the Senate Banking Committee and remarked that the economy is uncertain, as is the Fed's strategy for dealing with it. On this lack of action, stocks fell.

It must be noted that the Federal Reserve owns a significant share of the mortgage backed securities outstanding and that these are of questionable value. Meanwhile, over at Freddie Mac and Fannie Mae, there is no desire on their part to participate in the new federal program to write down principal balances to 115% of market value. This program won't totally solve the problem of underwater mortgages, but could spur enough movement for market prices to go up so that these borrowers can compete with properties being sold at foreclosure - which are currently dominating the market.

The Fed needs to use the leverage it has in holding mortgage backed securities to force lenders - including Freddie and Fannie, to write down mortgage principal balances and reintroduce liquidity into the housing market. Until this happens, underwater mortgage borrowers will be forced to either sit on property they might otherwise sell or walk away. The threat of the walk-aways and foreclosures is providing the uncertainty that keeps the market on the brink of a double dip recession. Take away that uncertainty and money will again flow. It may hurt the Fed's balance sheet a bit, but not more than having to write the securities down because of massive foreclosures - which could sink the Fed.

How is this not obvious?

Incentives Chuck Grassley will work for

I was flipping through the channels this evening and happenned upon Senator Chuck Grassley making comments about how allowing the tax cuts that he passed for Bush would cause rich people to be less productive. Dude has been in the Senate too long to understand what really motivates workers and business owners. Then it hit me, what motivates Senators?

Campaign contributions - and in Grassley's case, seemingly contributions from people who want lower taxes. This makes it easy to devise an example that Grassley can understand.
Let's suppose that in our example, Virginia did not have fixed conformity (meaning that what's taxable here is what's taxable federally). Instead, imagine that Maryland, the District of Columbia and Virginia all passed legislation making contributions to members of the Senate taxable at a rate of 30%. I say all three jurisdictions so that no one can simply cross the border to evade the tax with their grip and grin. Assume also that they considered contributions raised in the home state taxable income for Senators living part year in the national capital area - closing all loopholes.

What would most Senators do? Would they decide that they don't need the extra money for their campaigns because it is being taxed? Buying Grassley's logic, you would think that would be the case. (Obviously he has not asked either his wife or my wife about the acceptability of working less when your income goes down.) The reverse is actually true. If the tax man taketh, the Senator will lean harder on more donors to make up the loss. So do small businessmen and households. The amount of money anyone wants is not a function of the tax rate they pay to get it, but rather on what ones wants to spend. If you raise the tax rate, people will work harder to make up the difference.

This is why when Clinton raised taxes on the rich, the economy improved, revenue increased over and above the tax effect and the budget was balanced.

Somebody needs to share this with Obama, so that he does not wimp out on letting tax rates for the wealthy expire when the ball drops on New Years Eve. Indeed, he would be dropping the ball if he buys Grassley's nonsense.

Extending unemployment, bailing out the States and a holiday bonus for America

For the umpteenth time, funding extended unemployment has been brought up, fillibustered and debated. In the past, the leadership kept Congress going until someone caved. This time, it did not happen, largely due to the pressures of the July 4th recess and to take time out to bury Robert Byrd.

In the interim, people are losing their benefits. At the same time, many states, indeed the vast majority, are facing budget cuts - some draconian - as the new fiscal year begins.I am not sure that letting Senators and Members go home and face the music is not a bad idea. I would hope that whenever one of them makes a public appearance or holds a town meeting, they hear from local government officials, people who have lost or are about to lose their benefits and those agencies who are providing stop-gap assistance.

Of course, in DC (where this diary is being written), the member is always at home and knows full well how bad the problem is - although joblessness among the poor in DC is not as sexy as joblessness in the hinterlands. Additionally, because she has not vote and there are no voting (or non-voting) members of the Senate, the voice of DC voters on these issues does not matter.In Virginia and Maryland, this is another matter - although most area members are on the right side of the issue - although it is still a good idea to remind the Democrats that we feel this is important and give them some stories to use in debate when this issue comes up again. E-mail is also a good way to tell your story to your Senator. Go to http://house.gov and http://senate.gov to share your story. You can also make policy suggestions on how to deal with this issue. Here is what I told my Congressman, Jim Moran, and my Senators, Jim Webb and Mark Warner (feel free to cut and paste):

It is time to get serious on extending Unemployment Insurance. The Republicans keep demanding that we pay for extending coverage. I say we call their bluff and fully fund extended unemployment on a permanent basis in the only way that it is appropriate to do so, by raising the payroll tax on employer who have layed people off (leaving the base rate unchanged).

Indeed, while we are at it, the amount of benefits should also be increased (and funded by an increase to the base rate). Put this proposal front and center and dare the Republicans to vote against incentives to avoid unemployment and the extended unemployed. If this is the only alternative, we will hear nothing more from them again on funding this emergency through deficit spending.

On a related topic, I hope that during this recess you have heard from our local elected officials on their fiscal situation and are ready to come back to work with a stimulus that includes aid to the states.

Finally, let me suggest that a tax rebate that distributes money in November and December will be just in time for Christmas. Indeed, for some families, it will be the only Christmas they see - and for retailers too. This rebate should be for everyone - including people with no tax liability and even for people who owe back taxes to the IRS (normally rebates go to tax debt - this year the merchants need it more).