Transition Tax Team Comment 1

Submission to the Transition Team and to Secretary-Designate Bessent

WM Republican Tax Teams Comment on American Manufacturing, Main Street, U.S. Innovation and Global Competitiveness, October 11, 2024

Keeping Up with the World

President Trump is correct that the old neo-liberal agenda of free trade has not helped American manufacturing and the American worker. Starting a tariff war is not the answer, however. We must simply comply with the trade regime that holds in the rest of the world by enacting a credit invoice value added (aka goods and services) tax.

Credit Invoice Value-Added Tax (CI-VAT). Border adjustable taxes will appear on purchase invoices. The rate varies according to what is being financed. If Medicare for All does not contain offsets for employers who fund their own medical personnel or for personal retirement accounts, both of which would otherwise be funded by an S-VAT, then they would be funded by the I-VAT to take advantage of border adjustability. 

CI-VAT forces everyone, from the working poor to the beneficiaries of inherited wealth, to pay taxes and share in the cost of government. As part of enactment, gross wages will be reduced to take into account the shift to the Subtraction VAT described in our second set of proposals and the CI-VAT, however net income will be increased by the same percentage as the CI-VAT. Inherited assets will be taxed under A-VAT when sold. Any inherited cash, or funds borrowed against the value of shares, will face the CI-VAT when sold or the A-VAT if invested.

A Reform Agenda

Currently, firms and individuals who charge sales taxes deduct these tax payments from income. These deductions should be credits instead, as the current regime is simply a subsidy to states who collect sales tax.  This small TAX CUT will remove the resistance to enacting a VAT - and the customer at the end of the supply chain pays the same amount of tax as they would for a retail sales tax. There is no tax on top of tax paid.

Sellers on such platforms as Amazon benefit from tools provided by the platform - which collects the money on their behalf. Comprehensive reform which includes credit invoice value added taxes will feature automation, including modules to deal with remote sales. 

Such reforms are a good deal for small businesses, as exempting such firms from VAT filing deprives them of the rebate of taxes paid to vendors. Again, the current income tax deduction for sole proprietors only provides a deduction of sales tax paid - rather than a credit.

Background on Consumption Taxes

Eventually, the United States needs to join the rest of the developed world and enact consumption taxes on consumer goods and services, net business receipts and an innovative tax on asset sales - which would replace capital gains taxation and would require negotiation of an international rate to prevent rate arbitrage. 

The first two would make it easier to pay taxes in general because the simplicity of the first and the fact that the second would replace the business income tax while becoming a conduit for employee health and family support benefits - and would entirely replace the need for most families to pay personal income taxes (if not all) - which would greatly cut down on paperwork requirements businesses currently face. 

The reality is that business collects the revenue and submits it to the Treasury, along with a mountain of information to subsidize the tax preparation industry - who are consistent donors to both Chambers - especially the revenue committees. 

The proposed Fair Tax’s use of a retail sales tax, rather than use of a value added tax at each purchase (but note - the tax is only paid on the base markup  - not the taxes owed because of the markup) will lead to fraud as retail purchase are credited as wholesale - which under the FT is not taxed. This is a huge potential loss. This schema is proposed by Fair Tax sponsors because they misunderstand how a CI-VAT works. For the Fair Tax to ever pass, rather than being a talking point for fundraising, it must work the same way..

When CI-VAT is paid by a merchant or manufacturer, the CI-VAT that they paid for that good or service supplied is refunded to them. 

Saving American Manufacturing and Global Competitiveness

Consumption taxes could have a big impact on workers, industry and consumers. Enacting an CI-VAT is far superior to a tariff. The more government costs are loaded onto an CI-VAT the better for global competitiveness.

If the employer portion of Old Age and Survivors Insurance, as well as all of disability and hospital insurance are decoupled from income and credited equally and personal retirement accounts are not used,  there is no reason not to load them onto an CI-VAT. This tax is zero rated at export and fully burdens imports.  

Seen another way, to not put as much taxation into CI-VAT as possible is to enact an unconstitutional export tax. Adopting a CI-VAT is superior to its weak sister, the Destination Based Cash Flow Tax that was contemplated for inclusion in the TCJA. It would have run afoul of WTO rules on taxing corporate income. I-VAT, which taxes both labor and profit, does not. 

The second tax applicable to trade is a Subtraction VAT or S-VAT. This tax is designed to benefit the families of workers through direct subsidies, such as an enlarged child tax credit, or indirect subsidies used by employers to provide health insurance or tuition reimbursement, even including direct medical care and elementary school tuition. As such, S-VAT cannot be border adjustable. Doing so would take away needed family benefits. As such, it is really part of compensation.  While we could run all compensation through the public sector.

The S-VAT could have a huge impact on long term trade policy, probably much more than trade treaties, if one of the deductions from the tax is purchase of employer voting stock (in equal dollar amounts for each worker).  Over a fairly short period of time, much of American industry, if not employee-owned outright  (and there are other policies to accelerate this, like ESOP conversion) will give workers enough of a share to greatly impact wages, management hiring and compensation and dealing with overseas subsidiaries and the supply chain – as well as impacting certain legal provisions that limit the fiduciary impact of management decision to improving short-term profitability (at least that is the excuse managers give for not privileging job retention).  

Employee-owners will find it in their own interest to give their overseas subsidiaries and their supply chain’s employees the same deal that they get as far as employee-ownership plus an equivalent standard of living.  The same pay is not necessary, currency markets will adjust once worker standards of living rise.  Attachment Three further discusses employee ownership.

Over time, ownership will change the economies of the nations we trade with, as working in employee-owned companies will become the market preference and force other firms to adopt similar policies (in much the same way that, even without a tax benefit for purchasing stock, employee-owned companies that become more democratic or even more socialistic, will force all other employers to adopt similar measures to compete for the best workers and professionals).

In the long run, trade will no longer be an issue.  Internal company dynamics will replace the need for trade agreements as capitalists lose the ability to pit the interest of one nation’s workers against the others.  This approach is also the most effective way to deal with the advance of robotics.  If the workers own the robots, wages are swapped for profits with the profits going where they will enhance consumption without such devices as a guaranteed income.

Dealing with the National Debt - Less than full faith and credit

Any downgrades we have had - and there have been two - did not come because the Democrats are spending out of control. It is because Republicans refuse to compromise until the last minute, with a significant portion of leadership not wanting to compromise at all. This unwillingness cost Mr. McCarthy his Speakership and likely drove John Boehner out of Congress. 

Downgrades came for the same reason - brinkmanship on the debt limit in an attempt to force temporary tax cuts to be made permanent. The irresponsible strategy and the end goal alarm the bond markets because they indicate that one major party has no commitment to fiscal responsibility - play politics instead in fear of Grover Norquist - who no longer has skin in the game. Donald Trump took all of the radical oxygen away from the Republican fringe.

I am going to assume that leadership, especially among members of the Freedom Caucus, as well as their staffs are truly ignorant of how the national debt actually works. In short, it is the reason capitalism can exist at all. This is why, when the debt was paid off and the national bank was closed by Andrew Jackson, the economy collapsed. 

Historic perspectives

In the 1960s, the debt from World War II was quickly being paid down. By the end of the decade, there was no federal debt to leverage other liquid investments. This eventually led to tax cuts, but President Reagan overshot the mark and then codified it in the 1986 tax reform. Presidents Bush and Clinton found the growing deficits unsustainable and adjusted tax reform at the margins. Doing so reduced the debt while fueling economic growth. 

The Clinton cuts to capital gains taxes put too much money into the hands of speculators, which led to the tech boom and bust. It had nothing to do with technology and everything to do with IPOs. Even then, as budget balance was a real possibility, Alan Greenspan sounded the alarm about abolishing the debt. Many thought that this was to preserve the ability to maintain a fractional reserve currency, but the real motivation was to continue to provide the leverage on which capitalism depends.

Federal Debt Ownership

According to the Treasury Bulletin, the national debt is owned by the Federal Reserve System and its member banks (about a third), long term investment, insurance and retirement funds - both public and private - as well as Savings Bonds (another third). Using figures from the 2019 Federal Reserve Survey of Consumer Finance, I estimate that the top 10% of households own around 54% of these funds, with the bottom 90% owning the remainder (although the bottom three quintiles own essentially nothing - nor do they owe it - as will be described below.

The last third is owned by mutual and bond funds, as well as offshore investors. The top 10% of households own 77% of these funds. If the majority continues to dance on the edge of default, these are the investments that are at risk. The top 1% own the same percentages as of what the top 10% hold. This means that from the second to the tenth percentages own 25% of deposits retirement and mutual funds backed by Treasuries. 

The top 1% hold one quarter of debt assets held through deposits and long-term investment funds and half of what is held by mutual and bond funds. There are better ways to increase interest rates for these borrowers than messing with the Full Faith and Credit of the United States, which is essentially what the Freedom Caucus led assault on the status quo is doing.

Let us add that of the debt held overseas, roughly two thirds are held by foreign governments who, by doing so, facilitate international capitalism - especially the import of consumer goods from Japan and China. Messing with these funds put WalMart shopping at risk, as well as the entire chain. Much of the remainder of foreign bond holdings are in the Caymans, Ireland, Switzerland and Luxembourg. In other words, they are held in tax shelters for very wealthy Republican donors.

These investors know exactly where their debt assets are being held. It seems as if members of the Freedom Caucus do not. Unless there is a plot to destroy capitalism that I have not yet heard about, we suggest that the debt limit be abolished and the 2018 tax cuts allowed to expire on schedule. This will restore the confidence of both rating agencies and investors at home and abroad.

Continuing on the current path, where a major portion of the Republican Party acts against the interests of investors and the nation at large and sustains unsustainable tax cuts could have drastic consequences. The entire economy could collapse again, but this time for real. If the Federal Reserve loses its international leverage because the debt has become worthless, there will be no bailouts for questionable investments in mortgage backed securities - investments that have shifted from owner-occupied housing to single-family rentals. The bill to ban hedge fund ownership of these properties will reduce risk overall, but will not save the nation from the risk of losing its good credit.

Who Owes the Debt?

Debt obligation is a function of income tax paid (FICA tax paid to create assets held in trust by the government, not debt obligation). The current factor is 19 dollars of debt owed for every dollar paid in tax. 

Ownership of Social Security assets is realized when households are in the bottom quintiles who, at that time (because only 20% have income beside Social Security), own almost all FICA trust fund assets. The bottom quintiles hold more than their obligation.

The next three quintiles owe more than they own until we get to the top 0.1%. Because half of their income is earned through asset ownership taxed at preferred rates and their high share of ownership of debt, they break even. They own what they owe. In other words, when interest rates go up due to downgrades, their wealth expands in terms of debt owned compared to debt owed. This should guide how the debt should be reduced responsibly.

If we do not start paying our debts (which enactment of a CI-VAT will help us do) or default on the debt, our economy will be ruined. There is nothing conservative about that.