Tax code solution: taxing consumption

 

According to much conventional wisdom, the flap over corporate “tax inversions” is just the latest evidence that the tax code needs a comprehensive overhaul like the one agreed to by congressional leaders and President Reagan in 1986.

Whether you consider it greedy and unpatriotic for U.S. companies to establish corporate headquarters in lower-tax foreign countries, or merely regrettable but rational, part of the solution is to lower that rate and recoup lost revenue by closing loopholes, it is said.

“Lower rates, broader base” was the cardinal principle of the 1986 reform. And it is still the mantra of tax reformers today. House Ways and Means Committee Chairman Rep. Dave Camp, R-Mich., unveiled a 1986-style plan in March that would trim the top individual and corporate rates, while pinching popular breaks such as the mortgage interest deduction.

There’s just one problem: In 2014, the 1986 model looks like “a dead end.” Or so argues Michael Graetz, a former Treasury official in the first Bush administration and longtime advocate of radical tax reform who teaches at Columbia Law School.

In his latest paper, published by the National Tax Journal, Graetz contends, plausibly, that the 1986 tax reform worked because it was then possible to pay for rate reductions by eliminating billions of dollars in individual and corporate tax shelters without tackling middle-class breaks like the mortgage interest deduction.

Today, though, there’s less low-hanging fruit; a 1986-style reform would be politically difficult because it would be financially difficult, as Camp’s plan and similar attempts at “revenue-neutral” reforms suggest.

Even if our politicians did manage to push this boulder up the hill, Graetz notes, it would roll right back down. At the behest of lobbyists, Congress began fiddling with the 1986 reform almost as soon as it was enacted, giving us today’s loophole-ridden mess.

The United States’ real problem, according to Graetz, is its undue dependence on income taxes — corporate and individual — in the first place. He supplies a nifty world map with all nations shaded except the ones that don’t have a value-added tax (VAT), essentially a sales tax on goods and services imposed at each stage of their production and distribution. It’s striking to see the United States grouped with Myanmar, Saudi Arabia, Afghanistan and exactly zero developed nations.

Graetz would put a 12.9 percent VAT at the center of a new system – using the revenue to slash the corporate tax rate to 15 percent and eliminate income taxes for all households earning less than $100,000 ($50,000 for singles), that is, 80 percent of current filers.

For those above that threshold, there would be two rates, 16 percent and 25.5 percent. Payroll tax rates would stay the same, with credits for low-income workers to offset the regressive impact of the VAT, as well as an additional child tax credit.

Graetz points to independent analyses showing this would raise about as much revenue, about as progressively, as the current system. It could spur growth by reducing uncertainty and perverse incentives — of which “tax inversions” are but one example. By taxing consumption, it would encourage savings and investment, but not steer them in politically favored directions, as the current code does.

Indeed, Graetz’s latest pitch reiterates points he has made before — with no takers. Many Democrats object to the regressivity of a VAT. Republicans regard the very efficiency of a VAT as its biggest drawback, because if it’s easy for government to raise money, it will become too easy for it to spend money.

Graetz’s proposed credits would offset the VAT’s impact on lower-income consumers. As for the Republicans, they have a point — but you would think they’d like the near-elimination of income taxes. Besides, under what plausible scenario would the GOP shrink government to the point where it wouldn’t absorb a big share of the economy?

Federal spending last came in at less than 17 percent of gross domestic product in 1965; even Wisconsin Rep. Paul Ryan’s supposedly draconian 2011 budget plan wouldn’t get it below 19 percent of GDP until 2040, according to the Congressional Budget Office.

Graetz’s plan is undoubtedly susceptible to unintended consequences. The United States, and the world, rely on the American consumer to fuel growth, so higher consumption taxes here might be even more radical than Graetz realizes, and not necessarily in a good way.

Still, the sterile debate over tax inversions illustrates the limits of traditional tax-reform thinking. Graetz would go beyond the “lower rates, broader base” swap to a truly grand compromise — which, if it worked, might make this country more stable not only financially but also politically.

Charles Lane is an editorial page editor for The Washington Post

© 2014, The Washington Post

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