Tuesday, March 18, 2008

Top 10 Reasons Why America Needs a Consumption Tax

The most powerful tool that most societies have for shaping economic behavior is its tax system. America’s complex, convoluted and cumbersome system, overwhelmingly focused on income, is at the root of much of the economic behavior that accounts for our failure as a producing nation. At the heart of any viable tax system for the future will be a border-adjustable consumption tax. That may take the form of: a value-added tax as used in Europe, Mexico, China and the CAFTA countries; a national sales tax such as the Canadian tax on goods and services; or perhaps a business transfer tax that might rely on current financial statements but might tax the “value added” rather than “profit.”

Why should the US think of such a radical change in its tax system? Here are the top ten reasons:

1. We consume too much. If we collect more tax when dollars are spent than when they are earned, people will adjust. The more you spend, the more you tax pay, whether you are a lunch-pail factory worker, a high-flying stock broker or Paris Hilton.

2. We save too little. The solution: don’t tax savings by any American without any limitation or qualification. The more you save, the less tax you pay.

3. We invest too little. Solution: don’t tax invested funds; expense investment without any limitation or qualification. The more you invest, the less tax you pay.

4. We export too little. Increasing our net exports is the only way for the US to avoid a prolonged period of dollar weakness, high interest rates and steep inflation. Solution: rebate consumption taxes paid or due on all exports, just as more than 140 US trading partners do in a practice that is perfectly legal under international rules. The more you export, the less tax you pay.

5. Imports don’t pay their fair share of taxes in the US. Solution: impose the same consumption tax on imported goods as domestic goods must pay, also a perfectly legal practice under international rules. Outsourcers will be free to continue their supply chain practice, but they will no longer avoid contributing their full, fair share to the US economy.

6. The US is dangerously dependent on imported oil and gas. Solution: tax energy from renewable sources (overwhelmingly domestic in origin) at a lower rate than energy from non-renewable sources, whether domestic or imported. Instead of having an on-again, off-again policy of favoritism for specific technologies that are blessed with periodic subsidies, all technologies would benefit from the same tax advantage. The most competitive will win the biggest share of the market.

7. The underground economy, including many illegal immigrants, largely escapes taxation. Solution: tax people when they spend rather than when they earn.

8. Small businesses are unfairly burdened with bookkeeping, accounting and other administrative costs. The solution: substantially raise the minimum level for filing corporate and personal income tax returns, greatly simplify them (e.g. eliminate the alternative minimum tax), and do away with a host of smaller excise taxes now collected by the private sector.

9. Too much time and money are devoted to tax avoidance and evasion, leaving honest taxpayers to resent taxes as inherently unfair. Many taxpayers (and even their paid tax advisors) are often bewildered by the complexity of a tax code designed more to advance special interests rather than those of the nation as a whole. Solution: Rely on sellers to collect taxes from buyers; rely on the paper trail of purchases (taxes paid) and sales (taxes due); and devote the resources of the national tax agency to detecting and punishing

10. Lower-income families bear a heavy tax burden, taking into account the regressive effects of payroll taxes and those taxes imbedded in the cost of goods they buy. Solution: restore real progressivity to the tax system by eliminating payroll taxes on lower-income workers and refunding consumption taxes paid by lower-income consumers.

As a country we have become dependent on foreign borrowing to maintain our standard of living, ensuring that future generations will have to accept a reduced chance to live the American Dream. Every day we borrow more than two billion additional dollars to finance our trade deficit. The problem of America’s trade imbalance stems largely from systematic disadvantages stemming from our own tax system; the solution can be found largely in the same place. If America went from being a badly taxed country to be an excellently taxed one, we would start to benefit within a short period. By shifting towards a consumption-based tax system with progressive income taxation, we would also enable our government to immediately lower rates in response to a looming recession. No tax system is perfect, but ours is a perfect abomination to the national interest. Let’s change it – quickly, profoundly and with a steady eye on our performance as an international competitor. Good things will start happening once we do.

Monday, March 10, 2008

Valuing the Dollar; Devaluing Our Future

In a thoughtful op-ed piece in the weekend Wall Street Journal, Bob McTeer, former president of the Federal Reserve Bank of Dallas, echoed St. Augustine in wishing for a strong dollar – but not just yet. See Valuing the Dollar.

McTeer makes a strong case that a weaker dollar is part of a solution for the unbalanced US and global economies: “My preference,” he stated, “would be for dollar depreciation to reduce the [U.S.] current account deficit and slow the accumulation of dollar assets abroad. That process has already begun.” He concludes by warning: “A premature strengthening of the dollar would slow needed foreign trade adjustment and neutralize foreign trade as a source of domestic demand as we try to avoid a severe recession.”

This argument is a useful antidote to some of the confused economic logic that often beclouds the vision of Washington decision-makers. Experts are quick to bemoan “unsustainable” imbalances in the world economy, the low US savings rate, and our 35-year propensity to consume more than we produce. Their solution seems to be – get this! – coaxing the American consumer to spend more!

McTeer’s argument is a reminder that the default setting for a market economy such as ours is that persistent imbalances will be corrected through market forces. That’s what the depreciating dollar is doing. It will bring with it higher interest rates, higher exports and – contrary to what McTeer hints at – lower, not higher consumption. McTeer also glosses over the negative consequences of a dollar depreciation for those fools – overwhelmingly American citizens – who continue to hold American assets.

Cheapening the dollar may lead to a fire sale of American assets as foreign holders of dollars cash them in for something of real value at historically low process.

So, if the dollar depreciation runs its course without a major shift in American macroeconomic policy, America’s younger generations can inherit a reduced debt burden – hooray! – accompanied by a lower standard of living, reduced purchasing power, and increased foreign ownership of America’s most valuable assets.

That’s a high price to pay just because America’s political leadership does not take seriously the structural problems of the American economy. For starters, let’s adopt a consumption tax at a rate comparable to those in the rest of the world (say, an 18 percent value added tax). Use the proceeds principally to finance a fundamental restructuring of the rest of the tax system – much lower taxes on corporations and individuals and the elimination of a dozen or more nuisance taxes. Crucial to this is to expense – immediately write off – investments in production capacity.

Unless we change the structure of the American economy so that we can produce more than we consume, the market will achieve that end, however brutal and unfair the process might be. Our longstanding structural problems cry out for effective leadership. If the best that the presidential candidates can do is to argue whether the Bush tax cuts should be made “permanent,” our structural problems just might go on forever and along with it a succession of dollar crises.