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Combining Tax Reform with Health Care Reform: I Think Len’s Onto Something Here

May 27th, 2009 . by economistmom

I’m very pleased to read Lori Montgomery’s story in today’s Washington Post, highlighting Len Burman’s idea to fund health care reform through a major reform of the U.S. tax system.  The centerpiece of Len’s tax reform proposal is a new national value-added tax (VAT):

“Everybody who understands our long-term budget problems understands we’re going to need a new source of revenue, and a VAT is an obvious candidate,” said Leonard Burman, co-director of the Tax Policy Center, a joint project of the Urban Institute and the Brookings Institution, who testified on Capitol Hill this month about his own VAT plan. “It’s common to the rest of the world, and we don’t have it.”…

And in a paper published last month in the Virginia Tax Review, Burman suggests that a 25 percent VAT could do it all: Pay for health-care reform, balance the federal budget and exempt millions of families from the income tax while slashing the top rate to 25 percent.

In that paper, Len explains that the VAT would do more than pay for universal health care; the health care voucher system it would fund would contain cost controls (limits on what the vouchers could buy), which along with elimination of the health care tax exclusion would reduce overall health care spending.   Len estimates that the new VAT would thus do more than just fund health care reform, it would free up a lot of the current claims on the income tax system:

All told, the income tax would have to finance about $450 billion less in health spending than it does at present.  In addition, there would no longer be a tax exclusion for employer-sponsored insurance (ESI), a $168 billion income tax expenditure in 2009…Thus, the income tax base would become substantially larger.

Why is that larger income-tax base such great news?  Because it means that income tax rates could be cut and/or the deficit could be reduced.  Those sound like two “winner” ideas:  lower tax rates now, for us, or lower tax rates (and a stronger, more sustainable economy) later, for our kids and grandkids.

So when Len concludes in his paper that his proposal faces a lot of challenges, because “there is the reluctance of politicians to do anything that creates winners and losers” and that “[t]ax reform and health reform will both lead to that result”, I think he sells his idea short, neglecting the beauty of his combining tax reform with health reform in the way he’s done.  The public and politicians don’t like the idea of tax reform when any revenue neutrality, or especially the revenue-gaining side of that revenue neutrality, is obvious.  The Tax Reform Act of 1986 was revenue neutral, involving losers as well as winners, and yet passed largely because the public and the politicians didn’t focus so much on the losers, because the proposal raised revenue from corporations and lost revenue collected from households (i.e., gave tax cuts to them).  (Most non-economists don’t get the notion that corporations don’t ultimately pay the corporate income tax–actual people do, whether they be consumers, workers, shareholders, etc.)  Similarly, I think that a proposal for a new tax (such as a VAT) will go over much better if it immediately buys something perceived as a really good thing–such as universal health care.  People won’t think of it so much as a nasty fundamental tax reform effort that would inflict pain on those very people (politicians included) who most enjoy the current income tax system and all its inefficiencies, just the way it is.  (Len makes the point that fundamental tax reform will go nowhere anytime soon unless it hitches a ride on the health reform train.)  And if the new VAT buys even more than that, allowing income tax rates to be cut and the deficit to be reduced, then even if there are some truly hard choices (such as cost controls and reduced tax subsidies) wrapped up in that attractive package, I think it could look like an overall winner.

I think Len’s really onto something here.

8 Responses to “Combining Tax Reform with Health Care Reform: I Think Len’s Onto Something Here”

  1. comment number 1 by: Anandakos

    A TWENTY-FIVE PERCENT VAT? That’s extremely regressive. Remember that VAT is levied on every stage of production and distribution. So it is a “compound” tax. Imagine how much an automobile would cost in an economy with that high a VAT. The iron ore, limestone, and coking coal would be 25% more expensive, so if the raw materials were 40% of the cost of the steel, the price of the steel would have to rise by 10%, which means that after the VAT it would 127.5% as expensive as it is now. The rubber for the tires, the aluminum and plastic for body panels and bumpers, the wires and tubing. Everything going into the car would rise by at least 25% and more commonly more. The cost of the car would rise to at least 135% of current. Since the average car costs around $20,000, that means $30,000 would be the new average.

    The tax on the transportation and dealer prep is relatively small beer, but can’t be completely ignored. Typical transportation for a vehicle is about $2000 and dealer prep runs around $1000. Those together would add another $725.

    Now in this particular example there are good arguments that we want people to drive fewer miles in order to reduce anthropogenic global warming. But we WANT them to buy newer cars, in order to replace the gas guzzlers bought in the last decade!

    Why not just reduce deductions to “charitable” organizations to the percentage of benefit they give to people OUTSIDE their support group. That is, whatever churches spend on their own activities is not deductible. If people love God they’ll still go, even if the minister’s mill isn’t deductible. Only what they actually produce in charity should count.

    Similarly, people who give to “arts” groups should not be able to deduct the portion of performances which is subsidized by the giving. When a ballet company goes to a school and performs, enticing an eight year old to become a ballet dancer, the portion of the operating budget for that should be deductible. Or if a museum provides free tours for kids or sends the curator to speak at a school, the portion of the operating budget that represents should be deductible.

    Too much “charitable” giving is just Peter transferring money to a 501-C3 organization that gives Peter a service back. It’s a scam.

    This certainly would not raise as much as the current system, and I understand that many rich churches and arts organizations would scream bloody murder, because many of their high income supporters would trim their contributions way back. Well, if they want to see Tosca, let them pay full freight.

    P.S. I give to arts organizations (Oregon Ballet Theater, Oregon Symphony and Portland Museum) and tithe to my church. So I’m not advocating that we tax “someone else”.

  2. comment number 2 by: Anandakos

    My bad. “This certainly would not raise as much as the PROPOSED VAT….” Next to the last paragraph.

  3. comment number 3 by: Orlin Bowman

    A 25% VAT would throw our country into a deep depression in addition to making us one of the most uncompetitve (producing) nations in the world. VAT = Bad Idea.

  4. comment number 4 by: Jim Glass

    A 25% VAT would throw our country into a deep depression …

    No more than any other comparably sized tax — less, actually, considering how the fact that the deadweight cost of taxes rises by *the square* of the increase in the tax rate, mandating that you want to collect a given amount of revenue from multiple low-rate taxes rather than one high-rate tax.

    And if all the spending promises are to be kept — not to mention all the new ones, like for national health care, etc., plus servicing the debt cost of bailing out Chrysler, GM, (California?) and seemingly a third of the country — revenue hikes on that scale have got to come. No avoiding ‘em.

    Of course, OTOH, there is no chance whatsoever that a new big national sales tax or any other tax increase on that scale is going to get through the political system without corresponding cuts on the benefit side of the programs being paid for, to close the fiscal gap with a “compromise” agreement. (See the comments in this thread, the precedent of the ‘83 bailout of Social Security, etc.)

    Which is why I keep reminding budget hawks that it’s not enough to recommend tax hikes, to be serious about solving the problem you have to recommend the spending cuts to go with them.

    (BTW, while a VAT is imposed at every step of production, the tax imposed at each step is refunded at the next step — so it does not compound step-by-step. The purpose of imposiing it step-by-step and refunding it at every step but the last is to enforce compliance. With a “normal” sales tax, cheating and evasion at the retail sale end is so easy that complaince always collapses at a little over a 10% rate. With a VAT, the retailer doesn’t get the refund of the tax he paid to his supplier ubless his sale to the customer is made “on the books”, so he’s got a strong incentive not to cheat. Incentives are everything.)

  5. comment number 5 by: Jim Glass

    As an aside, anyone who’s interested in getting an idea of how the future real-world politics of fiscal reform is likely to work out should go spend some time on the AARP discussion boards, I really do strongly suggest.

    Get in touch, have some exchanges with the rank-and-file of motivated AARPers. Not the executives and PR people who make responsible sounding public statements, but the real activist rank-and-file.

    I’m talking about the ones with hugely disproportionate influence on political decisions … the ones who literally attacked Dan Rostenkowski on the street to get a just-enacted Medicare long-term care benefit repealed in a blink of an eye, because they were supposed to pay a small premium for it. Something all the politicians in Washington remember vividly to this day.

    I used to do a fair amount of chatting over with the AARPers and discussed this idea of a VAT with them. Let me report that they hate it. Really, I should put it this way: they HATE, HATE, HATE, HATE, HATE IT.

    First, they see it as regressive, which they assume means landing on them.

    More particularly though, and with some good reason, they see it as a double tax targeted right at them. To wit:

    “I spent my whole life paying income taxes and payroll taxes on my wages, and saving what I could after paying all that tax. Now, finally, in my old age, I can spend my savings which are not income and so are tax free, and my Social Security benefits that are (mostly) tax free, and the equity from my old home I sold which is tax-free savings … and you want to put a 25% TAX ON IT ALL!. You want to make all my savings that are after-tax already taxed again!”

    The arguments “economic efficiency” and “this will let younger people pay less income tax, or even none at all” really do not impress this group. And to be fair, they have a point about the “double tax”, as well as the political influence to express it.

    (They already have health care via Medicare, so a VAT to provide health care gives them nothing. And ‘expanding the tax base to close the fiscal gap caused by Medicare, etc.’ does indeed mean dropping a new 25% tax on them to pay for their own benefits — they know that, they aren’t stupid. And it’s one heck-of-a-lot-bigger try at it than what Rostenkowski tried, we can expect their reaction to be at least proportional.)

    How well do Burman’s numbers stand up if everyone over age 62 is exempted from the VAT? :-)

    Recapping the political lesson learned in Washington from Rostenkowski’s experience of being caught in his car as the mobbed banged on it and rocked it back and forth, like he was a Latin American politician caught in a revolution, Andrew Samwick said: “politicians learned that expansions to social insurance had to be financed by future taxpayers.”

    Here’s where the train wreck is a-comin’: The hugely expanding cost of the retiree programs is going to be landing on current taxpayers in about 15 years, exactly contra to that lesson learned. The tax that’s coming is going to be a whole lot bigger than the one the Rostenkowski mob was facing last time — so we can safely figure their reaction is going to be that much bigger too.

    So here’s real the challenge for fixing the long-term budget picture. It’s not coming up with an idea like a VAT, or some other such, that looks economically efficient and beneficial for the nation, peering down academically from above. That’s easy.

    The challenge is taking that idea over to the AARP boards and having the people there endorse it, rather than damn it, knife it, shoot it, and stomp all over its corpse with their hunting boots.

    The accounting for closing the funding gap and paying for anything else that one wants on top too is easy, simple — it’s the politics that is killing.

    The world would be a better place today if the politicians, faced with Samwick’s lesson, had been responsible enough to say: “Well, if the people don’t want to pay for expansions to social insurance then they won’t get any expansions to social insurance, not until they are willing to pay for what they get, instead of free-riding to drop the cost off on someone else … ” … One can dream.

  6. comment number 6 by: Anandakos

    Mr. Glass,

    When you say “the tax imposed at each step is refunded at the next step” I gather that it is credited against the purchaser’s taxes due on the purchaser’s sales. That does make it non-compound and much more tolerable. Thank you for the correction.

    Would such a VAT have exemptions for food and pharmaceuticals as sales taxes typically do? That would certainly lessen the burden on retirees, who mostly spend on those things. Of course it would also lessen the revenue raised.

  7. comment number 7 by: Bruce Bartlett

    Re AARP, keep in mind that the burden of the VAT is assessed by raising the price level by about the amount of the tax. (I know that this could be offset by Fed tightening, but that would cause a massive recession.) Since Social Security benefits are indexed to inflation the elderly would largely be held harmless by the imposition of a VAT.

  8. comment number 8 by: Brooks

    I have not yet read up on the VAT option, but one (of many) questions I have pertains to the incidence of a VAT not only across consumer segments, but between consumers (buyers) and producers (suppliers). I assume that a VAT, like any sales tax that is a percent of the retail price (either before or after application of the tax), shifts and rotates the supply curve upward (left), producing an equilibrium price that is higher, but not higher by the full percentage of the tax, because suppliers will eat part of it (i.e., set prices at lower contribution margins) to mitigate the loss of volume. Obviously the proportions of incidence between buyers and suppliers would vary by product category due to differences in price-elasticity, current contribution margins, and other factors, but in considering a VAT I’ll need to check into this broader split of tax incidence, and in turn, the ultimate distribution of the tax incidence across the U.S. population (since impact on supplier margins [as well as any net impact on volume, net of however the government spends the tax money] reduces income and wealth of investors [owners/shareholders] of supplier businesses).