How to Deal With the Deficit Through Progressive Tax Policy
October 2nd, 2009 . by economistmomI wanted to continue my discussion of Wednesday’s Center for American Progress/Center on Budget and Policy Priorities conference on “Progressives and the National Debt” with a recap of the tax policy that was discussed there. Although there had been a good deal of disagreement or at least “fuzziness” (even among the intentionally tilted “progressive” panelists) about how soon deficit reduction efforts should start and how heavily tilted toward taxes versus spending those efforts should be, when it came to how to raise needed revenue, one idea kept coming up all day long: introduce an add-on value-added tax (VAT). Paul Krugman mentioned the VAT (along with auctioned carbon permits) as a good source of additional revenue. Bob Reischauer, who disagreed strongly with most of what Krugman had said on the timing of spending restraint, also recommended the add-on VAT, particularly if used to fund expanded health coverage. Roger Altman similarly said we need a new revenue source such as the add-on VAT. And in the tax policy panel of the conference, Bill Gale of Brookings (and co-director of the Tax Policy Center) listed both the add-on VAT and carbon revenues as the two prime examples of new revenue sources to consider.
That a bunch of experts all at-least-slightly left-of-center would recommend a VAT is notable, because the VAT is known to be a “regressive” tax–that is, a tax that takes a bigger share of one’s income the lower one’s income (because lower-income households tend to consume larger fractions of their annual income, and the VAT is a consumption-based tax). “Progressives” usually favor more “progressive” tax policy, where average tax rates rise with income. But “progressives” need to tackle the federal debt to a decent extent via tax policy or else the required spending restraint would be too dire for their tastes. And given how inadequate the current federal revenue base seems to be, actually reducing deficits via revenue policy is way too broad a challenge to rely on only the existing (little) progressive pieces of our current tax system. Moreover, as Bill Gale emphasized in his presentation, we have to stop insisting that every single component of our tax system has to satisfy some overall ideal standard of progressivity. Some parts of the tax system can be regressive as long as other parts of the tax system, or even the tax-and-transfer system more broadly, are sufficiently progressive. Let each part of the tax system, and each part of the transfer system, do what it does best, so that the tax-and-transfer system as a whole is the most efficient and fair that it can be. Progressives like the idea of an even-regressive VAT when they think that the VAT makes some worthwhile and progressive government spending possible. Lately the worthwhile and progressive spending that most often comes to mind is expanded health coverage. But thinking just a little more broadly, that worthwhile and progressive purpose could be deficit reduction as well–because an unsustainable fiscal outlook is a large and largely regressive threat to the federal government and the economy.
But it’s not just the progressives who are advocating a VAT. Anyone who’s a regular reader here knows that fiscal conservative Bruce Bartlett, a Reagan Administration Treasury official who believes in the supply-side merits of low marginal tax rates, supports a VAT. And yesterday, Bloomberg reported that Alan Greenspan–the man largely blamed for the easy passage of the 2001 Bush tax cuts–”said the U.S. will have to both tighten credit and raise taxes” as the economy recovers, and strongly hinted at a VAT (emphasis added):
“The presumption that we’re going to be able to resolve this without significant increases in taxes is unrealistic,” Greenspan, 83, said in an interview with Bloomberg Television yesterday…
Greenspan said that the odds are growing that the U.S. will have to enact some form of consumption tax to help reduce the federal budget deficit…
And someone at the CAP/CBPP conference (sorry, I can’t remember exactly who now) reiterated a line from Larry Summers on the VAT which I’ve heard told many times, but has tremendous wisdom and not just wit to it. From a Cato Institute blog post by David Frum that’s over 3 years old:
Bruce Bartlett’s proposal for a VAT reminds me of a Larry Summers witticism: Explaining why the United States remains one of the rare major economies on earth without a VAT, Summers said, “Democrats oppose it because it is regressive, and Republicans oppose it because it is a mighty revenue-raising machine.” He then added: “And we will get a VAT when Democrats figure out that the VAT is a mighty revenue-raising engine—and Republicans figure out that it is regressive.”
Well, I think that time has arrived–or at least it’s approaching the station.
But back to the title of this post, I have to say that I was disappointed that although the conference and the CAP paper seemed to emphasize the need for a balanced approach toward deficit reduction, which would involve both spending restraint and increased revenues, that in terms of tax policy most of the experts seemed to avoid mentioning the most obvious and simple way to raise revenue in a progressive manner: to let the Bush tax cuts expire. Bob Reischauer did mention it during his panel as something that could be used by the Democrats “as a club” to take more assertive control of the policy agenda. Jane Gravelle mentioned it in her introduction to the tax policy panel. But Bill Gale did not list it as one of the (sub)ways (of his 3 major ways) to raise revenue (grow the economy, reform the existing tax system, or add new tax bases to the system); at least he did not explicitly list the expiration of the Bush tax cuts as one part (or a prerequisite) of “cleaning up” the existing system. Former Joint Committee on Taxation chief of staff Ed Kleinbard delivered a scathing attack on tax expenditures as the “current fiscal illusion policy tool of choice”, yet did not point out how the Bush tax cuts increased these tax expenditures and hence how expiration of the Bush tax cuts would reduce these tax expenditures. And despite the CAP paper blaming much of the deterioration in the fiscal outlook on the Bush tax cuts, in their “getting to a solution” section, they refuse to get specific on how taxes should be increased, only making the judgment that “balancing the budget solely with such tax increases is both unlikely and unwise.” So it seems to me they’ve missed the great opportunity to stress to progressives that one of the easiest ways to progressively raise more revenue and reduce the deficit would be to consider letting more of the Bush tax cuts expire than what President Obama has proposed. But of course, that’s just what I gripe about any chance I get…It’s just that I wasn’t given a turn at the podium.. 
Here’s the original source for Summers’ VAT quote:
http://www.nytimes.com/1988/12/19/business/tax-watch-the-likely-forms-of-new-taxes.html
A VAT huh,
Well, since I live in Chicago, the home of the VAT (known as our 10.25% sales tax), I must admit I’m pretty opposed to a VAT as a source of revenue.
The VAT is a stealth tax. You never know how much you paid unless you keep a record of every purchase and compute it at the end. And with a VAT, it isn’t even necessarily possible to compute how much you paid. In my mind, this is why liberals/progressives favor a VAT. It allows for tax increases that people won’t see once the tax has been put through.
I could imagine moving to a VAT if you scrapped the entirety of the current tax system, but it sounds like the proposal of the progressives was an “extra” tax.
In a discussion of tax policy, maybe we should start by agreeing what regressive means. In my mind, I think regressive means that the tax in question takes a larger share of the base taxed from the poor than the rich. By this definition, VATs are not regressive, they are neutral. Every item is taxed equally. Can you make an argument that necessities are a larger portion of the budget of the less well off? Of course, but the tax base of a VAT is purchases, not income. Thus, the only regressive Federal tax I can think of is SS because of the phase out. It is actually sharply regressive at higher levels of income.
By the way, the notion that conservatives favor “regressive” taxes, even if slightly tongue in cheek is a pretty provocative argument. I have not ever heard anyone argue that regressivity should be a goal of tax policy. Thus, I think if you want conservatives to favor a VAT, simplicity or minimization of distortion would be much better selling points than regressivity and I rather suspect the only way you would ever have support is as a substitute to the current tax regime rather than as an augment.
I would ask one more question. As a matter of overall tax policy, how much progressivity is enough? My own view is that taxation should be neutral as a percent of income (probabaly above the poverty line). Progressive friends of mine often argue for progressivity but never offer a sense of what is “enough”. Should the top 10% of wage earners (or wealth holders) pay 10, 20, 30 percent of the taxes? Progresives always argue for more progressivity regardless of how much there already is. How much is enough?
Diane,
What views, if any, were expressed regarding capping/eliminating the tax deduction for employer-provided health insurance? Did Kleinbard note that one in particular? Others’ views?
thanks
Shouldn’t we be looking at spending cuts? The last time I looked the Iraq and Afghanistan wars were costing $800 billion. That would be a good place to start.
That a bunch of experts all at-least-slightly left-of-center would recommend a VAT is notable, because the VAT is known to be a “regressive” tax…
Yes. Perhaps you could explain the puzzle of so many progressives all endorsing a regressive tax increase while being so opposed to progressive spending cuts?
Here’s the logic of arithmetic: Entitlement benefits are greatly underfunded going forward. We all know that in our progressive world, as things stand now, the bulk of the cost of this going to land on the rich — either by paying the bulk of the taxes to make up the shortfall, or by having the their benefits cut by means test. So either…
1) Progressive income taxes on the rich go up a lot, or
2) The benefits of the richest go down a lot (or combination thereof)
But being that there is nothing either efficient or “progressive” about raising taxes a lot to pay transfers to the rich; and that progressives apparently just don’t like the idea of cutting benefits, even to the rich, period, they are now coming around to favoring a new option…
3) A VAT that will act regressively as a consumption tax on the poorer to fund transfers to the richest.
Can somebody please explain to me how, by measure of progressiveness, #3 isn’t the worst option of the lot?
Really, this makes it look to me like the defining trait of contemporary “progressivism” is a drug-addict’s-like refusal to consider any spending cuts whatsoever.
Today, Warren Buffett’s employees at Dairy Queen have payroll tax subtracted from their first dollar of wages to pay his Medicare and Social Security benefits. Now, on top of that, they are supposed to additionally pay a VAT to be sure Warren’s benefits won’t have to be cut? And this is progressive??
Earlier you wrote:
Really??
Has the Earned Income Credit been undermined by not being available to the rich? Medicaid spending is dropping in how many states? Federal assistance for higher education has been undermined by the FAFSA form that means tests the parents of every college student (by value of home, total in savings, amount of income, everything) before the college sets its
price discriminated“needs based” tuition charge for the student?Society is *so* means-tested today — from income tax to EIC to Medicaid to Sec 8 housing vouchers to assistance for low-income public school students and on and on and on, that multiple studies show lowest-income individuals face effective marginal tax rates exceeding 100% due to the loss of benefits with rising income, and that this is significant perpetuator of poverty.
How many of these programs have been undermined by not being available to the well off?
If the honest answer is “none”, how does this square with your concern?
Of course, progressives have been the driving force behind all of this mass of explicitly means-tested programs and policies. So why is it that they (you) are so concerned about means testing only Social Security and Medicare??
(A person a bit cynical about the politics of it all might think the reason is: a major, if not the #1, driver behind the progressives’ ride into political power has been feeding ever-more entitlement benefits to all seniors. AARP as the progressives’ #1 constituent. Blowing up that political base by suddenly going to AARP, “Hey, you are a special interest that we’re cutting back on the basis of need and merit” would amount to a political self-nuking. Being how that must be avoided, progressives need a progressive rationale to avoid it … “if we cut back helping the rich, we will become unable to help the poor”… but enough of that, let nobody accuse me of cynicism regarding politics.)
For progressives to say, “if we don’t raise taxes on the poorer to pay the richer we’ll become unable to help the poorer” seems to me something of a ‘just so story’ sitting on a scale somewhere between “convenient” and “gross hypocrisy” — and I have no idea what could possibly be behind such a thing.
Anyway, here again is Keith Hennessey’s picture of the bottom line (especially that last chart). As Gene Steuerle put it, “If spending is always growing faster than the economy, you never catch up”.
Even progressives who can do that much arithmetic must admit that there is no way tax increases alone will ever close that gap — not even if you add a VAT, and a head tax, a Georgist 100% land value tax, and whatever else you want.
So, it seems to me, “progressives” have *two* good reasons to start saying the words “cut spending”.
#1) It is the progressive option compared to raising taxes to pay benefits to the rich — especially compared to doing so with a regressive VAT.
#2) Reality. It is going to impose itself in the end. Dealing with is sooner is better than later.
The only realistic, effective program that can be adopted to close the future monster budget gap by those concerned about it today is to start preparing for, lobbying for, a future deal of: “tax increases for spending cuts … spending cuts for tax increases” — as we saw in closing Social Security financing gap in 1983.
Yet still, among progressives the courage to say “spending cuts” remains missing — even when the only alternative is regressive.
As I’ve said before, it takes a lot more courage to say “cut spending” than it does to say “increase taxes”. Eh?
Apropos of Jim’s point re: means testing, here’s a post I wrote last year, “Means Testing Social Security & Medicare: A Conceptual Framework for Deciding” http://swordscrossed.org/node/2192