Wednesday, June 14, 2017

ABA-Tax Analysts Tax Reform Panel

Today at NYU I participated in a panel, sponsored by the ABA and Tax Analysts, regarding the current prospects for tax reform (be it so-called or actual). My fellow panelists were Ajay Mehrotra, Peter Merrill, Ray Beeman, and Lee Sheppard. Here's a photo (courtesy of the Tax Analysts Twitter site). I'm second from the left, and the others are in the order in which I named them above.
Here's more or less what I said during my speaking slot near the start of the session (much of it based on the content of these slides):

There's an old joke in which a proud mother, watching her son march with the high school band, says: "Will you look at that! Everyone's out of step but my Johnny."

The U.S. federal tax system invariably brings this joke to my mind, at discussions of tax reform, because of how it differs from everyone else's.  All peer countries have a VAT, a lower statutory corporate rate than we do, and less relative reliance in their tax systems on income tax revenues.

It's not just due to the wisdom of crowds that we might reasonably suspect that we have it wrong. Our distinctiveness also contributes to the facts that (a) our tax system is more progressive than the norm, but (b) our overall fiscal system is considerably less progressive than the norm, plus (c) we have worse problems of tax competition and tax inefficiency than we would have if we conformed to standard global practice.

All that being said, tax reform is easy.  All that we need to do is: (1) enact a VAT, (2) lower our statutory corporate tax and overall reliance on income tax revenues, plus (3) take care of THE REST - i.e., make all other changes that are needed to get to an overall tax and fiscal system that we like.

Obviously, I'm kidding when I say that tax reform is easy. Even leaving aside the political issues, which I'll turn to shortly, the big problem lies in properly defining "THE REST." It includes deciding on: revenue levels going forward, spending levels going forward, and achieving desired distributional goals - which relate to people on both the top and the bottom of the wealth/income spectrum.

But the thing is, properly handling "THE REST" should mean that one can get a better fiscal system, by one's lights, whether one is on the left or the right politically, or anywhere in between.  Indeed, it even should mean in principle that there potentially are "Pareto deals" available from the standpoint of people on the left and the right. If they could negotiate in good faith towards creating a stable new fiscal system that included a VAT, there ought to be available options, with regard to "THE REST," that would leave both sides happier than they are now. For example, the left could get a bit more funding for social spending, the right a bit less capital income taxation, and if there is increased efficiency and inbound investment there ought to be a source of surplus available for them to split to mutual advantage.

But there are two problems that impede our getting to this happy state: (1) our broken politics, which would prevent us from either negotiating the Pareto deal or keeping it in place afterwards, and (2) the apparently unshakable political constraint against our having an explicit VAT.

Why can't we have an acknowledged VAT? Part of the problem is historical (1970s tax revolt, defeat of Al Ullman in the 1980 election after he advocated a VAT, Reagan "revolution," etc.). But it's more than just historical - after all, decades have passed since then, and it still seems to be true.

To my mind, the key to why we can't have a VAT lies partly in the old Larry Summers joke that's frequently quoted but rarely analyzed. Larry reportedly said: "We don't have a VAT because conservatives view it as a money machine, and liberals view it as a tax on the poor. But we'll get it when liberals figure out that it's a money machine, and conservatives see that it's a tax on the poor."

People usually just mention this joke and move on. But there are two odd things about it. First, it's paradoxical. Why should liberals and conservatives be so myopic in opposite ways? Even if it's true, it doesn't make sense without further explanation. Second, it seems to make a prediction ("we'll get it once..."), but the prediction doesn't seem to be coming true.

So how can we explain these two odd aspects? I see two main points. First, even outside the US it's politically hard to introduce a new tax such as the VAT. In many countries, it got help from, say, its replacing rightly disliked gross receipts taxes, or being a precondition of joining the EU, or responding to a fiscal crisis. Without something like that, it's a hard political sell even without crazy US politics.

Second, US political dissensus, and both sides' risk aversion, stands in the way of a deal. While it's true that a tax system with a VAT can be superior to what we now have, from either a liberal or conservative standpoint, so long as "THE REST" is properly specified, it's also true that a VAT would permit either side (if it had control) to make the system worse, from the other side's standpoint (for the reasons that the Summers joke identifies). So the players are angsty about a VAT unless they are confident enough about what "THE REST" will look like, not just today but also in the future.

The end result is that one can only introduce a VAT by camouflaging it. And as it happens, for a structural reason only Republicans can currently do this. They can sub it in for the existing corporate income tax, and not admit that it's a VAT, thus avoiding both the label and the creation of a new tax instrument. But the Democrats can't do this, given that they generally want to retain the corporate income tax, unless they can identify something else to replace it with. (Here the payroll tax comes to mind, but the problem is that one can't turn it into a VAT and claim that it's still the payroll tax - whereas one can convert the corporate income tax into a VAT and pretend it's still a corporate income tax.)

Examples of a disguised VAT that would replace the existing corporate income tax include (1) Ted Cruz's "business flat tax" from the 2016 campaign, which Marco Rubio correctly, if inelegantly, called a "VAT tax" (i.e., a value-added tax tax), and (2) the destination-based cash flow tax (DBCFT) from this year's Ryan plan.

The DBCFT appears to be politically dead, but the episode was nonetheless politically illuminating. The public didn't understand it, and I thought at times that tax policy experts got a  bit confounded by it as well. Now, experts individually and collectively did a really outstanding job of analyzing, for example, its trade effects, the currency issue, possible legal problems under the WTO and tax treaties, etc. But where I thought they sometimes went wrong is in thinking of it as  really a thing - like, say, the Bradford X-tax is a comprehensive thing - rather than as an assemblage of distinct proposals that is incomplete unless one specifies the rest of the fiscal system.

Conceptually, the DBCFT has 3 main parts. First, it creates a VAT - clearly, in my view, a good thing if "THE REST" is suitably tailored. Second, it lowers the origin-based corporate income tax to zero. There are reasonable arguments for doing this, but in my own view (shared, for example, by business tax reform plan authors such as Toder & Viard, Altshuler & Grubert, and Kleinbard) zero is too low here unless one sufficiently fixes a bunch of other things as well. Third, it has its own "everything else," - including, in particular, a wage deduction. But (a) one can't really assess the wage deduction without looking at how wages are treated overall by the tax and fiscal system, and (b) we still haven't really fully specified the rest, so it's hard to tell without more if the sum total is good or bad. Also, putting the wage deduction into the same tax instrument as the VAT, instead of adjusting the overall treatment of wages somewhere else in the tax or fiscal system, appears to have huge downsides - pertaining, for example, to WTO and tax treaty issues, along with the refundability problem for exporters that would always have "losses" by reason of paying wages.

The apparently politically adverse fate of the DBCFT may tell us that disguising the VAT doesn't sufficiently address the political obstacles to adopting it. And I am not optimistic regarding the merits of what Congress might do this year instead. If they vastly increase the fiscal gap and also fail to achieve bipartisan buy-in, they will just be making things worse (and more unstable) and setting the stage for more and more lurching "tax reforms."


Andrea Martinello said...

"camouflaging" "disguised VAT" Puviani's theory still makes sense :-)#fiscalillusion

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DM Hasen said...

Although the problems you identify with reaching some kind of agreement on reform are partly based on structural disagreements (e.g., the Larry Summers joke), they also seem to be based on revenue considerations: Democrats will not sign on to a reform package that slashes revenues, while Republicans won't sign on to one that doesn't. This problem suggests Congress might make headway by decoupling rate reform from structural reform. It might be able to reach a meaningfully bipartisan agreement on the latter even though any measure to reduce rates will be passed by the Republicans only. The revenue measure will have a maximum 10-year window (subject to the outcomes of future elections), but the former could be more stable and might even be reasonable.

One could turn the point around by noting that a version of this two-step process is what happened in 1986. Reagan agreed to revenue neutrality, which is similar to simply decoupling the two questions, since revenue measures can always be introduced later.

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