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Financial Planning > Tax Planning > Tax Reform

Tax Reform Panel Tells Senate to Consider Value-Added Tax

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Senate Finance Committee Chairman Max Baucus, D-Mont., opened the second in a series of Tax Reform hearings on Tuesday with a quote from former President Dwight D. Eisenhower: “Neither a wise man or a brave man lies down on the tracks of history to allow a train to run over him.” 

Baucus asked, “Why do we need tax reform?” as he introduced the hearing, “Does the Tax System Support Economic Efficiency, Job Creation and Broad-Based Economic Growth?”

Baucus (right) stated that tax reform is needed to “stimulate economic development, encourage business activity, promote fairness and certainty and minimize regulation.” He added that after “7.5 million lost jobs since the beginning of the Great Recession, we need a tax code that puts Americans back to work.

Last Thursday, a different expert panel urged the Senate Finance Committee to consider some controversial reforms in addition to cuts in spending, including elimination of the health care exemption and the mortgage deduction; a potential consumer, or value-added tax, and finally addressing the myriad issues of the alternative minimum tax. See “Tax Reform Panel Tells Senate to Eliminate AMT.”

‘First Do No Harm’

Sen. Orrin G. Hatch, R-Utah, the ranking Republican member of the committee, urged that tax reform“first do no harm.” He noted that the current tax code “creates jobs…for CPAs and tax attorneys.”

The expert panel included Alan Auerbach, PhD, Robert D. Burch Professor of Economics and Law, University of California Berkeley; R. Glenn Hubbard, PhD, Dean and Russell L. Carson Professor of Finance and Economics, Columbia University Graduate School of Business; Dr. James K. Galbraith, PhD, Lloyd M. Bentsen Jr. Chair in Government/Business Relations and Professor of Government, The University of Texas at Austin, and son of the economist John Kenneth Galbraith; and an attorney, Michael Graetz, Isidor and Seville Sulzbacher Professor of Law, Columbia Law School.

Auerbach set the stage by outlining some of the most serious issues America faces, “very high unemployment, and very high, growing national debt.” He added that “Tax reform is not necessarily inconsistent” with “continuing growth out of the recession. Additional economic growth can generate additional tax revenue. Given how desperately we need additional revenue, [we] need as efficient a tax system as possible—a bad tax system gets worse as we try to raise more revenue from it.”

Tax expenditures [are] somewhat controversial, Auerbach explained; it’s “worth asking if this provision, if it costs lot of revenue, is worth having.” The mortgage interest deduction is “not the worst example…we could promote homeownership much more cheaply than we do through the mortgage deduction,” which, he asserted, “leads to overinvestment in housing.”

On the corporate tax front, Auerbach recommended exploring a “lower corporate-tax rate, moving to a territorial tax system and paying by reducing corporate tax expenditures,” which may be “expensive or flawed.

Taxes and Economic Growth

“Tax policy has potential to change the country’s economic growth rate,” said Hubbard. “Many tax policies have been short term,” and we need a “long term” view to fix the tax code. “Higher investment can help reduce unemployment,” he said, adding that we need a “benchmark where income is taxed no more than once; [it] can be a consumption or income tax.”

Hubbard urged congress to “get depreciation right” for corporations…We also need a corporate-tax structure that would not continue to encourage leverage,” which “wouldn’t distinguish between debt and equity spending by corporations.”

“Focus first on corporate income tax, not that the U.S. statutory rate is too high,” said Hubbard, but consider a “territorial tax,” for corporations.

Regarding the “deficit—[if it is] principally outcome-dependent on economic performance, the goal should be to affect economic performance,” according to Galbraith. There’s “no such thing as neutral tax. The tax reform act of 1986 [was a] remarkable reform, an adroit bipartisan effort that saved the income tax.”

That said, it left “two broadly undesirable effects,” according to Galbraith: the “tax rate structure encourages high CEO compensation,” and the mortgage deduction led to “over consumption” of housing, resulting in the housing bust and underwater homeowners. Moving “forward, there is little reason to make lower marginal rates, or deductions, goals for their own sake,” however, the “mortgage interest deduction, the earned-income credit, and the exemption for munis served well, and should be preserved,” Galbraith concluded. He added that the “payroll tax is a nasty piece of work, should be eliminated.”

Galbraith added something this reporter hadn’t heard so far in the tax debate: “The estate tax, part of social architecture for century, is a powerful incentive for philanthropy, which provides for 8% of employment.” Galbraith went on to suggest that Congress “consider effect [of reforms] on state and local governments,” and added that currently, “we have a mal-distribution of income and power.”

You “don’t need economics degree to know that the tax system doesn’t support,” spending, said Graetz. The “tax system is much more complicated this time than 1986.” He added “Fairness in tax reform requires that we not shift the burden down the scale—burden wealthiest without raising income tax rates.”

Graetz said that we “compete for capital around the world…the U.S. needs [to encourage] domestic investment by foreign and U.S. citizens.” The “highest corporate tax rate” provides incentive “for people to borrow here and shift capital abroad.” But he cautioned that a corporate “cash-flow tax would violate trade and income-tax treaties,” and it would be “difficult enough [to have] serious tax reform without having to renegotiate every trading treaty throughout the world.”

Graetz recommended that Congress reform taxes by allowing an “exemption of $100,000 from income tax; lower the tax rate to 15% on income above $100,000, 25% on income above $250,000,” and add a “value added tax (VAT) at a 14% rate. “ The U.S. is, the “only OECD country without a VAT.”

‘What Should the Top Income-Tax Rate Be?’

Hatch asked “Where should the top marginal tax rate be? If revenue neutrality is a ground rule, if the top rate was [greater than] 35%, would that yield efficiency gains?”

Auerbach said, “Raising marginal tax rates doesn’t improve efficiency—the argument would be based on belief it would lead to a more progressive tax system.”

Hubbard added, if we “had broad-based consumption tax (VAT) in place, it could [deliver taxes] from high-income people. [But] the spending side matters too.”  

Galbraith noted that “after the War, income-tax rates eroded de facto with exemptions and deductions until it was revenue neutral in reform with lower rates at the base (1986).”

What About a ‘Promise to the Future?’

Sen. Jay Rockefeller, D-WVa., said while he was “not comfortable with $14 trillion in debt, Congress seems [obsessed with] reducing debt, deficit, cutting spending, on things that give promise to the future: [programs like] America Competes and Head Start. What’s bigger threat to economy and future—cuts to programs that benefit lower-income Americans or reducing the deficit and debt?”

The “consequences of the Great Recession and financial crash probably will be here for long time. It’s playing with fire to aggravate that problem by cutting federal programs that provide relief and assistance to lower income Americans,” Galbraith said. How reform goes “with taxes and spending may repair the deficit, but impairs the economy, leaving us with as large a debt.”

Rockefeller asked Galbraith, “If we ignore future aspirations and capabilities of America Competes and that sort [of program], in the long term do you believe we do the country more damage?”

“I do,” said Galbraith.


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