What should the Grand Bargain look like?

It’s 2010.  That means WWII ended 65 years ago.  And that means a fiscal train wreck is approaching fast.  And that means it’s time for one of those committees of “wise men” to reach some sort of grand bargain, which provides political cover for both sides. 

WASHINGTON (AP) — President Barack Obama Saturday endorsed a bipartisan plan to name a special task force charged with coming up with a plan to curb the spiraling budget deficit, though the idea has lots of opposition from both his allies and rivals on Capitol Hill.

The bipartisan 18-member panel backed by Obama would study the issue for much of the year and, if 14 members agree, report a deficit reduction blueprint after the November elections that would be voted on before the new Congress convenes next year. The 14 would have to include at least half of the panel’s Republicans — a big obstacle.

“These deficits did not happen overnight, and they won’t be solved overnight,” Obama said in a statement. “The only way to solve our long-term fiscal challenge is to solve it together — Democrats and Republicans.”

The deficit spiked to an extraordinary $1.4 trillion last year and could top that figure this year as the struggling economy puts a big dent in tax revenues. Even worse from the perspective of economists and deficit hawks, the medium-term deficit picture is for deficits hitting around $1 trillion a year for the foreseeable future.

Before I begin, I’d like to clarify a few points.  I am not going to discuss my preferred solution, which is the Singapore small government model.  Rather, I will consider a solution that might actually be politically feasible given the realities of American politics, although even I’d admit it would be a stretch.  And finally, I will use numbers that I think are plausible, but the actual numbers would be somewhat different, as I am not a walking computer.

The basic problem is that the current trajectory of spending and taxes is not sustainable.  For most of my life federal spending has been around 21% of GDP and federal taxes have been around 19%.  The 2% of GDP budget deficit has been sustainable, indeed the debt/GDP ratio in 2008 wasn’t much different than the year I was born (1955.)  But we no longer are on a sustainable path.

For simplicity, assume spending is likely to move to a 26% of GDP plateau; that means we then need another 5% of GDP from taxes.  Experts on the European model such as Peter Lindert say that they are able to support large governments only by having relatively efficient tax systems, which rely more heavily on regressive taxes like the VAT, the payroll tax, and the gas tax.  The progressivity of their system comes from bigger government benefits programs for the unemployed, health care, child care, etc.  This is pretty much common knowledge among the smarter public finance economists on both the left and the right.

As of today, President Obama is not in a strong negotiating position.  I think he understands that the government needs more money if the Democrats’ goals are to be achieved, but also knows that Congressional Democrats would not be enthused about implementing a 12% VAT and higher gas taxes on a party line vote.  And I can’t blame them.  The Republicans have three choices.

1.  Put “moderates” on the commission who will cave into the Democrats’ demand for a VAT, in return for token Republican objectives.

2.  Stonewall, letting Obama stew in his own juices until they can re-take power.

3.  Do the sort of grand compromise I will describe below.

I think Republicans would be foolish to choose the first option, but that hasn’t always stopped them in the past.  The most likely scenario is the second, but that isn’t necessarily in their interest either.  When they retake power they are going to be faced with the same difficult decisions, and the Democrats would (quite rightly) be reluctant to bail out a Republican Party that had just refused to cooperate with them.  So what sort of grand bargain would be fair to both sides?  The answer starts from the insight that the public policy world is full of “free lunches,” or changes in public policy that produce massive net gains for society.  I will try to describe one such policy package:

1.  Raise about 7% of GDP through a VAT (and gas or carbon tax if you wish; those details aren’t important here.)  Now you have an extra 2% of GDP to work with.

2.  Abolish the income tax.  I seem to recall that the income tax raises about 8% or 9% of GDP.  So to get the extra 5% percent of GDP you would need another tax to raise about 6% or 7& of GDP in other taxes.

3.  The other tax would also have to be very progressive, or else the Dems will never go along.

4.  Increase the payroll tax on upper-middle class and wealthy American enough to raise at least 6% of GDP.  Currently the tax has a flat rate of about 15.3%, and then drops to about 2.5% somewhere over $100,000 a year.  Under my plan those making over $100,000 would face a marginal payroll tax more in the 25% to 40% range, although I have no idea what the exact numbers would be.  There would probably be a graduated system, with perhaps a 20% rate for those making between $60,000 and $100,000.   The EITC might have to be increased a bit to offset the VAT, and ditto for low income Social Security recipients.   The experts would tweak the rates so that the overall progressivity of the tax system (including the VAT) is roughly unchanged.  I think that would be necessary to getting any deal.

5.  Then we need to follow Steve Forbes’ advice and abolish the income tax entirely.  If we try to simply reform it (as in 1986) the bracket creep and loopholes will gradually return over time.  If we abolished it entirely that would represent a pretty definitive repudiation of the whole idea.  The Senate would likely filibuster any future attempt to reinstate it.

6.  That would be enough, as even liberal economists understand that a progressive consumption (or payroll) tax is better than an income tax (which double-taxes saving.)  But it would still look unfair to the average person as the rich coupon clippers wouldn’t seem to be paying much tax at all (although they actually would be paying taxes indirectly).  So you change the system so that taxation of capital is done at the source.  Banks would withhold taxes on interest, bond issuers on bonds, corporations would withhold taxes on dividends before they are paid out.  This means taxes on capital could not be progressive, but that’s not much of a problem as the poor receive very little capital income.  Any distributional effects could be offset by tweaking the payroll and EITC rates.  We could also allow corporations to expense new investment, which I believe would greatly reduce the problem of “double taxation of saving.”  I’ll leave the complex issue of taxing capital to the experts.

What are the advantages of this deal?

1.  Republicans get rid of the hated income tax.

2.  Democrats get political cover to expand the federal government as a share of GDP through higher taxes.

3.  Neither side wins or losses through changes in progressivity.

4.  Most importantly, you get massive net efficiency gains over the more likely alternative.

And what is the more likely alternative?  A mushy compromise.  Government only grows by 3% of GDP, not 5%.  The other 2% is cut through means-testing entitlements and other changes.  The income tax stays in place, massively distorting health care, housing, and all sort of other sectors.  In addition, using up valuable labor to deal with the complexity of the system.  Also remember that means-testing is really just another implicit marginal tax rate, so no Republican that worries about high MTRs should go for a plan that slightly reduces the growth in explicit taxes, if the means-testing raises IMTRs.  And means-testing means even more complexity, more forms to fill out.

By now you must think I am a John Lennon-type dreamer.  Yes, but I’m not the only one . . .

Seriously, it is a long shot, but maybe a bit less far-fetched that it seems.  There is currently near-total gridlock in government.  Any deal at all would be extremely difficult to achieve.  But at some point there simply must be some sort of deal.  And don’t talk about inflation as a solution, a bit more inflation would help a lot right now, but it doesn’t address the long run steady-state issues.  You can choose to be as cynical as you want, but we aren’t going to have 50% steady-state inflation in this country.  It will be higher taxes and/or lower spending.  Given that my proposal has such large net efficiency gains as compared to the more likely alternative, it’s not impossible that such a compromise might emerge from a committee of statesmen (and women.)  Whether it can get through Congress is another thing.  But sometimes you need to be so bold that the special interest groups just get overwhelmed, or form a circular firing squad.  The cut in the top rate from 70% to 28% under Reagan did hurt some special interest groups, but it also got substantial support from both liberals and conservatives in Congress. 

In the end what makes me slightly optimistic about this solution is the incredible difficulties of achieving any other solution, combined with the fact that some sort of deal will almost certainly need to occur within the next 10 years.  The alternative muddled compromise that I described earlier could also be constructed in such a way as to appear to leave the balance of power relatively unchanged.  But in practice, any gains to the Republicans would be ephemeral, as their preferred reforms would be washed away over time, while the VAT would hang around forever.  That might seem to imply that the alternative approach is better for the Democrats.  But I don’t see it that way, as public finance isn’t a zero sum game.  In a two party system the two parties will always take turn governing, that is a given.  The real question is: What sort of policy outcomes do we get?  And that is far from being a zero-sum game.

PS.  I would allow states to piggy-back onto this system if they wished, so that they could also raise taxes more efficiently.  This would allow states to abolish their income and sales taxes, and replace them with VATs and progressive payroll taxes.  Also, if you are comparing the 26% of GDP to European numbers, don’t.  You need to add in state and local spending.  If the US federal government moved up to 26% of GDP, then total government spending would move up to the bottom end of the Western European level, and above Australia/Canada/Japan, unless I am mistaken.  Given the anti-tax character of Americans, I don’t think the Democrats could realistically expect anything higher.

PPS.  Totally off topic, but if you like bizarre political humor you might find this funny.  It’s from an actual German movie I saw a few years back (I believe called Downfall), but the subtitles have been changed.  (BTW, I hope it goes without saying that the humor obviously isn’t really directed against either party.)


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34 Responses to “What should the Grand Bargain look like?”

  1. Gravatar of Mike Gibson Mike Gibson
    24. January 2010 at 13:06

    Reader request: I’d love to see that post on the Singapore small government model!

  2. Gravatar of Doc Merlin Doc Merlin
    24. January 2010 at 14:06

    No way, scott. I’m loving the gridlock.

  3. Gravatar of Thorfinn Thorfinn
    24. January 2010 at 15:10

    As Mankiw has pointed out, an income tax with savings exemptions is basically a progressive VAT. Adding more tax-sheltered forms of savings gets us a long way towards your ideal, and is probably easier.

    The big difference would be the mess of deductions–health insurance, mortgages, state/local taxes–that total around ~500 billion a year. The Republicans could agree to trade them all away in exchange for cutting the payroll tax.

  4. Gravatar of Mrs. Davis Mrs. Davis
    24. January 2010 at 15:14

    The key assumption you have made is that an increase of the share of GDP the Federals get to 26% is acceptable because we are becoming a European nation. That’s what’s not acceptable to me. Tell me how we get to the Singapore model.

  5. Gravatar of Kevin Dick Kevin Dick
    24. January 2010 at 15:43

    Another vote for describing your recommendation (even if it is very low probability) for getting to the Singapore model.

  6. Gravatar of TGGP TGGP
    24. January 2010 at 16:22

    A Venezuelan gamer unloads on Chavez here.

  7. Gravatar of david david
    24. January 2010 at 16:30

    Hi Sumner. I don’t know if you take requests, but it’ll be great if you wrote an elaboration on what, precisely, you mean when you say “Singapore model” – your past posts have alluded to mostly the Singapore healthcare and savings plans. Elsewhere details have been pretty sparse; even Singapore has an income tax. Would you also endorse Singapore-style generous helpings of sin taxes to raise revenue, or would that be too much of “petty authoritarianism”?

    More generally, the actual-Singapore government has a huge hand in the country’s economy and political landscape despite its low fiscal numbers. If I read your past writing correctly, you would be willing to discard this element (even if it means higher costs)?

    If you have written about this, I apologise – Google isn’t showing anything up, and I don’t recall anything from your previous posts.

  8. Gravatar of Tom Hickey Tom Hickey
    24. January 2010 at 16:58

    I don’t see a grand bargain in the making politically. First, the GOP is doing just fine being the party of no in their view, stopping “Obamacare” and with Brown’s unlikely win in MA. Secondly, being perceived as the party of “fiscal responsibility” is in tune with the tenor of the times, since a large number of people buy into the analogy between household finance and government finance. Even the president thinks that the US is running out of money, even though this is absurd for a monopoly provider of its own non-convertible floating fx currency of issue, with all its debt denominated in its own currency. It’s doubly absurd in light of present circumstances.

    In my view the Democrats would be best served by proposing a version of Abba Lerner’s functional finance updated for a non-convertible floating rate currency of issue, and pitching the government’s prerogative of currency issuance as the corresponding responsibility to provide the appropriate amount to balance NAD with real output capacity, injecting when C, I, and NX result in insufficient demand to purchase the goods and services capable of being produced, and reducing NFA as demand becomes excessive in relation to real output capacity, threatening inflation.

    Functional Finance: What, Why, and How? by Stephanie Bell University of Missouri at Kansas City

    This is probably too big a leap politically, however, in light of the prevailing economic universe of discourse, which is still influenced by gold standard thinking that assumes a convertible currency and fixed rates, and government that is financially constrained by them.

    But Lerner proposed functional finance back in the 40′s, so maybe it is time to revisit it. Functional finance updated present some interesting possibilities that mesh with the Democratic agenda, and it would undercut the conservative fiscal scolds and libertarian sound money crowd.

    I would venture to say that without some kind of innovative approach along these lines, the Democratic agenda is in big trouble, and we may be looking at a double dip a la 1937 if the deficit doves prevail.

  9. Gravatar of Mario Mario
    24. January 2010 at 17:55

    In order to get a realistic plan to replace the income tax with a consumption tax, you would need to include a phased-out exemption of some sort for seniors who accumulated their savings under the old regime. They’d never sign on otherwise, and they probably shouldn’t.

  10. Gravatar of StatsGuy StatsGuy
    24. January 2010 at 18:16

    The problem isn’t discretionary govt. as % of GDP – that’s dropped by 30% since you were born (15% of GDP to 10%), it’s transfers as % of GDP. What’s wrong with less than 26% of GDP? – but that means cutting social transfers, which are a consumption subsidy. Good luck running on that platform.

    Here’s another suggestion for a grand compromise:

    Reduce income to a flat tax with a simple deduction structure or a VAT, cut transfers across the board (including medicare), hike the savings rate, then use tax policy or direct fiscal expenditures to encourage massive investment in infrastructure (especially energy-import-substituting infrastructure, which we should be doing regardless of whether we had a utilization gap or not), and if demand falls then use monetary mechanisms to close the difference (which will probably involve devaluation too). Oh, and hike bank capital ratios to 20% of assets (for any bank operating in the US, including foreign banks), to anchor velocity.

    Any chance? Nada.

    Part of the political intransigence we’re seeing right now is generational warfare; the older fixed-pension social security dependent non-savers who are trying to preserve their consumption power in their waning years by holding to a strong dollar and forcing the govt into deeper debt (even as unemployment skyrockets), vs. pretty much everyone else. The legacy of the Boomers.

  11. Gravatar of Mark A. Sadowski Mark A. Sadowski
    25. January 2010 at 06:13

    Many of these same issues have been addressed by Bruce Bartlett. In general he advocates instituting a VAT as a way of raising more revenue efficiently in order to finance inevitably rising entitlement expenditures. A VAT has the further advantage of functioning as a WTO legal tariff. (Is it really a coincidence that virtually all of our trade parners have a VAT and that we also have trade deficits with nearly every one of them?)

    As far as tax reform ideas are concerned I personally like the USA Tax (unlimited savings allowance tax). It had some bipartisan support in the mid-1990s (I would guess there’s little chance of that now however). It would have replaced the corporate income tax with a VAT and the personal income tax with a progressive consumption tax. One of my field advisers wrote a book on it:

    http://mitpress.mit.edu/catalog/item/default.asp?ttype=2&tid=6126

    The progressive consumption tax (PCT) is something most people have trouble understanding. In general, consumption would be calculated by subtracting net savings from income. Households would have to file PCT returns annually just as they do now with the personal income tax. Bartlett opposes such an idea for reasons that are not totally clear to me. (Too progressive perhaps?) But then there was a time when he was violently oppossed to a VAT as well.

    It’s my understanding that there is a tax reform commission under the leadership of Volcker. They were scheduled to issue a report in December. (What happened to it?) However we have had several of these commissions since the Tax Reform Act of 1986 and little has come of them. (The most recent one under Bush gave fairly glowing reviews of the PCT).

    The problem however is that we have absolute gridlock in the federal government right now. When common sense supply side Republicans like Bartlett are booted out of conservative think tanks for daring to share their honest economic opinions how can anything be accomplished?

  12. Gravatar of StatsGuy StatsGuy
    25. January 2010 at 07:22

    By the way, here’s the other side of the coin:

    http://www.businessinsider.com/the-end-game-this-time-isnt-different-2010-1

    Essentially, “We’re all doomed. We’re going to pay the price, and there’s no way around it.”

    Why read something from John Mauldin? Because he has a readership of 1.5 million (claimed), and if you want a sense of the mood of the country, there you go.

    But here’s something rather critical. He (and many others, myself included) have quailed in terror at the two spikes in the famous Debt-to-GDP chart that he shows. But there’s something curious about both spikes. While Debt-To-GDP ratios were rising leading into the crisis (1929, and now), suggesting instability and reliance on short term debt rollovers had a role in the creation of the crises, note something that’s often left out of discussions… WHEN did Debt-to-GDP peak in the Great Depression?

    Was it 1929? Did, in fact, the Great Depression begin the reduction in Debt-to-GDP? Was Depression the “cure” to Debt ratio?

    No. It began private deleveraging, but at the expense of massive GDP contraction and increases in govt. debt (even under Hoover). The REDUCTION in Debt-to-GDP ratio began in 1933, 4 years INTO the Great Depression. And it occurred right about where Roosevelt devalued.

    Why do people always ignore this when they show this chart? I’ve seen this chart fifty times, and no one ever points out that the Great Depression peak was 4 years after it started, and thus could not have triggered the Great Depression.

    My suspicion is that the only way that Depressions are “functional” is by changing behaviors (of govt. and individuals). Notably, causing them to increase demand for savings (a shift in the demand curve, so more savings at any level of nominal income), so that monetary stimulus does not simply get channeled into even higher debt ratios.

  13. Gravatar of scott sumner scott sumner
    25. January 2010 at 07:28

    Mike, I seem to recall that Singapore has a flat rate tax on labor of about 15% or 20%, but am not certain. This early post mostly discusses Denmark, but ends up by arguing Singapore is superior.

    http://www.themoneyillusion.com/?p=368

    The key thing is they have very low taxes, and instead rely on forced saving plans. Since the savings goes into people’s personal accounts, it allows them to build wealth in a way our Social Security/health insurance/unemployment insurance system does not.

    Doc Merlin, Yes, but I’m afraid if the Republicans don’t try to get a deal abolishing the income tax, we’ll eventually end up with big government and the income tax. Does anyone really think the Republicans are going to massively cut Social Security and Medicare next time they take office?

    Thorfinn, Mankiw is completely wrong. An income tax exempting savings is nothing like a VAT. He is taking the academic view, looking at it in terms of abstract models.

    Each April is a nightmare for me, having to wade through my complicated taxes. And yet I spend zero time on the payroll tax, which by the way collects almost as much revenue as the income tax, despite much lower rates. And if we had a VAT, I wouldn’t need to worry about that either. VATs would mean some extra work for business, but it would be mostly offset by the likely abolition of the sales tax.

    I’m guessing Mankiw hires a tax accountant to do his taxes. He is also pretty wealthy, so perhaps he doesn’t think too much about the massive inefficiencies in the income tax. And I haven’t even mentioned deductions and exemptions. Most real world VATs are cleaner and less distortionary than income taxes. And don’t think we can just reform the income tax–we tried that in 1986, and it didn’t work, the complexity crept back in.

    Mrs. Davis, See my answer to Mike, above. I agree with your sentiments, but tell me how to get Congress to pass the Singapore model.

    Thanks Kevin.

    TGGP, When Chavez first took office, my Venezuelan students told me that not only was he a leftist, but he was also something of a moron. That his speeches on TV were long rambling exercises on nonsense.

    It is also important to remember, however, that Venezuela was poorly governed even before he took office. The mainstream parties opened to door for him through their own corruption.

    David, If people are seriously interested they should read the book “Singapore’s Success.” I am not enough of an expert to do anything more than provide the sort of sketchy summary you see in my posts.

    Regarding sin taxes, if the sin is against the environment, then I’d favor high taxes. Singapore has high taxes on gasoline and/or cars, and this means that Singapore is the only major Asian city that doesn’t have bad traffic jams and pollution.

    If the sin is drinking/smoking/fatty foods/drugs/gambling then I am not in favor of high taxes.

    I am pretty sure that their income tax is more like a consumption tax, as they exempt saving and investment. But I am not positive, so someone should check that out.

    BTW, even free market economies like Singapore and Hong Kong are far from perfect. There is no economy in the world that is laissez-faire. Hong Kong may be the closest, but even there the government controls the big real estate industry, making house prices very high and greatly reducing living standards.

    Tom Hickey, You don’t seem to realize that we are approaching a fiscal train wreck. The Republicans may be “doing fine” now (although I don’t think they are doing well, they have lost control of the government at all levels, even most state governments) but they need to think ahead to when they retake power. If they had to implement a VAT, can you imagine how unpopular they would be?

    BTW, there is no way of permanently financing a big budget deficit, say 7% of GDP.

    Mario, I alluded to that in my post, but it isn’t as big a problem as you think. The payroll tax is far better for most seniors than the income tax, so they’d gain more from that shift then they’d lose from the VAT. The low income seniors without any income would lose, but as I said that could be dealt with with a modest supplement to Social Security benefits for the elderly poor.

    Statsguy, As I said, I oppose the simple flat tax idea because we saw that the 1986 tax simplification didn’t work, the complexity crept back in. The income tax must be abolished. If the Republicans can’t get that concession, then they should just stonewall. Remember that the deal I propose is actually pretty favorable to the Dems. They get the bigger government they want, with no change in progressivity.

    I can’t imagine that low income seniors who rely solely on Social Sec. are behind our tight money policy. I doubt they even follow monetary policy closely. I am proposing 2% or 3% inflation. I don’t recall them being outraged in the 1990s and 2000s when we had 3% inflation.

    Obviously I agree with your ideas like encouraging more savings and carbon taxes, etc.

    I don’t think capital ratios worked well with the Basel accords. To many ways around it. Better to require minimum downpayments like some other countries do.

    Mark, The VAT is NOT A TRADE BARRIER. That is 100% false. It is completely neutral, treating imports and domestic goods the same way. Ask any trade economist in the world, and they will tell you the same thing.

    I’d be very surprised if Bartlett has advocated abolishing the income tax. If he has, good for him. It would be a horrible idea to add the VAT on top of the income tax.

    You said;

    “Households would have to file PCT returns annually just as they do now with the personal income tax.”

    That is a deal breaker for me. It completely misses the point of eliminating the income tax. The income tax is an oppressive monstrosity. It forces people to either break the law, or guess as to how much they owe the government. The Feds have never even defined income. See my answer to Thorfinn above. If the Republicans get suckered into something like this, then they are even more stupid than I thought.

    Can you imagine have to keep track of every dollar? Imagine having to calculate how much you consumed every year. It would have to be done on a cash flow basis. No thanks. The payroll tax is also a pure consumption tax, and is 100 times easier to calculate. And it can also be made as progressive as you’d like.

  14. Gravatar of Mark A. Sadowski Mark A. Sadowski
    25. January 2010 at 09:11

    Scott,
    I believe it is you who are wrong concerning the trade effects of VATs (correct me since you seem so sure).

    It’s my understanding that countries generally rebate VAT taxes when local producers export goods and assess a VAT upon imports. Thus it functions as an import tariff on those countries that have no VAT (the US and maybe a dozen much smaller countries). The WTO agreement allows rebates and assessments for VATs, but not rebates or assessments for most other forms of taxation, because, in most cases, there is no way of knowing exactly how much tax has been effectively assessed.

    The average VAT level is 17.7% for OECD members. This means that on average U.S. goods are effectively charged a 17.7 percent tariff when selling to another OECD country.

    As for Bartlett’s views concerning the income tax he has not to my knowledge advocating eliminating it (although I don’t necessarily think he would be opposed to eliminating it). He is much more concerned with how to finance the growing budget deficit in the long term. He wants a VAT in addition to our other taxes, although I know he is at least as interested in comprehensive tax reform as I am.

    With respect to the PCT I agree that defining personal income may be a problem and it could leave open a can of worms to be exploited later. I personally would probably count interest and dividends as personal income. I would also probably adjust capital gains for inflation and treat inheritances like any other form of personal income. (But I am purely speaking extemporaneously for myself.) And of course, as I said earlier, under the USA Tax corporate income would not be taxed.

    A PCT on a cash flow basis should be considerably more simple than our current system and would simply amount to a transition from our current system of taxing income to one of taxing consumption. Some income would be withheld by the IRS much as it is currently. Calculating total income and net savings should be fairly straight foreward. (One would also have to adjust for the imputed rent of owner occupied real estate but many other countries do that already.) Then one would simply consult a graduated table as there would be no credits, deductions or exclusions (although perhaps some form of adjustment for the size of a household may be deemed necessary).

    And as for the payroll tax I disagree with you. Even if it comes back eventually in the form of an entitlement it is not proportional to personal consumption. First, it is statutorily a tax on labor income. Second, since the supply of labor is very inelastic, the effective burden of the payroll tax falls almost entirely on the wages and salary of labor. Third, and most importantly, the tax is completely independent of labor’s consumption level, either in the present, or after coming back as a future entitlement.

  15. Gravatar of Assorted links | India News Blog, Latest News From India, Latest Blogs From India Assorted links | India News Blog, Latest News From India, Latest Blogs From India
    25. January 2010 at 09:12

    [...] 3. One proposal for The Grand Bargain. [...]

  16. Gravatar of Tomasz Wegrzanowski Tomasz Wegrzanowski
    25. January 2010 at 09:54

    Drastic changes like that are not going to happen, regardless of how much sense they make from policy point of view.

    Drastic changes means that the privileged will lose their status, and someone else will take their place. Politicians represent different privileged groups, so they won’t let anything like that happen.

    I’m willing to bet real money on intrade that the result will be stonewalling.

  17. Gravatar of Doc Merlin Doc Merlin
    25. January 2010 at 10:26

    Agreed Scott, income tax is an abomination and we need to get rid of it. However, in bargaining its bad to show your hand. One should act as if they want far, far more than they actually do, then settle.
    If any republican politicians open with a grand compromise, when they retake the house, it will end up with them not getting but a fraction of it.

  18. Gravatar of Doc Merlin Doc Merlin
    25. January 2010 at 10:27

    Oh a side note, i’d favor getting rid of capital gains tax as well. It would reduce some inefficiencies in financial markets and would effectively allow for alternative non-governmental currencies to function.

  19. Gravatar of Matthew Yglesias » Endgame Matthew Yglesias » Endgame
    25. January 2010 at 15:15

    [...] — I am still perfecting my unrealistic tax scheme, so for now check out this one. [...]

  20. Gravatar of cmholm cmholm
    25. January 2010 at 17:19

    Regarding Mr. Sumner’s approval of Singapore tax policy: as someone else pointed out, there’s a lot more going on than a tax bill. How does he feel about Temasek Holdings?

    http://yglesias.thinkprogress.org/archives/2010/01/temasek.php

  21. Gravatar of OGT OGT
    25. January 2010 at 17:47

    I have no problem with that deal. I feel like something also has to be done on the expenditure side, notably raising retirement ages and reining in health costs. Of course, we have just seen that there is absolutely no political constituency for health cost restraints, so good luck to us on that.

    I’d say medical waste is more of a problem than the income tax administration in pure GDP wasted. This is especially true if you take the view that (as I sort of do) that these tax breaks are mostly hidden, nontransparent spending programs, sometimes crazy and inefficient ones. But, administering these programs through the IRS is actually a bit easier than taking your contact lens receipts and home insulation work order down to the Medical Expense Bureau and the Home Fuel Efficiency Administration.

    I also see all the little deductions and such as a symptom of our political stalemate, Dems can’t get the spending programs they want passed and Republicans can’t get rates lowered so they both play around with a deduction here and a credit there. (See Obama’s new tack on the SOTU).

  22. Gravatar of Mrs. Davis Mrs. Davis
    25. January 2010 at 18:50

    tell me how to get Congress to pass the Singapore model.

    This Congress certainly won’t. But another might. The choice is up to the American people. We are going to have a debate on whether we can afford to let the Federal share of GDP rise to 26% and take us further down the Road to Serfdom or whether we are prepared to take responsibility for our health care and retirement, even at the cost of a reduction in both, at least for the short term.

    I have no idea how this debate will turn out. Much will depend on what else will be happening in the broader world when we are forced to decide. But I suspect we are likely to choose an American model and not a Singaporean or a Swedish model. Upon its success lies the future of the Republic and the ability of mankind to responsibly govern itself.

    That’s why they called it the study of Political Economy at my college.

  23. Gravatar of scott sumner scott sumner
    26. January 2010 at 07:07

    Mark, You said;

    “I believe it is you who are wrong concerning the trade effects of VATs (correct me since you seem so sure).
    It’s my understanding that countries generally rebate VAT taxes when local producers export goods and assess a VAT upon imports. Thus it functions as an import tariff on those countries that have no VAT (the US and maybe a dozen much smaller countries). The WTO agreement allows rebates and assessments for VATs, but not rebates or assessments for most other forms of taxation, because, in most cases, there is no way of knowing exactly how much tax has been effectively assessed.
    The average VAT level is 17.7% for OECD members. This means that on average U.S. goods are effectively charged a 17.7 percent tariff when selling to another OECD country.;”

    I hope this doesn’t sound arrogant, but when I am certain about a theoretical point, you’ll find I am usually right. You are right about the facts, but not the interpretation. It is true that American built goods sold in France must pay the French VAT, but that is equally true of French built goods sold in France. French exports to the US don’t pay a VAT, nor do US goods sold in the US. The VAT is nothing more than a French consumption tax, on anything consumed in France. I am not trying to sound overconfident because I am an expert (I’m not), but rather because I know that the people who are experts on international trade 100% agree that a VAT is not a trade barrier. There really isn’t any dispute over this.

    You said;

    “I personally would probably count interest and dividends as personal income. I would also probably adjust capital gains for inflation and treat inheritances like any other form of personal income.”

    Most liberal and conservative tax experts agree that consumption should be taxed, not income. So there is really no justification for taxing interest and dividends. You are essentially taxing future consumption at a higher rate than current consumption, or double taxing saving, as some people put it. I included a tax on this income because there is so much confusion about the issue that I thought it would be politically easier to tax it and then expense actual investments to offset the effect.

    Don’t even think about indexing capital income for inflation, do you want to have to covert all you flows in an out of mutual funds into real variables. What a nightmare! Furthermore, if someone really believes in taxing cap gains (and I don’t) you should tax them when they occur, not when the asset is sold. The fact that they aren’t treated this way explains why the government sharply limits tax write-offs from cap. losses. It’s a chain reaction, one bad policy leads to another, which leads to another . . . Taxing capital income of any sort is an abomination.

    You said;

    “Even if it comes back eventually in the form of an entitlement it is not proportional to personal consumption. First, it is statutorily a tax on labor income.”

    Again, the experts disagree with you. The first thing you learn in public finance courses is that in the long run a flat 10% tax rate on labor is identical to a flat 10% tax rate on consumption. (Except at the moment it is implement.)

    Here is a general piece of advice. DO NOT USE COMMON SENSE TO TRY TO FIGURE OUT THE INCIDENCE OF TAXES. It doesn’t work. For instance, it is easy to construct plausible scenarios where 100% of a corporate income tax falls on labor. Indeed that is approximately true for countries like Ireland.

    Tomasz, In the short run you might be right about stonewalling, but in the long run I am 100% sure you are wrong, because the present situation is not sustainable. There will be a grand compromise, make no mistake about it. The only question is when and how.

    Doc, No fear of compromise here, as there is nothing short of complete elimination of the income tax that will do. It’s like being a little bit pregnant—you either get rid of the income tax or you don’t. A 1% income tax is just as bad as a 90% tax, as it will soon move to equilibrium anyway.

    I included eliminating the cap gains tax in my proposal, as it is part of the income tax.

    cmholm, I am not a fan of Temasek. The Singapore government is too heavily involved in the economy for my taste. If they want to have that sort of fund, it should be a global stock index fund, or stock and bond index fund.

    OGT, I agree, and was assuming there would be some entitlement cuts in my proposal. Otherwise we’d go even higher than 26% of GDP. The retirement age is already scheduled to rise from 65 to 67 in the next 20 years.

    I agree about medical waste. But eliminating the income tax would greatly reduce the cost of health care. Right now the cost is being driven up by the fact that 40% of the bill for private insurance is picked up by Uncle Sam, meaning we spend much more than we would if paying out of pocket. We also need to move to medical savings accounts.

    Mrs. Davis, I agree with most of what you have to say. I also think we can get a model with much more individual choice and accountability in the long run—but it will take education. Over time on this blog I may move away from monetary issues to these other public policy issues. I am glad you are interested.

    I should say that one area I disagree with conservatives is that I don’t think the US is as special as many other people do. (That’s why while I don’t like Obama-care, I don’t defend our current system either.) Yes, America is probably the most successful country in world history. But we have a lot to learn from the rest of the world in specific areas. Even the Nordic countries are far ahead of US in privatizing certain government functions.

  24. Gravatar of scott sumner scott sumner
    26. January 2010 at 07:24

    Statsguy, Yes, hemlines and debt levels both rose in the 1920s, but neither caused NGDP to fall in half. Tight money and private gold hoarding did.

  25. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. January 2010 at 08:08

    Scott,

    US goods exported to France bear both the implicit US tax burden and the French VAT. French goods sold in France only reflect their local implicit tax burden. In short US goods imported to France reflect both US taxes and French VAT taxes. Similarly US goods sold in the US reflect the local implict US tax burden, whereas French goods sold in the US reflect only a fraction of the French implicit tax burden since they are rebated the French VAT. I really don’t see how this could possibly be interpreted any other way.

    You wrote:
    “Most liberal and conservative tax experts agree that consumption should be taxed, not income. So there is really no justification for taxing interest and dividends.”

    The whole point is that a PCT doesn’t tax income, it taxes consumption. But in order to calculate consumption you must first compute income. Under a PCT if interest and dividends are rolled over 100% back into savings and investment they’ll not be taxed at all. It’s only to the degree that they are spent on consumption that they are taxed.

    You wrote:
    “Don’t even think about indexing capital income for inflation, do you want to have to covert all you flows in an out of mutual funds into real variables. What a nightmare! Furthermore, if someone really believes in taxing cap gains (and I don’t) you should tax them when they occur, not when the asset is sold.”

    It’s actually not that difficult if you index net flows on on an annual basis. Furthermore, the point is not to tax the capital gains income per se but to tax any capital gains income that is used for consumption. Thus you only want to consider realized capital gains as income because that’s the only time that might occur.

    You wrote:
    “Again, the experts disagree with you. The first thing you learn in public finance courses is that in the long run a flat 10% tax rate on labor is identical to a flat 10% tax rate on consumption. (Except at the moment it is implement.)”

    I think the key qualifier here is “in the long run.” I’m not sure I buy it and in any case if it is a truism I certainly didn’t learn it in public finance (Laurence Seidman, author of the book on the USA Tax was my instructor). In the meantime, while I’m ruminating on this point, please cite one of those experts to help me see the light.

  26. Gravatar of cmholm cmholm
    26. January 2010 at 10:13

    I was guessing that Mr Sumner wasn’t a fan of Temasek, so it’s good to have that cleared up. However, Temasek is a fact, as are the other little details of how Singapore is run. Singapore’s success is not solely due to its tax policies.

    My impression is that when someone expresses approval for Singapore’s taxes, or for any small, prosperous spot with moderate rates and a simplified code, frequently they’re making the implicit argument that if the US emulated their tax policies, we’d enjoy the same results…

    …while all they’re actually concerned with is a lower bill, whatever the consequences to the nation as a whole.

    So, while I find Mr. Sumner’s original post interesting and worthy of investigation, his brief mention of Singapore as an object worthy of emulation left me wondering 1) exactly why, and 2) to what degree he was aware of the variables contributing to Singapore’s success.

  27. Gravatar of Mrs. Davis Mrs. Davis
    26. January 2010 at 18:16

    Over time on this blog I may move away from monetary issues to these other public policy issues.

    Let’s hope not so much move away from as share more space with.

    I am one of those who think America was exceptional because it took the opportunity to look at the experience and lessons of other governments in setting its own up from scratch. Few others have had the luxury of that opportunity, fewer have tried and even fewer have succeeded as well.

    Imitating others has led us toward debacles such as the proposed health care reform. Failing to learn from them has kept us with the cancerous health system we’ve evolved. I look forward to reading about the Scandinavian privatizations.

  28. Gravatar of Doc Merlin Doc Merlin
    27. January 2010 at 13:50

    @Scott, Re: Income tax.

    Ok, makes, sense. I agree.

  29. Gravatar of scott sumner scott sumner
    27. January 2010 at 19:35

    Mark, You said;

    “US goods exported to France bear both the implicit US tax burden and the French VAT. French goods sold in France only reflect their local implicit tax burden.”

    This is not correct. French goods also have to pay the VAT. You also forget that exchage rates adjust to reflect differences in taxes. All that matters is whether the tax regime discriminates between domestic and foreign goods. And the VAT does not. It is a pure consumption tax, which applies equally to domestic and foreign made goods consumed in France. Whether the US has other taxes is completely irrelevant.

    I’d suggest you might want to read a good book on international trade if you don’t believe me. If you are right, I can almost guarantee you a Nobel Prize in economics. It would mean all the great experts on international economics are wrong about a very fundamental issue.

    You said:

    “The whole point is that a PCT doesn’t tax income, it taxes consumption. But in order to calculate consumption you must first compute income. Under a PCT if interest and dividends are rolled over 100% back into savings and investment they’ll not be taxed at all. It’s only to the degree that they are spent on consumption that they are taxed.”

    I know all that, my point is the PCT has very cumbersome paperwork, that’s why I prefer a payroll tax, which is also a consumption tax.

    You said;

    “It’s actually not that difficult if you index net flows on on an annual basis. Furthermore, the point is not to tax the capital gains income per se but to tax any capital gains income that is used for consumption. Thus you only want to consider realized capital gains as income because that’s the only time that might occur.”

    Now I’m really confused. If your goal is a consumption tax, why did you bring up indexing in the first place? A consumption tax doesn’t require indexing.

    I learned public finance from Arnold Harberger, but nothing I say here is at all controversial. Consider the following scenario. You earn $100. The interest rate is 7% and you invest for 10 years. So your money doubles in 10 years. With no tax you can have $100 consumption today or $200 consumption in 10 years. With a 50% consumption tax (of gross price), your choice is $50 consumption now, or $100 in 10 years. With a 50% income tax you can have $50 dollars consumption now, or $75 in 10 years. With a 50% payroll tax you can have $50 consumption now or $100 in 10 years. So the payroll and consumption tax are identical, whereas the income tax is biased against future consumption. That’s the basic thought experiment of public finance.

    cmholm, You said;

    “I was guessing that Mr Sumner wasn’t a fan of Temasek, so it’s good to have that cleared up. However, Temasek is a fact, as are the other little details of how Singapore is run. Singapore’s success is not solely due to its tax policies.

    My impression is that when someone expresses approval for Singapore’s taxes, or for any small, prosperous spot with moderate rates and a simplified code, frequently they’re making the implicit argument that if the US emulated their tax policies, we’d enjoy the same results…

    …while all they’re actually concerned with is a lower bill, whatever the consequences to the nation as a whole.”

    This is silly. If I was so selfish that my goal was a slightly lower tax bill, would I spend 3 hours a day 7 days a week answering comments like yours? And why do you seem to assume Temasek plays some sort of role in Singapore’s success? My view is that Singapore’s growth is held back by Temasek. Studies have shown that investment in Hong Kong has been much more productive than in Singapore, probably because the government of Hong Kong doesn’t try to direct investment spending as much as the Singapore government does.

    But even though i don’t like Temasek, I still like there overall economic system much more than ours. I’d swap systems even if we had to have a Temasek. There are more free market than we are, even with Temasek.

    Thanks Mrs Davis.

  30. Gravatar of Mark A. Sadowski Mark A. Sadowski
    28. January 2010 at 05:48

    Scott,
    You wrote:
    “You also forget that exchage rates adjust to reflect differences in taxes.”

    This implies that you forgot that exchange rates also adjust to reflect tariffs. Theoretically the effect of a VAT on exchange rates is identical to the effect of an across the board tariff. I don’t think this observation merits a Nobel Prize but I’ll take one if they’re handing them out.

    However, I acknowledge that this implies in the long run VATs may not act as a trade barrier. On the other hand this also implies that if we are the sole major country without a VAT there may still be distortionary effects in nongoods markets resulting from missaligned exchange rates.

    You wrote:
    “Now I’m really confused. If your goal is a consumption tax, why did you bring up indexing in the first place? A consumption tax doesn’t require indexing.”

    Because you’re taxing the realized capital gain that is used for consumption. There’s a considerable difference between taking $1000 in realized capital gains and investing it in a company making solderless breadboards and spending it on snickerdoodles.

    You wrote:
    “Consider the following scenario. You earn $100. The interest rate is 7% and you invest for 10 years. So your money doubles in 10 years. With no tax you can have $100 consumption today or $200 consumption in 10 years. With a 50% consumption tax (of gross price), your choice is $50 consumption now, or $100 in 10 years. With a 50% income tax you can have $50 dollars consumption now, or $75 in 10 years. With a 50% payroll tax you can have $50 consumption now or $100 in 10 years. So the payroll and consumption tax are identical, whereas the income tax is biased against future consumption. That’s the basic thought experiment of public finance.”

    Suppose all of your income ($100) comes from something other than labor. With a 50% consumption tax, your choice is $50 consumption now, or $100 in 10 years. (And with a 50% income tax you can have $50 dollars consumption now, or $75 in 10 years, also as before.) But with a 50% payroll tax you can have $100 consumption now or $200 in 10 years.

    To someone without labor income the payroll and consumption tax are not at all identical. It’s only identical if 100% of your income is from labor. I hope that was also taught in your public finance course.

  31. Gravatar of ssumner ssumner
    29. January 2010 at 06:33

    Mark, You said;

    “Theoretically the effect of a VAT on exchange rates is identical to the effect of an across the board tariff. I don’t think this observation merits a Nobel Prize but I’ll take one if they’re handing them out.”

    With all due respect, this is just nonsense. A VAT is nothing like an across the board tariff. I was serious, if you could prove the aerguments you are making you’d definitely win a Nobel Prize. I think non-economists often underestmate just how rigorous and highly developed the technical side of economics is. You comment is exactly analogous to someone coming on here and saying all the pyhsicists are wrong about gravity. In fact someone did come on here and make that claim. He said only he really understood gravity. What do you think of his claim?

    Regarding indexing, if you are going to tax consumption using the tax flow approach, no indexing is necessary. (Even when capital gains have been earned.)

    You need to reread my example on taxes. The period two income all came from investments, and the consumption and payroll taxes were still identical in effect. They merely imply that the check to the government is written at a different point in time. QED.

  32. Gravatar of Mark A. Sadowski Mark A. Sadowski
    29. January 2010 at 09:52

    Scott,
    I’m not trying to beat a dead horse however….

    1) I think you’ll agree that a one-for-one adjustment of exchange rates to a destination-based VAT is exactly what theory predicts. An explicity mention of this “fact” can be found in “Value-Added Taxes and International Trade: The Evidence” (NBER 2002) by Mihir A. Desai James R. Hines Jr. (although that particular paper finds evidence that contradicts theory but that is another matter entirely).

    2) In “Tariffs and Nontraded Goods,” Journal of International Economics, Vol. 4 (May, 1974), pp. 177–85 Rudiger Dornbusch developed a model that showed that an
    increase in tariffs will lead to real appreciation if nontradable goods are substitutes for tradables. My interpretation of Dornbusch’s model implies that an across the board tariff should also result in a one-for-one adjustment of exchange rates.

    So I don’t think I’m claiming anything out of the ordinary or particularily noteworthy (darn, I really could use the Prize money). And by the way, after 30 undergraduate credits and another 60 graduate credits in econ, plus a pass in the comps and field exams I’m a dissertation short of a PhD in economics. So I like to think I almost qualify as an economist (in fact an applied macroeconomist). However I try learn something new everyday, and I like to think I’ve learned quite a bit from reading your blog and debating you.

    You wrote:
    “Regarding indexing, if you are going to tax consumption using the tax flow approach, no indexing is necessary. (Even when capital gains have been earned.)”

    I’m sorry I must be dense because I don’t follow what you’re saying here.

    You wrote:
    “You need to reread my example on taxes. The period two income all came from investments, and the consumption and payroll taxes were still identical in effect. They merely imply that the check to the government is written at a different point in time. QED.”

    I don’t think you’ve read my counterexample carefully enough. I understand that all of the income in period two comes from investments. I’m discussing an alternate case of an individual who has only nonlabor income in period one. In that case there is a clear difference between consumption and payroll taxes in effect. Thus payroll taxes are not identical to consumption taxes.(QED)

  33. Gravatar of Bill Bill
    30. January 2010 at 10:19

    Scott,

    Could you maybe be more explicit about what you are claiming about VATs and trade and how this applies to the actual US tax system ante?

    Suppose, hypothetically, that the US had a system of uniform flat taxation on labor, profit, & interest (ignoring foreign-source profits, interest, etc). This is pretty much equivalent to a VAT, no? But, hypothetically, it doesn’t call it a VAT, so it is not refunded at the border and it is not imposed on imports.

    If it then switches to a VAT by making the administrative changes necessary to call the system a VAT, it can then refund it at the border and impose it on imports. You are not seriously suggesting that this hypothetical change is different from imposing a simultaneous import tariff and export subsidy, are you? And we agree that in this case “A VAT is nothing like an across the board tariff” is crazy talk, right?

    So, the difference between you and your interlocutors is on the question of how close the current US system is to being equivalent to a VAT as an empirical matter. With you taking the position “very, very far indeed” and your interlocutors taking the position “not so far that it is wrong to think of moving to a VAT as imposing a tariff/subsidy regime.”

    So, what are the big differences, why are they relevant to the trade question, and what empirical case convinced you?

    Or, to put the thing another way, suppose the US replaced some portions of its current, actual tax system which look VATty with a VAT and left the rest as they are. So, you impose a 14% VAT and remove fourteen points of the payroll tax, reduce corporate rates by 14 percentage points, reduce rates on interest income by 14 points, etc. This is the same (roughly) as a 14% tariff plus 14% export subsidy, right?

    And it would raise revenue because of the trade deficit, yes?

    I don’t doubt the theoretical point you are making. I doubt that it is relevant to the actual case at hand which is the US moving in a VAT direction.

  34. Gravatar of scott sumner scott sumner
    31. January 2010 at 07:09

    Mark, I have a suggestion. Instead of reading articles like the Dornbusch paper you mention, why not read a few textbooks that explain why VATs do not distort trade. See what you think of their arguments. Then tell me the logical flaw in their argument.

    Regarding your second comment, it is no wonder you had trouble following my argument, my argument was all garbled. I said:

    “Regarding indexing, if you are going to tax consumption using the tax flow approach, no indexing is necessary. (Even when capital gains have been earned.)”

    I should have said “cash flow” not “tax flow”

    You said;

    “I don’t think you’ve read my counterexample carefully enough. I understand that all of the income in period two comes from investments. I’m discussing an alternate case of an individual who has only nonlabor income in period one. In that case there is a clear difference between consumption and payroll taxes in effect. Thus payroll taxes are not identical to consumption taxes.(QED)”

    My argument is not that people would pay the same amount in each period, but rather the present value of their taxes would be the same in either case. Obviously a consumption tax is paid when money is spent, and a wage tax is paid when money is earned. In a given year that may be different. This means that if you transition between the two tax systems someone may be undertaxed or double-taxed in the transition. But the long run steady state is identical for each system. That is the point I was trying to make.

    In your example, the money that was invested to produce the capital income had to be taxed at some point as wage income, assuming you had a wage tax in effect. If you are transitioning from a consumption tax to a wage tax then you can impose a one-time wealth tax during the period of transition. But that would not be necessary in the US, because we already have pretty high taxes on labor income.

    Bill, First let me emphasize that the term “claim” is misleading here, it isn’t my theory. It is a well established and completely uncontroversial part of international trade theory. Believe me, people much smarter than me have thought about all the issues raised by Mark, and completely rejected them as falacious.

    You said:

    “Suppose, hypothetically, that the US had a system of uniform flat taxation on labor, profit, & interest (ignoring foreign-source profits, interest, etc). This is pretty much equivalent to a VAT, no? But, hypothetically, it doesn’t call it a VAT, so it is not refunded at the border and it is not imposed on imports.”

    There are two big mistakes here. A flat income tax is not equivalent to a VAT, which is a consumption tax. Rather a paytroll tax alone is equivalent to a VAT.

    But even if you were right, and had used a payroll tax, your second point is misleading. Countries with VATs don’t just rebate VAT on exports, they also impose the VAT on imports.

    You said;

    “If it then switches to a VAT by making the administrative changes necessary to call the system a VAT, it can then refund it at the border and impose it on imports. You are not seriously suggesting that this hypothetical change is different from imposing a simultaneous import tariff and export subsidy, are you? And we agree that in this case “A VAT is nothing like an across the board tariff” is crazy talk, right?”

    It is a well known fact that an across the board 10% import tax combined with an across the board 10% export subsidy, cancel each other out, and do not distort trade at all. This is an important point, as the view of the man on the street is that a 10% tariff on all imports combined with a 10% subsidy to all exports would be a mercantilist policy–a policy that would distort trade. Actually, the combined impact of the two policies causes a 10% rise in the real exchange rate (regardless of what governments do with their nominal exchange rate.)

    First think about PPP as like the open water between lake Michigan and Lake Huron. Water flows to keep the lakes level. In trade, prices equilize. Now consider a 10% VAT country as like Lake Superior, which is higher than the other two. The subsidies and tariffs are like locks that raise and lower the ships. Imports have to be raised up 10% to compete equally with domestic goods that pay the 10% VAT. In contrast exports must be lowered uin price to compete with others. That’s why things often seem more expensive to Americans when they visit Europe.

    You said;

    “I don’t doubt the theoretical point you are making. I doubt that it is relevant to the actual case at hand which is the US moving in a VAT direction.”

    There is nothing that is true in theory but not in reality. If it doesn’t work in reality, the theory is wrong. Tell me where the theory is wrong.

    You said;

    “So, the difference between you and your interlocutors is on the question of how close the current US system is to being equivalent to a VAT as an empirical matter. With you taking the position “very, very far indeed” and your interlocutors taking the position “not so far that it is wrong to think of moving to a VAT as imposing a tariff/subsidy regime.”

    This is completely misleading. What you call my view is actually the view of all serious trade and tax economists. It is completely uncontroversial. What you call my interlocutors” is one commenter named Mark, arrayed against the entire economics profession; liberals, conservatives, moderates.

    I don’t mind you guys disagreeing with me, but I just want to make sure you understand that what you are doing is analogous to someone walking into a physics class and saying one of Newton’s laws is wrong (beyond relativity and quantum issues) It’s possible you and Mark are right, but it is a real long shot. And if you were, it would turn the field of economics upside down. because it would imply a fundamental problem with the models that we use to establish this proposition. All of trade theory and all of public fiancne books would hav eto be torn up and we’d hav eto start over. It’s like one of Newton’s laws of motion. You can’t show that it is fundamentally wrong, and expect other part sof physics to escape unscathed. It’s all connected.

    If I wanted to make the sort of argument you two are trying to make, I’d try to make some sort of argument that real world VATs are not implimented correctly, and therefore distort trade. Perhaps taxes are easier to collect at the border than internally, or vice versa. Then you might be able to work out some sort of trade distortion argument.

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