Tuesday, December 1, 2009

Pelosi Planning Huge Mistake

I love Ronald Reagan, as do you. But Reagan made two mistakes. One he’s admitted -- the illegal alien amnesty. The other took longer to become apparent. Now Pelosi seems intent on undoing that mistake by making her own version of that mistake. Hmmm. Read on my friends. . .

The second mistake Reagan made was the tax reform he enacted in 1986. From an economic perspective, this was a great reform. It eliminated some tax brackets, flattening the tax structure, and lowered the capital gains rate. That reduced some of the distortions of the tax code and spurred the economic growth that we’ve continued to enjoy until pretty much last year.

But within that success lay a political disaster. As a result of those reforms, millions of people came off the income tax rolls. Economically, that’s a good thing. But politically, it created a problem. People who don’t pay taxes have no incentive to keep the size of government under control. To the contrary, they have an incentive to increase the size of government because it doesn’t cost them anything. Thus, by taking millions of Americans off the tax rolls, Reagan accidentally created a class of people that had nothing to lose from an increase in the size of government!

And that class has been growing. Indeed, the number of Americans who pay no income tax has risen from 15% in 1985 to 40% today. Add in the fact that just over 52% of Americans now receive a check from the federal government, and you’ve got the makings of a “pro-government-growth” constituency.

But if Nancy Pelosi has her way, this problem may be about to correct itself. Over the past few weeks, the left, i.e. Pelosi and many within the MSM, have begun talking about “the need” for a value added tax.

A value added tax is like a sales tax, only the product is taxed at every stage of its production rather than at the point of sale. Said differently, whereas a sales tax is paid once -- by retail consumers, a value added tax is paid by each business that participates in the creation of the product or service. Each business is taxed on the “value it adds” to the product. Since businesses don’t pay taxes, they pass those along to consumers by rolling those taxes into the price of the product as it moves along the production chain.

Economically speaking, a value added tax is a good method for raising taxes. It doesn’t distort people’s incentives to work, like an income tax, nor does it distort their consumer behavior, like targeted deductions. It is also much less intrusive than an income tax. Thus, economically speaking, a value added tax is far superior to an income tax.

But the downside with a value added tax is that it is an easy tax to raise because consumers don’t see it. They only see the final price of the product, they don’t see where it was taxed at each stage of production. And while this could be countered with a requirement that all products identify the total tax paid, consumers still are a notoriously difficult group to organize against bad governmental decisions. A case in point is sugar subsidies, which harm all consumers and which everyone agrees should be eliminated. But because consumers are a diffuse group and the sugar industry is a determined lobby, no one has been able to gather the political muscle needed to eliminate those subsidies.

In any event, if I had a choice between an income tax and a value added tax, I would probably lean toward the value added tax, with certain safeguards. But Pelosi isn’t talking about replacing the income tax, she’s talking about adding a value added tax to the income tax. This, I cannot support.

Anyhoo, here’s the interesting bit about what Pelosi is trying to do. She wants a value added tax. But a value added tax hits all consumers. Thus, she’s working hard to pass a tax that will suddenly smack right in the face that 40% of Americans who currently pay no income taxes. What does this mean? It means, that if she passes this, she’s going to undo Reagan’s 1986 mistake by taking this “pro-government-growth” constituency and making them pay for the services they get. God bless her little black heart.

What’s even more interesting is that a value added tax smacks all consumers equally. That means that the tax is “regressive” in that it takes a larger share of poor people’s income than it takes from rich people. This is not going to make the “pro-government-growth” constituency happy at all. Indeed, even if they exempt food and medicine, for example, this constituency will suddenly find that cars, clothes, DVDs and consumer goods are 20% more expensive.

And here I thought liberals cared about poor people?

Interesting times ahead.


Pittsburgh Enigma said...

Is it possible that Pelosi would allow "the poor" to receive credits in order to offset what they pay in value added tax? (similar to earned income credits) And do you think a VAT would have a chance in the Senate?

StanH said...

Unintended consequences could be just deserts, but my guess they would figure someway to be certain that the sainted poor remain un-taxed. Those of us that pay taxes would just be taxed more. I hate to be cynical.

Better than a VAT or the income tax would be the “Fair Tax.” It’s much fairer at a 23% rate, and is revenue neutral, meaning it pays for government at the present rate. You’d have to repeal the 16th amendment, to keep pesky congress critters in line, and my favorite part dissolve the IRS, yes! Check it out.

AndrewPrice said...

Pitts, I can't see this passing the Senate, no. Not unless it was part of some much bigger reform or we faced a true disaster, like the budget disaster that will be coming in year 10 of ObamaCare.

In terms of a credit, I have no doubt that Pelosi et al. would try to give some sort of credit, possibly through the earned income tax credit. But usually they try to exclude items that poor people buy -- like food and medicine.

If that's the case, then the poor are going to be furious when ipods, cars and appliances suddenly become out of reach economically.

If they give a lump sum credit (the other possiblity) people will still be furious at the price of goods and services, even if they get a chunk of change at the end of the year.

Either way, I see this as a tactical error by Pelosi and company, one of many.

LawHawkSF said...

PittsburghEnigma beat me to the punch. Any government that can call tax-eaters "tax-payers" will have no trouble coming up with some euphemism to offset a VAT by granting credits to, umh, taxpayers below a certain earning level. We could call it the "we don't pay taxes anyway, why start now?" credit.

I'm in favor of a combination flat income tax and a federal excise tax. I don't think one without the other can work. Charge the excise tax on high-ticket and luxury retail purchases to slake the thirst of the "tax the rich" crowd, and everybody else pays the same income tax rate. Even I think that if you can afford a yacht, you can afford the excise tax.

Oh, and reduce corporate taxes by 20% to 30% to make us competitive again. In the developed world, only Japan has a higher investment-killing corporate tax than the US.

AndrewPrice said...

Stan, It's not possible to keep the poor from being taxed because everyone gets taxed. All you could do would be to exclude certain items and give a rebate/credit. But that won't keep the 40% from feeling that the free ride is over.

I'm not a fan of the Fair Tax proposal. It's too complicated and there is much about it that doesn't make sense to me.

Besides, if we're going to get rid of the income tax, then the best tax would be a VAT. If we're not getting rid of the income tax, then the Fair Tax is a moot point.

AndrewPrice said...

Lawhawk, Politically, you'll never get a flat tax without a massive Republican majority. And if you've got that, why not drop the income tax entirely and switch to something that is less intrusive and less distorting?

In terms of the credits, see my response to Pitts above.

LawHawkSF said...

Andrew: I didn't say I thought it would ever happen, I just wish it would. I would love to see the income tax gone forever, but that would be a draw-down that would take fifty years while the government is being weaned off the public teat. A flat income tax, reduced on a schedule over a long period of time until it reaches zero would be the ideal which will never happen. At least not as long as we still have the damnable Sixteenth Amendment (aka The Federal License to Steal). An excise tax, on the other hand, does affect only the rich or well-heeled, since it taxes luxury purchases but does not tax investment in business or profits on business (that's where the flat income tax comes in).

As for the VAT credit, I was merely agreeing with you.

AndrewPrice said...

Lawhawk, If we're going to have an income tax, I'd love to see it go flat. But I'd rather see it replaced with a consumption tax -- something like a VAT only more visible.

And you're probably right that politically there is no way we could get a simple flat tax without something like an excise tax to satiate the "tax the rich" crowd. Sad.

My concern right now is that they're laying the ground work for adding a VAT on top of the current system. That's unacceptable. But if they can create a big enough budget crisis, then people may accept it.

Writer X said...

Andrew, weird. I just got off the phone with my brother and we were talking about this very topic. I kid you not. Has Commentarama turned into the "V"? :-) I will need to send him this link.

Anyway, wouldn't businesses simply pass along the VAT to customers in the form of higher prices? I'm not sure I like that very much--either as a consumer or for businesses--particularly small business--owners. I agree with you though: it would very creatively undo Reagan's inadvertent mistake. I'm surprised Pelosi had the brain cells to cobble her idea together.

AndrewPrice said...

Writer X, We do read minds! And we tap phones -- we got the authority after the Commentarama Act passed Congress! :-)

You're right about business, they would absolutely pass on the tax through higher prices. One of the problems with the VAT is that sometimes consumers don't know how much tax there is because they just see the final price. That's why any reasonable VAT would need to include a statement of how much tax is included.

As for Madam Botox getting the idea, I think she's repeating what she sees the Europeans do. Next thing you know, she'll propose that we celebrate Bismark's birthday.

LawHawkSF said...

Andrew: I see the 16th Amendment as a major stumbling block. But your idea is a good replacement for the income tax if we can remove Congress's 16th Amendment backstop. People must remember that even the most legitimate and limited government still needs income to support itself. Whether it's a flat tax, a VAT, or some other alternative, "the only things that are inevitable are death and taxes." I want to slow the former and reduce the latter.

AndrewPrice said...

Lawhawk, LOL! I agree.

Tennessee Jed said...

I am pretty much with Stan and Hawk on this issue, although it will require a time when there is a huge conservative majority. If you set up a system where business flourishes in this country, it cures a lot of problems. Of course from a jobs standpoint, we still need to focus on creating a skilled workforce. Unskilled labor will always follow the country with the lowest standard of living and wages. We know what labor unions can do to competiveness as well.

AndrewPrice said...

Jed, I would love to see reform, but I just don't see the will to do it out there. Maybe we should do an article on the types of reform that are being discussed out there and how they might be implemented?

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