Friday, December 11, 2009

Stirring the VAT

The elites who matter in the formation of economic policy have long favored a national value-added tax (sort of like a sales tax), and from time to time we see puff pieces like this one in today’s the New York Times. The story is always the same: we (the masses) need to consume less and save more, so that the economy can be fertilized with more investment and grow faster over the long run. The urgency of this message is amplified by two more current concerns: changing America’s consumption behavior is seen as key to bringing down the current account deficit, and the mushrooming fiscal deficit requires fresh thinking on the tax front.

It’s all rejectable.

1. The decision to save does not prompt a decision to invest. It might lower interest rates, but interest rates are only weakly related to business investment (unlike investment in housing which does not stoke productivity), and in any case interest rates will be low in the US for years to come. (Yield curves tell us this.) The only circumstance under which savings are a bottleneck for investment arises in an economy that is generating high levels of investment for other reasons. European countries that use a VAT, for instance, typically have industrial policies, whether they admit it or not, which keep investment bubbling. In the US, less consumer spending means depressed employment and output. This is in our probable future no matter what, but why exacerbate it?

2. We are back to the tail and the dog, the horse and the cart, or whatever metaphor strikes your fancy: is the yawning US trade deficit (down but not sustainably in the latest monthly release) the result of spending beyond our means, or have our means been downsized by decades of outsourcing and reliance on imports? Those who have followed this blog know that I think the weight of logic and evidence comes down mainly on the side of explanation #2. Thumbnail version: the first story depends on confusing identity with behavioral relations—to be a net importer is to identically be a net dissaver—and the evidence on potential transmission mechanisms clearly points to the primacy of trade competitiveness, or lack thereof, in recent US history. (There will be a new paper on this topic for the Atlanta meetings.)

3. Big fiscal deficits at a time of deep recession are the medicine, not the disease. If the US economy remains this depressed for years into the future then, yes, the deficits are dangerous—but the cause is the economy, not the fiscal policies taken to stanch the bleeding.

But there is a bigger story here. During the decades in which the Washington Consensus was gospel, we were told that, because markets could do no wrong, the private sector should be free to accumulate as much debt, and in whatever form, as it chose, whereas governments, being irredeemably corrupt and incompetent, must be held to the highest standards of fiscal prudence. Then the roof caved in, and now the private debt has been nationalized. Today we look to the sovereign advantages of government as debtor of last resort to hold off the threat of private insolvency and credit gridlock. Indeed, from a purely arithmetic standpoint, if households and businesses in the US commit to deleveraging, the US external deficit can only be sustained by fiscal deficits of a similar magnitude.

This problem cannot be solved by playing with the tax system.

5 comments:

Curmudgeon said...

Elites love the idea of a VAT because it allows them to eliminate the deficit without increasing their own taxes much. Sales taxes are inherently regressive, after all.

Everyone loves free money and the usual suspects see a VAT as a way of making other people pay for bank bailouts, the wars, tax cuts for the rich, and the rest of governmental largess aimed at the wealthy.

Min said...

Unlike sales tax, the VAT is collected before the sale to the consumer, so it is hidden from the consumer's view. That makes it more palatable.

One argument that is made for a VAT is that, despite its regressive nature, the gov't could provide offsetting aid to the poor and lower middle class. Yes, they could, but, as we know, could does not mean would. If the gov't has not done much in regard to the sales tax, they would not be likely to do more in regard to a VAT. In fact, since it is a hidden tax, they would probably do less (in proportion). The fact that other countries may have done so does not at all mean that we would.

Brenda Rosser said...

" 3. Big fiscal deficits at a time of deep recession are the medicine, not the disease. If the US economy remains this depressed for years into the future then, yes, the deficits are dangerous—but the cause is the economy, not the fiscal policies taken to stanch the bleeding. "

The trouble with the idea of further US Government spending is: (i) US dollar hegemony; (ii) related structural problems with the US and global economy prevent the flowing of currency through large swathes of the US domestic and other populations; (iii) there is an oversupply of capital in manufacturing and finance and these areas are most likely to benefit from a fiscal boost by the US government; (iv) there's a huge pool of US dollars already being used by the big private equity corporations to buy up everyone and everything else at present (check the current activities of TPG, Carlyle Group, KKR etc); (v) the fiscal stimulus would need to be directed into areas that don't simply create further inflation (away from traditional sources of energy, into local food production and sustainable housing etc).

The concept of fiscal stimulus is a good one. In the right (structural) context and with an appropriate currency. Free up the ability to create and use local currencies.

demand side said...

In defense of the VAT. It is often described, perhaps I should say inevitably described as a sales tax. There are historical and political reasons for this, not economic, primarily having to do with the way it is levied and reported. But "value added" is not "sales." It is gross sales minus purchased inputs.

Jerry Brown in 1992had the best VAT imaginable before it was sunk in this "sales tax" mire following some effective and aggressive campaigning by his opponent Bill Clinton.

Brown's idea was to levy the VAT at the point of the business. Replacing the corporate income tax. He claimed that this 13 percent VAT and a 13 percent flat tax (with deductions to make it progressive) could replace all income, payroll and corporate taxes. The form would have fit on a postcard.

I realize both proponents and opponents use VAT to mean sales tax. But it is just not necessarily so.

It IS a good, broad-based tax that could have a very low rate and generate a lot of revenue. But ...

In these times, there is revenue to be had in economically efficient taxes like on financial transactions, carbon, or high rollers. (In the context of economic collapse, what is the rationale for favoring the elites? They're no longer leading the country into prosperity. Greed is good because ....?)

TheTrucker said...

Peter Dorman said,

"This problem cannot be solved by playing with the tax system."

I would say that the _ONLY_ way to solve this problem is by playing with the tax system.

Brenda Rosser said,
"there is an oversupply of capital in manufacturing and finance and these areas are most likely to benefit from a fiscal boost by the US government; (iv) there's a huge pool of US dollars already being used by the big private equity corporations to buy up everyone and everything else at present (check the current activities of TPG, Carlyle Group, KKR etc); (v) the fiscal stimulus would need to be directed into areas that don't simply create further inflation (away from traditional sources of energy, into local food production and sustainable housing etc)."

Money is created and blown into the economy by government spending. It matters where that money is injected (on what does government spend) and it matter where and how that money is then sucked back out of the economy. Taxes do that sucking part. Import duties suck money out of the pockets of offshore producers and highly progressive taxes on ordinary individual income suck money out of the pockets of people who don't earn it.