Fred Sautet is unhappy with my examination of a VAT. He writes:
The main reason one should resist Tyler’s idea is political economy. The VAT is such an efficient machine that the temptation to use it to obtain more tax revenues is always there. History shows that VAT rates generally go up quickly but rarely go down. New Zealand initial 10% rate was raised to 12.5% in 1989. There are now talks that it will be raised to 15% to help with the current fiscal situation.
Fred has lots of dire words for the VAT but there's no comparative analysis indicating that spending cuts will prove viable. Fred also neglects to mention that after New Zealand adopted the VAT (or GST, 1986), the country moved from being one of the least free in the Western world to one of the most free, economically speaking. New Zealand is actually the best case scenario and if anything it is unrepresentative in the positive direction. I believe the economic liberation of New Zealand could not have happened, had the reformers had to institute massive spending cuts instead of the VAT. (By the way, I did live in NZ in the early 1990s.)
New Zealand also used its VAT to help get their national finances in order, an option which many MR commentators have suggested is impossible. Not every fiscal deal falls apart; many last for ten, twenty years or more so again it is a question of probabilities, relative to the "cut spending" path.
Under the fold, I'll whine about being misunderstood by trigger-happy critics...plus I'll tell you what I really think...
Here's another response to my post on the VAT. It misrepresents my position and ignores how changing demographics will make it harder — much harder — to restrain spending than it was during the Clinton years. It is hard for me to see how such a simple point could be missed.
Here is a post by Dan Mitchell on the topic. He offers up some words which I find enlightening:
The bad guys do not want to control the size of government and the good guys do not want to raise taxes…Tyler’s approach, while not unreasonable, is about how to lose gracefully. Even if his strategy works perfectly, the result is bigger government. I’d much rather fight.
That's an example of using "us vs. them" thinking to avoid the problem-solving mode. There aren't many "guys" — good or bad — who actually favor cutting spending and thus the problem arises. (And the one "cutting spending" advocate cited by Mitchell — Paul Ryan — also happens to favor a VAT.) Impugn it as you wish, but "losing gracefully" isn't so bad when you have only a few million people on your side! There are worse ways to lose and another financial crisis — much bigger next time because it's Uncle Sam himself – is one of them. We still need to see a comparison of the relative probabilities and Mitchell is reluctant to serve that up, instead retreating into moralizing about "which side are you on?" and a call for toughness.
In economics, be suspicious when you read discussions of "whether" rather than "how much" or "with what probability." I am sure I would not wish to institute a VAT today, as on top of other considerations we are still in a recession. But let's say the years progress and we don't see spending cuts or even declines in the rate of increase. After how many years of this path would you consider a VAT?
What if government default were a week away and there wasn't enough short-term spending to cut? Would you consider a VAT then? I hope so. How far back toward the present will you go in considering a VAT? Once you're willing to confront the hard questions most of us are on a spectrum, however much the tax cutters might wish to posture. The way to get closer to the truth is to start with the conditions under which you're wrong, not to list all the reasons you think you are right.
In the meantime I'll still call for spending cuts but I don't see a lot of good answers to my initial query about whether we might have to end up supporting a VAT. What I do see is conservative and libertarian commentators who don't know what to do next — either practically or intellectually — if spending restraint doesn't pan out. Right now, to me, the chance of that looks pretty high.
>>What if government default were a week away and there wasn’t enough short-term spending to cut?>>
How can a country which issues debt denominated in its own currency possibly default (other than just stupidly refusing to pay)? All we have to do is print more money to pay off debt.
Wouldn’t that run the risk of high inflation which is effectively defaulting on your debt anyway??
Fusion, et al.;
The problem with the “inflate the debt away” is that it only works if you are paying down the debt, i.e., if you have spending under control, which we do not in this hypothetical. If you are still rolling over the debt, then the market will jack up the interest as you roll it over in direct proportion to how much currency you’re printing. So unless you control spending or raise taxes, you cannot print your way out of the hole.
This is an entirely too scientific approach. How dare you insinuate that we be rational in our policy advocations!
I’m not the biggest supporter of a VAT, since I tend to view sales taxes as regressive (the rich save a higher % of their income than the poor, thus paying a lower effective rate).
That said, there is at least one good example for VAT taxes declining:
http://www.pm.gc.ca/eng/media.asp?category=1&id=1952
If there is to be a one-off fiscal day of reckoning, during which haircuts will be had, but there is no telling who gets them until it happens, there is a rational case for a younger person preferring that it happen sooner rather than later, to get the uncertainty out of the way while they still have a significant chunk of their working years in front of them.
There is also a rational case for an older person preferring it happen later rather than sooner, later being after they are dead.
Which might explain the difference of opinion: a large tax increase will delay that day of reckoning, but if future Congresses spend the tax increase and then some, the day of reckoning will be worse when it does happen. Restructuring the risk of a fiscal crisis into the future at the cost of perhaps increasing the total risk may or may not be a winning proposition. It all depends on your time horizon.
They wouldn’t allow it to get that bad. The politicians have no excuse. They have single-party control. The “40-vote super-majority” is nice, but it’s a red herring. They over-spend because they like it. Why enable them?
To say the voters support the spending is not accurate in my opinion. It is not the voters’ job to deal with the details. This November it will be impossible to claim that the voters are happy with the way the politicians are managing the details of the voters’ wishes.
Cyrus said, “Yes, “other countries” have instituted a large tax increase, and figured out how to behave in a fiscally responsible fashion before spending it all. But “other countries” have also instituted a large tax increase, and still not figured out fiscal responsibility.”
Other countries have also instituted moderate flat tax regimes, and have brought in more money than they can spend as a result.
Fusion said, “You guys don’t seem to have much faith in bond markets, which are not demanding very high yields from treasuries. Maybe traders haven’t read about the US fiscal issues?”
On short term assets you are right, but 10 years are at about 4% and 30 at about 5%. I’m sure none of them assume we are going to monetize anytime soon.
How collectivism nearly killed the Pilgrims
http://joshfulton.blogspot.com/2010/02/how-lack-of-property-rights-nearly.html
Before we go to VAT, we should look at stemming some of the deductions and exemptions to income.
For example, for those who are concerned about excessive US borrowing (which, by the way, can be from government or the private sector (US private debt rose from below 60% of GDP in 1999 to over 110% in 2009), you could limit the interest deduction for housing to something like $50k a year. That would also deal with secondary residences. What happens now is that people overleverage to minimize taxes, we borrow from abroad to finance this, all in the name of favoring home ownership. Well, ok, if you want to favor home ownership, you still should have a limit.
In the same way, I would also cap the deduction for medical insurance to encourage purchasing the product more sensitively and creating more skin in the game (copays) so that people purchase medical services more carefully.
“What if government default were a week away and there wasn’t enough short-term spending to cut?”
I don’t understand this. If default were a week away isn’t cutting short term spending the only thing we can do?
Reduce Social Security and other entitlement checks, lay off federal employees, delay medicare reimbursments etc. Can’t you do all of these things quicker than adding a VAT?
So, I’m wondering, just what are the policies, worse than the VAT, that Tyler foresees as likely to be implemented in a moment of crisis if we forgo implementing the VAT now? And since he’s asking for probabilities from others, maybe he would be willing to share the probabilities he assigns to those policies.
I’ve lost sight of Tyler’s point.
If I understand correctly: He thinks that spending cuts would be preferable to a VAT. He thinks that spending cuts are not politically feasible. Therefore he advocates a VAT instead of spending cuts.
What’s the point of advocating a second-best solution instead of a best solution simply because you don’t think the best solution is going to be adopted? It’s not like your advocacy of either solution is going to have an effect on which is adopted. Why not simply say “spending cuts would be best, a VAT would be better than doing nothing, but neither one is likely to happen.”
Default is not the end of the world. I would much rather see default then pay taxes the rest of my working life to make interest payments on bank bailout money.
Here’s what I believe. VAT is regressive, which is a little bit of genius. That’s why Tyler is Tyler and why I’m not.
1. A dollar spent today by the government is a destruction of some value, not just dollars spent in the future. We need more ROI today, and the only way politicians can help is to cut governemnt spending.
2. The solvency problem is with the future liabilities. Those liabilities have not yet been spent, only promised, and the government has already said on record there is no actual guarantee of these liabilities. Understanding that paygo programs that make future promises amounts to an unsustainable Ponzi scheme is something the voters will learn at some point.
3. Spending has to be contained. It is not a matter of how, if, or whether it has succeeded in the past. It is going to happen.
4. I don’t see myself benefitting all that greatly from the current system to be extremely worried about it not being continued. That is because the current system includes the unsustainable parts that are going to change.
5. I don’t believe that the government will get smarter by giving them another revenue source. We will need some degree of crisis to focus the mind.
6. I don’t think that if the ulitimate crisis comes we will turn into Iran. The TARP is what mobilized the tea parties, the next crisis will create other feedbacks.
7. It is no more hypocritical to want the benefits of programs but not want the waste than it is to say we have to accept the waste when we can’t pay the overall bill (this can be restated as “the tea partiers are right”).
8. Evan Bayh is a smart guy and he knew the jig was up. What he calls partisanship I call accountability. Spending has mostly been contained with a Democrat president and Republican Congress.
9. Even if we wanted to cut the deficit, we’d have to fight Krugman and Stiglitz. Why bother? Why not spend efforts on lobbying for nuclear power plants?
10. It is not like the US is going to be the only defaulter and our credit will be destroyed. Where else will the money go? And if it doesn’t go to the government I’m not convinced that’s a bad thing. We were really worried about defaulting on Fannie and Freddie and now look at us. It is actually the credit itself that is also unsustainable. I’m for free trade, but it is insanity to be paying China to take our jobs and expertise.
Yes, the current system works well for Goldman Sachs and unionized public employees. For small business owners, the self employed, and many of the rest of us, shrinking government’s size and regulatory burden has a lot to offer. . .
Government corruption is the problem and I fail to see why giving them more money will help anything. They will spend it all, print 10% more, and continue to cause problems and chip away at our liberty.
I say fight.
Is it not at all reasonable to be willing to see the US plunge itself into a sovereign debt crisis, and folks like me suffer (severe perhaps) individual economic losses as a result, all for the prospect of getting things right for our grandchildren?
The choice you are offering me is “permanently high government spending balanced by permanently high taxes” vs. “low taxes and high spending that will lead to a crisis, after which the government loses some of its capacity to get in debt and will have, with high probability, no choice but revert to low spending and low taxes”.
I’d rather take my chances with the latter.
“The VAT is such an efficient machine that the temptation to use it to obtain more tax revenues is always there. History shows that VAT rates generally go up quickly but rarely go down. New Zealand initial 10% rate was raised to 12.5% in 1989. There are now talks that it will be raised to 15% to help with the current fiscal situation.”
If the example of New Zealand provides the main reason to be concerned that a VAT, once instituted, would perpetually rise, I have to say I’m not that concerned. According to the example, the rate has been the same for 21 years. The fact that people are now *discussing* the possibility of raising it in response to a massive financial crisis is hardly alarming.
Default is not the end of the world. I would much rather see default then pay taxes the rest of my working life to make interest payments on bank bailout money.
You mean you’d rather be unemployed – no income, savings wiped out, etc. – than work and pay taxes?
That’s what would happen to a fair number of people in the case of a default. Let’s see. Treasury interest rates go through the roof. Stock values collapse. Business can’t raise capital at anywhere near a tolerable cost, etc.
Of course we could just print the money and not technically default. Much the same, isn’t it? You can give someone a piece of paper that says “We’re not paying,” or you can give them a piece of paper that isn’t worth anything, with a picture of George Washington on it, and say, “Here’s your money.”
All these calls for “spending cuts” are ridiculous. The budget problem can be summed up in one word: Medicare. You could zero out discretionary spending (you know…. the courts, FDA, SEC, DOJ, NIH, etc.) and there would still be a deficit. Even SS isn’t a big problem until several years out. There is no “policy” that gets adopted by Congress every year increases the size of Medicare it’s on auto-pilot.
The people hoping for default amaze me. Really. You’d rather burn it all down than pay slightly more taxes.
Yeesh. I’d like to see some long-term spending cuts (my primary targets would be Medicare* and the Pentagon) too, but I sure as hell hope that the US government stays out of default. At some point, push will come to shove and cuts will have to happen, likely alongside tax increases. I’d rather it not get to that point – I’d like to address these things now (or rather over the next couple of years), but our political culture is so screwy that it probably won’t happen.
* though I imagine my ideas on health insurance are likely to be different than most of the posters here, the fact is that the projected Medicare budget is insane. Something HAS to give. Our current system is a disasterous blend – a dash of socialism, a dash of capitalism… not a free market, not a government-run one either. Somehow it seems to have become the worst of both worlds. I’ve gotten to the point where I think I’d rather accept the conservative/libertarian reform ideas than the status quo. Go the whole hog. Either fully privatized or fully socialized. Our Rube Goldberg system sucks.
Oh, and “conservatives” are not the only reason that our military budget is insane. They just happen to be the present-day group that tends to go nuts if one suggests cutting that part of the budget. But the spending levels have been a truely bipartisan effort over the course of decades. And it’s set up very well to continue, what with each congressional district getting its piece of the pie…
The Tax Foundation’s own data on income taxes for the rich indicates that they have fallen — from an effective 29 percent rate in the 1990s to less than 17 percent now. Part of that is down to the cuts in “investment” taxes under New Gingrich’s Contract With America and the rest is the Bush tax cuts. Sorry, but by any standard that is a ridiculously low rate. There is much more to be gotten through the income tax. And I don’t see the VAT flying in the United States when billionaires are paying less than 17 percent income tax.
If Fred’s point is that VAT (or GST as it’s called in NZ) is “the temptation to use it to obtain more tax revenues” then he should know two things: That the proposal was met with a significant opposition, and that the increase was proposed as part of a package that included lowering income tax rates, transferring taxation from earning money to spending it rather than just seeking more income.
When is anything that increases taxation ever going to be politically popular? If it were up to the voters, as it was in California recently, they’d vote against increases even while the state went bankrupt. So what politician is ever going to do so unless they really believe it’s a necessary and beneficial change? And if it isn’t, elections are never more than a few years away.
< < You mean you'd rather be unemployed - no income, savings wiped out, etc. - than work and pay taxes? That's what would happen to a fair number of people in the case of a default. Let's see. Treasury interest rates go through the roof. Stock values collapse. Business can't raise capital at anywhere near a tolerable cost, etc. >>
And it would kill the military too. How very melodramatic. Countries have defaulted before and survived. For the US, worst case scenario is a few years of high inflation. Which is a lot less damaging than permanently high taxes.
The proposed increase in GST is being partnered with personal tax cuts. The move to increase GST is (IMO) mainly so they can afford the tax cuts, not to help with the fiscal situation (although it will help by a couple billion a year IIRC).
“All we have to do is print more money to pay off debt.”
That was tried in Brazil, Argentina, Mexico and most of the Developing Word.
It doesn´t works. It leads to both superhighinflation of something like 19% a month, high interest rates and default.
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