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No VAT For Now

There's no easy fix to the budget mess.

2:48 PM, Apr 16, 2010 • By MATTHEW CONTINETTI
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Yesterday the Senate voted 85-13 for John McCain's anti-VAT resolution. The lack of any substantial support for a VAT in the Senate would suggest that, even if the president's fiscal commission recommends such a tax when it reports in December, Ross Douthat is right and the chances a VAT will be imposed prior to the fiscal crisis are small. Whew.

No VAT For Now

We're going to need a bigger bottle.

On the other hand, tax increases are still coming. Taxes on incomes, capital gains, dividends, and estates all go up on January 1, 2011. The health care bill raises all sorts of taxes and fees, including the Medicare tax for high earners. In this post, David Frum runs through some other taxes that will likely be raised. For those of you too lazy to click on the link, the answers are (1) the AMT, (2) taxes paid on mortgage interest, and (3) the Medicare tax (again). At the state level, the Times had an eye-opening piece a couple weeks ago on the taxes being levied on haircuts and funerals.

Taxes are going to go up whether we have a VAT or not. But they won't solve our fiscal problem. Donald Marron makes the point convincingly in "America in the Red" in the latest issue of National Affairs:

As with almost any large, complex problem, there is a natural desire to resolve our budget crisis with just a single solution. Some observers look at the numbers and conclude that the solution is obvious: raise taxes to pay for the additional spending. Others look at the same figures and conclude just the opposite: cut spending so we do not need to move beyond historical levels of taxation. And most observers cling to the hope that growth might set us free, boosting revenues so much that we will not have to face any hard choices. Unfortunately, none of these single solutions will work.

Why? Brookings's Tax Policy Center found that "The size of the required tax increases would almost certainly induce affected taxpayers to adjust their behavior in ways that would reduce economic efficiency and thus offset at least some of the gains from smaller deficits and lower national debt." Congress is allergic to spending cuts and offending the senior lobby. As for economic growth, there are no guarantees, especially when high taxes and massive spending crowd out private investment.

When you look at the budget projections, you see that social insurance is the prime cause of future imbalances. Pensions and health care will bury us, not earmarks or the Department of Education. American politicians have made promises they cannot possibly keep. And the American senior is understandably reluctant to give up the benefits for which his taxes have paid. Which is why we've reached an impasse.

What to do? The American welfare state transfers massive amounts of money from the working (and relatively poor) young to the retired (and relatively affluent) old. It's a looting strategy that is unsustainable. But, since no one pays much attention to what young people think, maybe the best possible reform of the welfare state starts with them. For example, Paul Ryan's Roadmap for America's Future keeps the current welfare state in place for everyone 55 years old and over. Why not introduce a bill that means-tests Social Security, indexes benefits to inflation, eliminates the incentives to early retirement, and raises the retirement age to 70 while indexing it to life expectancy -- but only for everyone 50 and under? (No need to include controversial personal accounts, which do not address the solvency question and actually increase deficits in the short-term.) Americans in that age cohort know they aren't going to see the benefits government promises them. They might appreciate the straight talk. And everyone seems to agree that Social Security is "easy" compared with Medicare and Medicaid. The health care conversation is much tougher, especially in light of Obamacare's passage, but a bill that reforms Medicare and Medicaid along free-market lines -- but only for young people! -- makes sense too.

Meanwhile, I have confidence that Congress will consider tax reforms like Gregg-Wyden in the near future. You're beginning to see a consensus that the American tax system is too complicated and too inefficient for its own good. Marron outlines some principles for tax policy here. And in light of the upcoming election, recall that the last major tax reform -- lowering rates while broadening the tax base -- occurred when the government was divided. God willing, we may face a similar situation soon.

Young people are paying for the welfare state we have now. They'll face the penalty for our profligacy in the coming decades. We might avoid the latter scenario if we begin to admit that we cannot keep our promises to the young. I think they'll be able to handle the dismal reality. When it comes to social insurance, they're used to shouldering the burden.

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