A Fine Mess

by T. R. Reid

  The most ambitious recent study came from the George W. Bush administration. Just after his reelection in 2004, Bush created a study commission, the President’s Advisory Panel on Federal Tax Reform, with instructions to leave no stone unturned in search of ways to make the U.S. tax code fairer, simpler, and more efficient. The group allocated a great deal of debate, and a full chapter in its final report, to the idea of a federal VAT. It concluded that such a tax would allow for a substantial reduction of income tax rates, with no loss of revenue. In an earlier section of its report, the advisory panel had proposed a revamped federal income tax, with a progressive rate structure of 15% for the lowest brackets and then additional brackets of 25%, 28%, and 33% for people at higher incomes. But if the United States adopted a 15% VAT on purchases, the income tax could be slashed to two brackets: 5% for lower-income families and 15% for taxpayers above the median income. With a top rate of 15%, few taxpayers would find it necessary or productive to invest in complicated tax-avoidance schemes, so compliance would go up and IRS administrative costs would go down. Accordingly, the panel reported that imposing a federal VAT could be a key element of successful tax reform.

  But this study took place in 2005, when the polarization and division that mark American politics today were already starting to take root. Sure enough, the President’s Advisory Panel on Federal Tax Reform was so badly divided that it couldn’t muster a majority to support any plan. On the VAT, the final report said, “Panel members recognized that lower income tax rates made possible by VAT revenues could create a tax system that is more efficient and could reduce the economic distortions and disincentives created by our income tax. However, the Panel could not reach a consensus on whether to recommend a VAT option.

  “Some members of the Panel who supported introducing a consumption tax in general expressed concern about the compliance and administrative burdens that would be imposed by operating a VAT,” the report explained. “Some members were also concerned that . . . the VAT would be a ‘money machine.’ . . . Others expressed the opposite view and regarded the VAT as a stable and efficient tool that could be used to reduce income taxes, fund entitlement programs, or serve as a possible replacement for payroll taxes.”8

  One substantive objection to a national VAT or GST in the United States is the federal system. There are thousands of state, county, city, and special district governments that must raise revenues themselves, and many of them do it through a retail sales tax; Professor Jay Rosengard of Harvard’s Kennedy School estimates there are more than six thousand different sales taxes in place in the United States today. In most communities, they accumulate atop each other. The sales tax in Denver, where I live, is fairly typical. Denver’s 7.62% sales tax is a combination of state, county, and city levies, along with an additional 1% for the local transit district, 0.1% to pay for the Denver Broncos football stadium, and another 0.1% for something called the Scientific and Cultural Facilities District, which pays for museums, libraries, zoos, and the like. If the United States were to add a significant new value-added tax on top of all those local sales taxes, we’d be approaching European levels of tax on most purchases.

  President Bush’s advisory panel worried about this aspect of a federal VAT. “Coordinating between states’ retail sales taxes and the VAT would be a major challenge,” its report said. “States likely would view a VAT as an intrusion on their traditional sales tax base.”

  Around the world, though, the existence of local sales taxes has not been an insurmountable obstacle to imposing a federal VAT. Several countries have done exactly that, including New Zealand, Australia, and Great Britain. In some countries, the federal government collects all the tax and then distributes it to local governments. In others, there’s a tax like the combined sales tax I have to pay in Denver, with part of the take going to the local government and part going to the national tax agency. That’s the system Canada has set up, although getting there wasn’t a particularly easy process.

  For decades, Canada imposed a tax on manufactured goods called the manufacturers’ sales tax (MST). Most Canadians were unaware of its existence, even though it was passed on to consumers through higher prices. The business community fought consistently for its repeal. Economists, too, opposed this tax; after all, it was a penalty on producing things, something any developed economy should encourage, not penalize.

  As in the United States, there were advisory panels and study commissions on tax reform at regular intervals. As in the United States, nearly all of them urged the country to adopt a value-added tax at the federal level. By the start of the 1990s, with federal deficits increasing and the MST getting stiffer—the rate went from 5% to 13.5% in a dozen years—it was clear, even to the antitax Conservative Party, that the time had come. The Conservative prime minister, Brian Mulroney, muscled a consumption tax through the Parliament. Following New Zealand’s example, Mulroney called it a GST. It took effect on January 1, 1991, and was immediately unpopular.

  A major reason was that nearly all Canadians were already paying a sales tax. Every Canadian province except one had a retail sales tax in effect at the time. When the GST came along, people suddenly found themselves paying a new tax, piled on top of the provincial sales taxes already in place. Three provinces went to the Supreme Court to fight this new federal impost. To duck the tax, Canadians by the millions started traveling south to make major purchases (a practice that ended after 9/11, when crossing any U.S. border became much more difficult). Although the 1991 GST brought in significant revenues to pay for popular government services, Canadians were still furious in 1993, when the Conservative government had to stand for reelection. The Liberal Party leader, Jean Chrétien, based his entire campaign on the new tax—the Liberals’ slogan was “Axe the tax”—and won such a huge victory that Mulroney’s Conservatives saw their sixty-nine seats in the Parliament reduced to two.

  In fact, though, the Liberals couldn’t “axe the tax.” By the time Chrétien came to power, revenues from the GST were such an important part of the federal budget that the new levy simply had to stay in place. Chrétien offered voters an apology but then started negotiating with the provinces on a consumption tax that combined the provincial and federal taxes. The result was a new levy, the harmonized sales tax (HST), with proceeds split between the national and the provincial governments. Nearly all the provinces have gone along; 80% of the Canadian economy today operates under the GST/HST arrangement. Both Conservative and Liberal governments have backed this regime for more than two decades. In 2016, the federal portion of this tax was 5%; provincial rates, added to the federal levy, ranged from 4.75% to 10%. “Canada’s experience shows that you can impose a federal VAT on top of local sales taxes and make it work,” said Professor Bird of the University of Toronto. “And it might even be easier in the [United] States, because you could learn from our example.”

  The major problem facing a VAT or GST in the United States is not so much administrative as political. The tax is known as a “money machine,” and that in itself is enough to make it a bad idea for many American political leaders. It would bring in more revenue, which could fund more government. Grover Norquist, the founder of the tax-cutting lobby group Americans for Tax Reform, likes to say that “VAT is French for big government.” Daniel Mitchell of the Cato Institute has said the term “VAT” evokes certain other terms, including “Bad! Europe! France! Greece! Ebola virus!”9 Some politicians who might favor a VAT because it taxes consumption, not labor or thrift, have been scared away by the potential political cost. On Capitol Hill, the very idea of a VAT tends to bring back scary memories of a U.S. representative from Oregon, a Democrat named Al Ullman.

  When I was covering Congress, Ullman was a powerful figure: a twelve-term veteran who was chairman of the House Ways and Means Committee, the tax-writing committee. A former teacher, he was a serious student of tax policy. When I would interview him, he showed no interest in sports or hobbies or the politics
of his sprawling eastern Oregon district; he liked to talk tax. After conferring with countless economists, Ullman became Congress’s leading champion of a national VAT and proposed such a tax in 1979. Ullman saw the VAT as a way to cut personal and corporate income taxes; the Republicans saw it as a new tax on hardworking Americans and poured money into his district to defeat him. Sure enough, he lost the 1980 election, although it’s hard to say the VAT was the only reason; Ronald Reagan carried his district by a whopping margin that year. But ever since, any mention of a VAT on Capitol Hill has prompted the comment “Remember Al Ullman.” Another top Democrat, Senator Byron Dorgan of North Dakota, used to tell his colleagues, “The last guy to push a VAT isn’t working here anymore.”

  And yet you can make a strong case that the guys on Capitol Hill—particularly conservatives—should be pushing a VAT.

  “The irony is that the VAT is probably the ideal tax from a conservative point of view,” wrote the Republican tax expert Bruce Bartlett, who oversaw tax policy in the Treasury Department under the first president Bush. “As a broad-based tax on consumption it creates less economic distortion per dollar of revenue than any other tax—certainly much less than the income tax. If Republicans are successful in defeating a VAT, the alternative will inevitably be significantly higher income taxes, which will do far more damage to the economy than a VAT raising the same revenue.

  “I myself opposed the VAT on money-machine grounds,” Bartlett continued. “I changed my mind when I realized that there was no longer any hope of controlling entitlement spending before the deluge hits when the baby boomers retire; therefore, the U.S. now needs a money machine.”10

  Bartlett is not alone in his party. Alan Greenspan, the Federal Reserve chairman who endorsed the Bush tax cuts at the start of this century, has argued that a VAT is the “least worst” way to raise taxes. Now and then Republicans propose a VAT/GST or a similar form of consumption tax, operating on the theory that it’s better than the personal and corporate income tax regimes we have in place today. During the 2016 presidential primaries, several of the GOP candidates suggested plans—although they were not always crystal clear—for a national consumption tax. The most fully developed was a classic value-added tax put forth by the Texas senator Ted Cruz, who offered himself as the most conservative of all the sixteen Republican hopefuls.

  Cruz, of course, did not use the tainted words “value-added tax.” He called his plan, alternately, the “simple flat tax” or the “16% business flat tax” (BFT). He promised that his new tax would eliminate the corporate income tax, the estate and gift tax, the ObamaCare taxes, and the payroll taxes that pay for Social Security and Medicare (“while maintaining full funding for Social Security and Medicare”). He insisted that his plan would allow Washington to set everybody’s personal income tax rate at 10%—a major tax cut for most Americans—while maintaining the tax deductions Americans like best. To do all that, Cruz proposed a 16% value-added tax on businesses. He said that every business should file a quarterly tax return listing its total revenue for the quarter but subtracting its total purchases (but not wages). “This would tax companies’ gross receipts from sales of goods and services, less purchases from other businesses, including capital investment,” Cruz wrote. The difference between a company’s revenues and its purchases—that is, the amount of value added by that company—would be taxed at 16%. Because each company would report to the government how much it paid to all of its suppliers, the tax would be self-policing.11 And by the way, Cruz added, “the business flat tax in my proposal is not a VAT.”

  Economists from the left and the right begged to differ. All of them gave Cruz credit for laying out a tax plan in detail, something few of his rivals for the presidency in either party were willing to do. But the economists agreed that the business flat tax was, in fact, a VAT, because it tallied the difference between a company’s output and its input—that is, the value added—and taxed that amount. Professor Len Burman, a tax economist and head of the Tax Policy Center, called the Cruz tax plan “a textbook example” of a VAT. Alan Cole, an economist at the corporate-funded Tax Foundation, agreed: “This is definitely still a value-added tax.”12

  Cruz felt a need to deny that his BFT was really a VAT, because the money-machine view of that tax makes it a nonstarter for small-government advocates. In fact, though, it’s not so clear that this form of tax is necessarily a recipe for bigger government. “In most countries,” noted Professor Bird, the VAT or GST “has not resulted to any significant extent either in higher taxes or bigger government, but rather in governments being able to finance their expenditures in economically less damaging ways.”13 In Britain, for example, the increase in VAT from 17.5% to 20% was followed by a significant cut in government employment and welfare spending. (The government used most of the increased revenue to shore up the National Health Service, the country’s most popular public program.)

  —

  WHETHER IT’S A VAT, a GST, a BFT, or any other three little letters, can a national consumption tax ever be enacted in the United States? The former Treasury secretary Lawrence Summers offered a tongue-in-cheek prediction of when that could happen. “Liberals think the VAT is regressive,” Summers said, “and conservatives think it’s a money machine. If they reverse their positions, the VAT may happen.”

  EPILOGUE: THE INTERNAL REVENUE CODE OF 2018

  Ah, the blithe joys of springtime in the United States of America: azaleas in bloom at the Masters, school trips to the state capital, big sales at the garden stores, baseball’s opening day, picnics in the park on bright, breezy April afternoons—and the ordeal of Form 1040, with instructions like this one from the Internal Revenue Service: “If you determined your tax in the earlier year by using the Schedule D Tax Worksheet, or the Qualified Dividends and Capital Gain Tax Worksheet, and you receive a refund in 2016 of a deduction claimed in that year, you will have to recompute your tax for the earlier year to determine if the recovery must be included in your income.”1

  The U.S. tax code often seems to be at war with the taxpayers. The tax law has become so stuffed with obscure provisions that were important to some group or other at some point in time that the mess just becomes too difficult for anybody to understand or to manage. The resulting complexity—made worse by the so-called anti-complexity clause that Congress threw into the stew some years back—has reached absurd dimensions. When I asked the commissioner of the IRS whether anybody in his agency has read all seventy-three thousand pages of IRS regulations, he laughed at the very suggestion.

  At the same time, the tax code often seems to be at war with itself. There are many provisions, for example, that provide benefits or preferences for families that have a child. The problem is that the different sections of the Internal Revenue Code can’t agree on what constitutes a “child” for tax purposes. There’s a “child credit” in the personal income tax that applies to any person under the age of seventeen. But there’s also a separate “child and dependent care credit,” which defines a “child” as somebody under thirteen. For families getting the earned income tax credit (that’s the reverse income tax that sends checks to taxpayers who have low-paying jobs), a “child” is any person under nineteen—unless the person is a full-time student, in which case a “child” is anybody under twenty-four. Every time Congress decides to give a tax break for having a child, it just picks some definition of “child” and stuffs that language into the tax code, regardless of how many other designations of “child” have been stuffed in the code somewhere else.

  This has been going on since the birth of the federal income tax a century ago. And history has shown that every three decades or so the tax code becomes so huge and complicated and contradictory that the only way to fix it is to scrap the whole mess and start over. The thesis of this book is that, by looking at other industrialized democracies that have faced the same tax questions we’re dealing with, we can decide what should be in this new tax code
and what should not. That’s why the U.S. Treasury secretary in 1984, Donald Regan, dispatched his policy experts to look at other systems and bring back the best ideas—a process that ended with the dramatic tax changes of 1986, widely recognized as the most sweeping, and most admired, reform in the history of the U.S. tax code.

  Here at home, our political leaders talk about fixing the tax code all the time. But their proposals involve incremental change to the existing system, and incremental change, over the decades, is what got us into the fine mess we’re stuck with today. These approaches to tax reform, including the plans we heard during the 2016 presidential campaign, all suffer from the same problem: they’re too timid.

  They all have a rearranging-the-deck-chairs quality at a time when the whole structure is sinking from its own weight. As we’ve seen in other countries, the way to bring about fundamental change in a dysfunctional tax code is to start over—to rewrite from scratch. In chapter 4 of this book, the New Zealand parliamentarian Maurice McTigue explained why his country was able to scrap a decrepit, inequitable, inefficient tax code and replace it with a system that has won plaudits from tax experts everywhere. “A key reason was that we did it big,” McTigue said. “They changed almost everything at once. And that’s an important lesson: if you’re going to do tax reform, you’d better make it a large reform. That way, for every change a taxpayer doesn’t like, there’s something else in the package that he wants.” It’s the same conclusion the former senator Bill Bradley drew from our country’s successful revamp of the Internal Revenue Code in 1986. “You can’t just tinker,” Bradley said then. “Facing a huge, almost incomprehensible system, you have to take it on. Your goal has to be to fix the whole damn thing.”