Game On!

Wow.  The Presidential Commission on Reducing the Public Debt released its draft proposal today and it really puts a lot of options on the table.  Here's a New York Times article summarizing some aspects of the plan.  This could be the start of a very large discussion that changes the fundamental operating parameters of tax-and-spend government.  Or else it could be a flash in the pan like President Bush's bi-partisan, blue-ribbon tax panel in 2005.

Will the new proposal actually be the catalyst for serious change - or will it operate much like the Bush panel - proposing great, practical ideas that are really for the best long term interest of the country, but get summarily ignored because politicians don't want to risk telling voters that they will actually have to pay for the benefits that they are getting?  Let's take a look below.

From the beginning, we note that the Obama commission plan goes far beyond the mandate of the Bush plan.  The Bush plan was limited to taxation.  The Bush commission had two mandates: 1) tell us the best tax structure for economic growth, and 2) tell us the best structure that still maintains the "progressive" nature of the current tax code that taxes harder working people more.  The Bush panel reported (in agreement with commonly accepted economic principles) that the best tax system for economic growth was a tax on consumption, not on income - for example a national sales tax or a Value Added Tax (VAT).  For those that don't know, a VAT is similar to sales tax, but while a sales tax only imposes a single tax on the transaction from retailer to consumer, the VAT imposes smaller taxes on the increases in the value of the product as it moves through the supply chain.  For example, if the eventual product is a stick of gum, the manufacturer will be taxed based on the difference between the commodity prices it pays and the prices of the goods it sells to the distributor.  The distributor is then taxed on the difference between what it pays the manufacturer and the price it gets paid by the retailer.  The retailer is then taxed on the difference between what it paid the distributor and what it charges the consumer.  In operation, a VAT acts much like a sales tax, but it minimizes much of the tax fraud associated with a sales tax so that the actual tax imposed on the consumer is slightly lower.

However, even though that system would increase our economic activity - making a bigger "pie" for everyone - it is politically dangerous because our current political system uses the "progressive" nature of the tax code as a political myth that the "rich" are paying more in order to make average taxpayers more comfortable.  As for me, I am behind whatever is best for the country as a whole in the long term - and I very much believe in treating people equally.

Taking a look at the current proposal, I note that it has several aspects that are very reasonable.  It also is careful to postpone implementation for a couple of years until we are on firmer financial footing.  In this regard, I note that every dollar that we "stimulus" away now is going to have to be paid for with interest in the future - and I grind my teeth in frustration about that - but the negative consequences of allowing the economy to fall into deflation are really, really bad - in virtually every example, it creates a self-reinforcing downward economic spiral that yields great pain for decades.  Consequently, I know it is expensive now - and I certainly don't agree with the particulars of several stimulus plans - but I agree in principle that we need to use government intervention to prevent a deflationary meltdown.

As I mentioned above, one thing that is well known is that consumption-based taxes are economically better than income-based taxes.  So if you value the long-term health and growth of the US, you should be favoring consumption-based taxation.

In this regard, I see several aspects that are appealing:

1. Upping the Federal gasoline tax from 19 to 34 cents/gallon in order to make the Department of Transportation revenue-neutral.  As you can see, this is obviously a consumption-based tax.  In that regard, it replaces the funding that the Department of Transportation would have received from income-based general revenue with consumption-based taxation, which is a move in the right direction.  Also, it seems more balanced because the bulk of the DoT's spending is subsidies to states to build and maintain roads and highways.  The question of whether the DoT should operate the way it does is a larger issue, but at least this seems like a step in the right direction.
2. Elimination of the "Earned Income Tax Credit".  This provision is really a welfare provision hidden in the tax code wherein some people get back far more than they actually paid in taxes.  If you want to implement welfare, do it separately.  This just distorts the tax code and moves us away from consumption-based taxation.
3. Cutting defense spending - We spend 10-50 times as much on defense as comparable first-world countries.  We spend far too much.  Additionally, while there is some continuing economic benefit in that research for defense may be used to design products that are useful elsewhere (like GPS), overall the bulk of our current spending does not produce an economic return.  Cut defense spending at least in half - keep the research.
4. Eliminate Farm subsidies - Like defense spending, there is some limited economic benefit, but overall farm subsidies have been pitched as payments to small farmers (and were in the beginning - and were useful to prevent massive labor displacements away from the farm - and unemployment - when commodity prices shifted).  However, the payments are increasingly not economically justifiable with the substantial elimination of the small farmer and the global connection of the commodities market. 

The plan also includes some provisions for Social Security reform, but that's a story for another post!