Jewish World Review Nov. 30, 2004 / 17 Kislev 5765
Change the tax regime to help America save
Pre-election, post-election. Any time is a good time to bash the U.S. over its savings rate. Thus, early in the month Jean-Claude Trichet of the European Central Bank warned that the U.S. must "correct this lack of savings." Yet more warnings about the delinquent U.S. saver were conveyed to John Snow, treasury secretary, when he crossed the Atlantic last week.
The nasty current account deficit and the sliding dollar, Snow was told, represented proof that America was in the wrong. Snow smiled his big Snow smile. The savings rate mattered, but perhaps not the dollar.
Economically speaking, the critics are right except about the dollar, about which more, later. After all, as Alan Greenspan, chairman of the Federal Reserve, noted when he chimed in on the topic at the weekend, the U.S. does spend more than it saves or invests. Foreigners rush in to fill the gap and invest in the profitable U.S. There are two ways to address this imbalance. The first is for other nations, especially those doing the bashing, to make their economic cultures more attractive for investment. The second is for the U.S. to save more.
One way to get that increased saving is for America to switch to a consumption-based tax system from its current archaic income-based arrangement. The Bush administration is not going to reform the tax code tomorrow Social Security, the national pension plan, likely comes first but it is looking at a number of proposals to move the U.S. toward a consumption system.
The worst of them would damage America's civic culture, the same culture that generates that much-envied growth. The best would strengthen the U.S., both politically and economically.
Start with the flashiest idea, a national sales tax on retail purchases. The idea is to replace America's old income tax in one dramatic step and to annihilate the Internal Revenue Service, the country's hated tax authority, in the process. In some versions, social insurance Social Security, Medicare are also included in the sales tax. Economists are willing to consider the sales tax, since it is clearly a consumption tax only spending is taxed. And, politically, it is seen to be a big winner. After all, "Nuke the IRS" and "Kill the Code" are slogans that go over fabulously with voters especially in now-famous red states such as Georgia or President Bush's own Texas.
Manufacturers tend to believe that a sales tax regime will put them on a better footing with their competitors in Europe. But it is not really clear that this is so.
And, all in all, the idea of a national retail sales tax is loony. To pull in enough revenue, the tax rate must be more than 20 percent. The Fair Tax Act, one version that legislators have put forward, sets the rate at 23 percent. This levy comes on top of state taxes, so consumers would be confronting something like a 30 percent effective rate. Even Americans, admired the world over for their rate of tax compliance, would balk at forking over so much at once. The authorities would have to create a tax police more aggressive than the IRS.
It would be a bitter irony if the tax-cut enthusiasts among the Republicans ushered in a system that replicated the very sort of intrusive bureaucracy they claim to detest. But that is the kind of thing that happens when you let your tax policy be written by focus groups.
The second proposal is a value-added tax, levied at every stage of production. Again, economically, this makes wonderful sense. What is more, a value-added tax alleviates the problem of price tag shock and to a great degree, evasion. Indeed, the trouble with a value-added tax is the opposite of the trouble with the sales tax: It works too well.
With a value-added tax, you vastly increase the size of the government relative to gross domestic product before you know it. At least that is what happened in Europe.
Two other taxes that foster saving are under review. The first is magazine owner Steve Forbes' flat tax, a postcard levy of 17 percent that allows taxpayers to deduct dividends and interest, so they are taxed on salary alone. The flat tax is popular in 2003, five flat tax bills were introduced in Congress, mostly with rates of about 20 percent.
The last reform on the table is a gradualist one: simply continue the cuts to taxes on capital and investment that Bush began in his first term. The goal would be to gradually expand tax protection devices for savings until only income is taxed. This approach and the flat tax would improve the business climate and restore some of the faith lost in government. They would also push up the savings rate.
What they would not move is the exchange rate. For the dollar will continue to weaken until two things happen. The first is that the U.S. overcomes the negative consequences of inflation by the Federal Reserve in an election year. The second is that Snow stands up for the dollar instead of reiterating the need for more currency flexibility from the Chinese.
Still, if the U.S. changes its tax structure, it will improve its savings rate. It can also improve its savings rate by privatizing some share of Social Security. In either case it will then be up to America's trading partners to do their part by expanding faster. Over to you, gentlemen.
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JWR contributor Amity Shlaes is a columnist for Financial Times
. Her latest book is
The Greedy Hand: How Taxes Drive Americans Crazy and What to Do About It. Send your comments by clicking here.
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