Will We See a National Sales Tax?

Summary

The Obama budget is based on false revenue assumptions. It is unlikely that tax revenues will recover as quickly as they project. Also, there are costs not currently budgeted that will add substantially to the deficit. Add to that increased interest costs on the national debt. It will not be feasible to raise tax revenues on the upper 2% sufficiently to reduce the deficit as they project. It is likely that they will look to new revenue sources to reduce the deficit. A national sales tax may be the most politically feasible alternative for the Administration. A 4.5% tax could cover expenditures after rebating these tax costs to lower income taxpayers. Such a tax would be regressive.

President Obama released his budget for the 2010 fiscal year. The projected budget deficit is estimated to be $1.7 trillion. He plans to cut that in half by the end of his first term (2012). That’s $850 billion extra he’ll need to come up with. As we know, he’s excluded 98% of taxpayers from any tax hikes. That means the lucky 2% will be squeezed for more. But can they make up the difference?

Professor Russ Roberts ran some quick numbers to see if this could work and made the astute observation that it would be rather difficult to impose that big of a tax increase on the upper 2%.

The Wall Street Journal saw the same problem. “A tax policy that confiscated 100% of the taxable income of everyone in America earning over $500,000 in 2006 would only have given Congress an extra $1.3 trillion in revenue. That’s less than half the 2006 federal budget of $2.7 trillion …”

I ran the numbers from the IRS. Here are my calculations:

There are 3,853,000 taxpayers in the $200,000 and up income bracket (they don’t break it down at $250,000-2%). Their total adjusted gross income-AGI (taxable income, before deductions and credits) was about $2.4 trillion, which averages out to be about $623,000 of AGI per taxpayer. They paid $522 billion in taxes, about $135,500 per taxpayer (22% of their AGI), or 62% of all Federal personal income taxes paid. The top 2+% would have to come up with another $169,000 on average to pay the $650 billion difference, or 49% of their AGI

That big of a tax increase might be hard to get through Congress, but you never know. According to Robert Reich, “It’s about time a presidential budget uneqivocally [sic] redistributed income from the very rich to the middle class and poor.” According to Joe Biden, it’s patriotic to pay more taxes. I don’t think it will fly.

But the Obama Administration faces a bigger problem: the deficits for the foreseeable future will be much larger than they have projected. Has any administration been very good at budgeting?

The Concord Coalition’s … estimates show that if all expiring tax cuts are extended, revenues as a share of GDP will fall to 17½ percent over the next ten years, while spending as a share of GDP will grow to 24 percent, producing a deficit of 6½ percent–before any new spending or tax cuts considered as part of “economic recovery” policy. 

Add to that the likelihood that the stimulus bill won’t work.  Revenue will likely be much less than projected. I also think that when they realize that the stimulus package doesn’t work they will try more stimulus, which means more spending and higher deficits. 

Also, not all spending is included in their budget. For example, the budget doesn’t include the $250 billion in additional TARP funds. The budget books the cost of TARP at one-third of the cost of acquiring assets from bailed out banks. Thus, they hold toxic assets on their books equal to two-thirds of their TARP costs. If the toxic assets can’t be sold for two-thirds of what they paid, the deficit will increase proportionately. 

Another additional and unanticipated cost will be increased interest costs on the national debt. The debt is now $10.8 trillion, with interest costs of about $550 billion, or about 5%, per annum. Add another $1.75 trillion this fiscal year (2009-2010) for $12.55 trillion of total debt and there would be another $78 billion in interest costs, for an annual cost of about $627 billion.

But what if interest rates go up? First, for the Treasury to place that much new debt into the market without putting upward pressure on interest rates would be unlikely. If we have $12.55 trillion of national debt, for each ½ percentage point increase in interest (50 basis points), the interest cost would increase another $63 billion. It is possible that the impact of this additional debt on the market will be somewhat offset by additional savings by Americans. As we have predicted, consumers won’t consume as hoped; instead they’ll save to prepare for the worst.

It is also likely that when the skyrocketing money supply hits the economy, prices of everything, including interest rates, will go up. History has shown that high inflation is caused by a rapid increase in the money supply by the Fed. Money supply is exploding right now. At some point this money will hit the economy, and when it does, prices will climb. History also tells us that inflation means higher interest rates.

Our foreign creditors may not be so accommodating in buying our debt this time. The problem is that our foreign creditors are having problems of their own. The largest foreign creditors as of December, 2008  are (in billions): China-$727.4; Japan-$626.0; Caribbean Banking Centers-$197.5; Oil Exporters1-$186.2; United Kingdom-$130.9; Brazil-$127.0; Russia-$116.4. In tough economic times we can be assured these creditors will look to their own national interests before the well being of the U.S. We may be required to increase the coupon on our debt in order to place that much new Treasury paper with willing foreign buyers.

All of the foregoing suggests that (1) revenues will be less than expected, and (2) the deficit will be greater than projected. President Obama can cut spending but this runs counter to his political goals. He can partially raise taxes on the upper 2% and add the difference to the deficit. Or, if he is true to his word, he will find a new tax to cover the spending.

Based on his budget and promises, President Obama doesn’t have much room to maneuver. My guess is that he will try to impose a “temporary” national sales tax to finance the deficit. Of course, it will never be repealed, but the idea of being “temporary” will get it through Congress. He will structure it so that low income people will get a refund of taxes paid. The refund will be phased out as income increases.

My guess is that it will include non-food retail sales and they will add services (information, professional, technical and scientific, administrative and support, waste management and remediation, but excluding medical services). The services aspect is important because this will skew the tax more to corporations and upper income taxpayers.

In 2008 retail sales (excluding food) were about $4 trillion. Services in 2007 were another $2 trillion. Let’s say they need to raise $1 trillion over the next 4 fiscal years, or $250 billion a year. That would require a 4.5% national sales tax. In Europe they call this a value added tax (VAT) and the rate in the E.U. is about 15%. 

Unfortunately this will be added to the existing income tax structure which makes it a regressive tax, further hampering recovery.

So lay down your bets and let’s see what happens. Some time during Obama’s administration I think we’ll see a VAT. I hope I lose this bet.


1. Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, Algeria, Gabon, Libya, and Nigeria.


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14 comments to Will We See a National Sales Tax?

  • Matt

    The idea of a temporary federal sales tax is kind of funny to me. “Temporary” has always been the gateway drug to increased taxation that doesn’t ever go away. Much like the original federal income tax, which was put in place to pay for WWI, and all the increases along we’ve seen to pay for more and more mis-managed government.

    However, I’m all for a federal sales tax of 4.5% as long as they remove INCOME tax altogether. What better way to increase spending? Have all of your money, and spend it the way you want, they collect on the back end. Tax collection as a whole would go up dramatically as there’s no way to get out of sales tax. The combination of an income tax and a federal/national sales tax feels too much like double jeopardy.

  • Econophile

    Excellent observation. But, I’m afraid the VAT would have to be much higher than 4.5% to do away with the income tax. But I agree, it would be a more preferable way to tax.

  • Pii

    “There is nothing more permanent than a temporary government program.” -Ronald Reagan

    Econophile – Saw your comments on Robert Reich’s blog (which I was reading for laughs), which led me here.

    It is staggering that the top 2.9% in earnings pay 62.5% of all income taxes. How on earth could anyone seriously assert that “the rich” aren’t doing their fair share?

    As for a national sales tax, at one time, I seem to remember hearing that a figure of 17.5% would fully replace all revenue derived from the income tax.

    Great blog…

  • Econophile

    Pii:

    Thanks for the comment. Reich is entertaining and provides me with good material.

  • Art A Layman

    Financial analysis is such a fun thing. Spent mucho years doing it. Of course one must always be careful about GIGO and, even more so, ummm…errr…shall we say, massaging? Maybe fine tuning sounds better.

    Was struck by the Wall Street Journal quote. Not sure if the two were correlated but the Obama presumption was that increased tax revenues would cover half the deficit. The WSJ quote nets to a 100% tax on the top 2% in 2006 would equate to less than half the total budget of 2006. No doubt true. No doubt numbers that show up within the same ballpark. But being an old green eyeshade accountant I prefer precision and paralleling what the $1.3 trillion would have done to the 2006 deficit would have been more meaningful. Arguably not apples to oranges but surely, Delicious Reds to Greens.

    We are all familiar with, “Figures never lie but liars sometimes figure”. Somewhat a misnomer. “Finaglers sometimes figure” would be more apt. Many would substitute “Accountants” for “Finaglers” but that’s another story.

    Another obscurity appears in a comment above: It is staggering that the top 2.9% in earnings pay 62.5% of all income taxes. How on earth could anyone seriously assert that “the rich” aren’t doing their fair share? We see variations of this theme appear all over the blogsphere. The flaw, even maybe fallacy in logical terms, is that the statement means nothing if we don’t include what the 2.9%’s share of total income is. Smoke and mirrors is not dissimilar from haze and reflections in windshields.

    As to a national sales tax? Ain’t gonna happen on the Dems watch. You’re correct, far too regressive. Beyond that you’d be treading on a province left to the states. The Fair Tax is the biggest sham to come along in eons. The APT tax, with all its flaws would be better.

    Perhaps the best solution would be a financial transactions tax. Been there, done that and it could be small enough, ratewise, so as not to infuriate the masses.

    Best get out the crying towels guys. The era of Reagan buffoonery is over.

    In my best impersonation: Good day!

    Haven’t read the proposed budget. Retirement not only means “Never having to say you’re sorry” but also that you don’t have to look back. Would guess that Obama’s projections are predicated on the meager return to a top rate of 39.6%, coupled with the return to 20% on capital gains. Off the top of my head I would tend to agree you can’t get there from here. Now a top rate of 50% or 70% or 90%, beyond appropriate income levels could get us there, maybe in spades. It may be that Obama needs to think bigger.

  • Econophile

    Art:

    I am honored that you would read my blog. I appreciate your comments because they probe to the meat, so to speak. I agree with your general comment about numbers, but for another layman, like me, it’s difficult to come up with anything original, so I’ve got to live with what I get from the IRS. You are correct in that the WSJ quote was referring to a 100% balanced budget, not the one-half that I and Obama were discussing. But it was in the same vein.

    While we may agree that a VAT is a bad idea, I don’t think the Obama Administration necessarily believes that. They believe so much other BS that a VAT isn’t such a big leap. Especially if they rebate the po’ folks. My point is that the deficit numbers will be much higher than they project and, if he’s true to his word, the money will have to come from somewhere. If you want something truly regressive, as history has shown, go for a confiscatory top rate as you suggest.

    I also don’t think your comment about Reagan as being an era of buffoonery is valid or fair. It’s just name calling. We can argue about history until we’re blue in the face.

    But, thanks for your comments. I hope you continue to participate because it is helpful to me and my readers to see another intelligent viewpoint.

    And, I heard Reich this morning on NPR and he’s so ingnorant that I may do another piece on him. (Thought I would yank your chain a bit.)

  • Art A Layman

    Econophile:

    Don’t be to honored, I’m an equal opportunity liberal blather spewer. My viewpoints have been called many things, seldom is intelligent one of them.

    Among my pet peeves are those who use numbers selectively in support of their ideas, or “strongly” held beliefs. I subscribe to the doctrine of “the whole truth”. Half-truths tend to imply, at least, half-lies. If your premise cannot withstand scrutiny when all facts are exposed can you even have a valid premise?

    Another hot button is incongruity. A gentler, kinder word for, hypocrisy. To wit:

    I also don’t think your comment about Reagan as being an era of buffoonery is valid or fair. It’s just name calling.

    Then:

    And, I heard Reich this morning on NPR and he’s so ingnorant that I may do another piece on him.

    Granted the former may represent a serious moral judgment, while the latter was simply joking but then could the reference of the former perhaps have been said with tongue in cheek? Given that I am an expert on the reference of the former, let me state that it was a serious observation, coming from one who had quite a few years under his belt before Reagan entered the national stage.

    We can argue about history until we’re blue in the face.

    True, but it is fun and interesting. Arguing about the future, while also fun and interesting, will find some of us, literally, blue in the face before we know who was actually right. History is certainly no blueprint for the future. The dynamism of this thing we call life seldom ever allows for a completely comparable set of events. However, it is the only template available to appraise actions and potential effects. Thus, history is worth revisiting, even though some have views much more myopic than others.

    Case in point; If you want something truly regressive, as history has shown, go for a confiscatory top rate as you suggest. Being a lawyer, or formerly one, I would think you would use words more carefully. “Regressivity” or “progressivity”, in tax discussion parlance, refers to the effect of the taxes on a basis of income levels. A top rate of 90% on astronomical income levels cannot, by definition be termed “regressive”, until perhaps we all get there. Horrendous, absurd, even insane, might be appropriate, depending on your point of view, more specifically your political ideology, but it ain’t “regressive”. You can claim history supports your view, doubt you can prove it.

    Economic history would tell us that during the period when 90% top rates were in place, we enjoyed the greatest economic growth in the history of the world. This is not to suggest cause and effect but it does suggest that the high marginal rates were not much of a hinderance to economic prosperity, especially for all.

    BTW, I like and admire Dr. Reich. I’m not a disciple nor a blind follower. I take him to task from time to time but overall he and I share a belief in THE only valid political ideology.

  • Econophile

    Art:

    Here’s what gets me: Mr. Reich does exactly what you accuse others of–half-truths, innuendo, false conclusions. He passes himself off as an intellectual but there’s nothing very insightful in his writings. I also can claim quite a few years to my hide, but so what. We need to discuss theory before we can discuss history. I try to discuss theory at a practical level, often using history to prove a theoretical point. (I know I’m generalizing here.) I should be more careful what I say around you. I was using progressive-regressive in the economic sense. Maybe I’m wrong, but generally high taxes tend to depress economic activity. More later. I would agree that your philosophy is far from mine, but that’s why we have to have serious discussions and find a common ground to get at the truth. Thanks for the comment.

  • Art A Layman

    Dr. ;) Econophile:

    Dr. Reich is, in TV appearances, his blog and maybe others of his writings, a political commentator, generally pushing a political ideological agenda. As such, even though one may disdain his shortcuts, one does understand the necessity or reason for them.

    TV talk shows are no venue for intellectual debate. They do not, nor cannot, afford the time to delve deeply into theoretical or practical applications of all the variables of any given subject, especially not economics. Blogs are only minimally better. Time is not the constraint on blogs, but there are limits concerning how interested and involved an audience will stay if a blog entry runs on page after page after page of esoteric ramblings.

    I’ve have often wondered what Dr. Reich’s purpose is in his blog. To invoke thinking and thus commenting? To get things off his chest in meaningful, albeit shorthand, dialogue? My best guess is that the responses are for use in his classes as fodder for discussion and learning. Maybe, in the end result, to do nothing more than expose his students to the inanity of the average joe. To use his blog as a medium for truly intellectual discussion would necessitate longer entries from him and longer, and frequently boring, comments from a more educated audience. Arguably the more honorable goal but it returns you to intent and purpose.

    I haven’t had time to review all your entries but a cursory review does not suggest that you have overcome many of the same pitfalls that Dr. Reich, or any other blog owner, falls victim to. The question always comes down to, do I write a book or merely an essay?

    Now theoretical debate is enjoyable, although the advantage goes to the one better read and more knowledgable of the theories being debated. Arguing theory only is somewhat of a masturbatory exercise. Economic theories exist, lo, proliferate, across a broad spectrum. Start with some basic premises, generally accepted by most economic theories, and then you enter a decision tree with multiple branches, usually beginning with Adam Smith, moving to the Austrians, the monetarists and, maybe near the bottom Keynes. No doubt there are many other branches of which I am totally ignorant. The point being that theory alone tells us nothing. Only practice and application can teach us anything and that requires real world examples which can only come from history, perhaps with a little aid from analogy.

    Take for instance your assertion, of which you seem uncertain: Maybe I’m wrong, but generally high taxes tend to depress economic activity. In theory, absolutely correct, but you cannot, using all of history prove the premise. If we could isolate only taxes and their impact on economic growth we might be able to argue the “theory” and find historical examples, but again, dynamism. Reviewing only cursorily, Clinton’s term in office would prove the contention false. Even rigidly parsing Reagan’s term might disprove the “theory” given his multiple tax increases along with his tax decreases. He is still on record for signing the largest tax increase in US history, 1982.

    The biggest problem I have with economic theories, and the thing that turned me off quickly when taking economics classes in college, is that there are no hard postulates, no axioms. Most every economic theoretical “fact” is based on a number of assumptions many of which must be held constant to prove the “fact”. The worst one might be “rational man” theory. All, using that word hesitantly, economic argument, proposing given this then that, is predicated on a “rational” behavior of the players involved. What is “rational”? Is it fixed or variable? Our current dilemma would suggest very variable.

    Enough for now, welcome to Econ 1, as opposed to 101.

  • Econophile

    Ah, Art:

    Perhaps you are right about Reich. Perhaps I’ve haven’t delved deep enough into his archive of scholarly articles to see the depth of his thinking. That would be an interesting exercise. But, based on his general comments, which are very similar to other liberal, Keynesian commentators, I would challenge his intellectual assumptions. Forgive me if my assumptions are wrong.

    Here is the problem as I see it. When you say only “history” can lead us to the truth, I would strongly disagree and say that only theory can lead us to the truth.

    This gets sticky and I try to not get into theory here because it bores people. But the essence of Austrian theory is, well, theory. Their argument is epistemological (the science of how do we know what we know). Austrians would say, well, “history” is made up of a million facts because there were a million actors on the economic stage all making individual decisions. How do you know you picked the right facts to make your analysis? Well, most social scientists would say, they have a “theory” of why “x” happened and not “y.” Then they fo off and do empirical research. If it starts with theory, then you better have your theory correct, or your examination of the facts (history) is just going to be a guess.

    We Austrians would say that theoretical examination is superior to empirical analysis. They have developed a type of logical analysis, starting with Aristotelian logic, and continuing through to today with new ideas about epistemology and logic.

    The Austrians have been able to show, theoretically based on logical analysis, that Keynes’ theory (i)is incorrect, (ii) is internally inconsistent, and, (iii) if you do look at history, has failed miserably whenever applied.

    This is not really the forum to discuss all of this stuff because it’s really deep and complicated. But if you ever wish to study Austrian theory (I’ve read Keynes’ General Theory) you should read Mises’ Human Action. Then you could appreciate the difference in the two theories. I think economics is quite different than how you perceived it in college. (Maybe you used Samuelson’s book as did I.)

    I don’t mean to sound pedantic or arrogant here, but it’s hard to explain. I urge you to start with the idea of why current economics and its econometric analysis is incorrect and why it has led to disastrous results. The best explanation if von Hayek’s Nobel acceptance speech. It would explain a lot about how we think. http://nobelprize.org/nobel_prizes/economics/laureates/1974/hayek-lecture.html

    Gotta go.

  • Art A Layman

    Econophile:

    Am winding my way through the Hayek lecture, as I suspected it is causing great pain to my hair.

    So far, and I’m sure there are “buts” to come, his argument would not seem inconsistent with mine on the relative value of economic theory.

    BTW, are you throwing Krugman into your list of blathering Keynesian non-intellectuals? If so, one might posit that your vision is tainted by the old adage of beauty and the beholder.

    I’ll be back.

  • Econophile

    Art:

    I very much appreciate your labor. Yes, those Austrians can be dense, but thrilling.

    Krugman is at the top of my list. Brilliant mind, wrong premise.

  • Art A Layman

    Econophile:

    Even a “wrong premise” can be argued intellectually. Especially when again, the “wrong premise” might be less than an objective observation.

  • Econophile

    True. But the only tools we have are our reason and the rules of logic.