Value-Added Tax for America?

Dan Mitchell wrote an interesting op-ed in NY Post (link) concerning the prospects of adopting a European-style value-added tax (VAT) in the United States.

Imposing a VAT would be detrimental to economic growth and productivity performance. If the U.S imposed the VAT, its spending levels would quickly approach the European spending levels. Indeed, the VAT is already used by OECD nations. In European Union, European Commission’s Directive requires each country to harmonize value-added tax rate at the level of at least 15 percent. Federal spending in the U.S has already escalated. The consequence of $787 billion of stimulus measures is high public debt. Congressional Budget Office has forecasted the public debt to approach 70 percent of the GDP by 2012 and remain constant until 2020 (link). Rising costs of health care, entitlement spending and aging population have triggered government spending (link) and tax burden on the U.S firms and households. By 2020, health care spending is expected to reach 20 percent of the U.S GDP (link). Historical figures suggest a rather glimmering fiscal scenario for the United States in the next decade. In 1965, before the VAT spread across the European community, average tax burden of EU15 reached 27.7 percent of the GDP versus 24.7 percent in America. In 2006, the average tax burden for 15 developed European countries reached 39.8 percent. In United States, where VAT has not been introduced, average tax burden in 2006 remained close to the level of 1960s – at 28 percent of the GDP. The immediate consequence of VAT introduction in Europe was a surge in government spending. From 1965 to 2006, average government spending (as a share of the GDP) in the European Union increased by 17 percentage points while in America it increased by 7 percentage points. The total increase of spending growth in Europe and America is attributed to the widespread growth of the welfare state which includes entitlement spending and a growing cost of health care.

The economics of tax system is pretty straightforward. Alan Viard of the American Enterprise Institute (link) has outlined basic features of the VAT system. Contrary to the income tax system, VAT is a consumption tax. From the economic perspective, consumption tax is less distorting to economic behavior than the income tax. A pure VAT is tax at each stage of the supply chain. The taxation of individual income is a major distortion mostly because the source of direct taxation is labor supply. Introducing a tax on labor supply creates the so-called substitution effect where lower wage (w’=w(1-t)) is offset by a decrease in working hours and an increase in leisure hours either in pure leisure time or working more in household production or in the informal sector of the economy. Higher tax wedge in net wages has been the major factor behind fewer working hours in slow-growth European countries (Italy, France, Germany, Belgium etc.). The VAT is not as damaging as the income tax since the tax rate on individual consumption is applied when the income is already earned, so that income earning is not distorted. From a pure economic perspective, consumption taxation is more appropriate than income taxation mostly because the price elasticity of consumption goods is lower than price elasticity of labor supply. The consumption tax is based on the so-called Ramsey rule which states that the optimal tax rate is the inverse of the price elasticity of demand for a particular good ((t*=1/-dQ/dP*(P/Q)). It follows that on consumption goods with lower elasticity of demand, higher tax rate should be applied since the deadweight loss is smaller than in consumption goods with high price elasticity of demand. For example, price elasticity of demand is very low in goods such as gasoline since there’s no close substitutes to gasoline. On the other hand, the elasticity of demand is pretty high in goods such as Big Mac or Coca Cola since there’s a lot of substitutes for these goods (Subway snacks, Pepsi etc.) and a tax rate on Big Mac or Coca Cola can easily divert consumers to consume more Subway snacks, Pepsi or other goods.

While the introduction of a VAT is less income-distorting than a direct income tax, the imposition of both tax structures is a negative effect on economic growth, productivity and employment. Aside from the harmful taxation of income, the introduction of the VAT would further hamper individual consumption, raise consumer and producer prices and harm the manufacturing activity. One advantage of the VAT is a low cost and easy way of raising revenue. In economic theory, a uniform consumption tax is preferable to the income tax mostly due to fewer distortion in generating income which is the key feature of economic growth. A VAT also avoids imposing additional penalizing disincetives to labor supply and productivity.

Congressional Budget Office (link) has recently released Budget Outlook 2010, in which it laid out future perspectives of America’s fiscal policy. Assuming an exerting pressure of tax burden in the coming years, the CBO has predicted the individual income taxes to grow from 6.4 in 2009 to 10.9 percent of the GDP by 2020. Imposing a VAT on top of the existing income tax would further reduce real disposable income and individual consumption. If a VAT were implemented on the federal or state level, there would be a significant and immediate increase in effective tax rates. The evolution of federal effective tax rates from 1970 to 2001 (link) shows a trend of decreasing effective tax rates and a growing after-tax income in all income quintiles.

The introduction of a VAT would dramatically change the US fiscal map. An article from OECD Observer (link) shows a comparative tax revenue distribution for the U.S, Europe and Japan. Back in 1999, the U.S was the only global economic giant with tax revenue from goods and service taxation of less than 30 percent of all tax revenues. The share remained steady until now. The non-existence of the VAT in America has contained the growth of overall tax burden. In 2004, total government revenues were 32 percent of the US GDP, far below the shares of high-tax countries. In Sweden, government revenue presented 59 percent of the GDP. While the U.S tax burden, measured as a share of government revenue in GDP, stayed below the level of France (50 percent), Germany (43 percent), Italy (45 percent), the introduction of a VAT may quickly turn America into a European-style country with high tax burden and benign economic growth. The international data (link) on total tax revenue in 2007 show that total tax revenue in the U.S presented 28.3 percent of the GDP. In 2007, taxes on goods and services presented about 4.7 percent of the US GDP; about three times less the level in Sweden (12.9 percent of the GDP) and four times less the level in Denmark (16.3 percent of the GDP). If a revenue from a VAT captured approximately 9.5 percent of the US GDP, America’s tax revenue from a VAT would present about 14.2 percent of the GDP (9.5+4.7=14.2) comparable with high-tax countries such as Finland, Austria or Belgium and even more than in France.

Although the VAT is an easily applied method of taxing general consumption, imposing a VAT on the federal and state level would seriously harm America’s future growth, investment, personal consumption, manufacturing activity and productivity. It would make America look like a typical slow-growth European welfare state for the first time.

Treasury Assists with $90B in Bonds: Saves States $12B

Last year’s stimulus package included a program for states and municipalities entitled “Build America Bonds.”

The U.S. Treasury announced that so far it is on target to save those local governments $12.3 billion in borrowing costs with federally subsidized taxable bonds already sold during the first year of the program.

Since the stimulus passed last April, the Treasury has helped state and local governments sell $90 billion of these bonds to assist their jurisdictions with new liquidity to fund their local projects.

While most government agencies traditionally issue tax-exempt bonds, the Build America Bonds are taxable bonds with a 35 percent federal subsidy on interest costs. This means that a jurisdiction ultimately pays much less in interest to provide the same capital improvements or service upgrades to their constituents.

Denver Water which was one of the first agencies to take advantage of the program in order to effect need upgrades to the Denver water system. Chips Barry, manager of Denver Water stated that they were “pleased to be able to sell bonds at a very reasonable rate in the current market environment. For ratepayers, this means we are able to keep costs as low as possible while providing us the funding to improve our system.”

California issued seven of the top 10 bond deals according to analysis of Treasury Department data. The state also issued roughly one-quarter of the $90 billion worth of bonds since last April. Most of the bonds issued by the sunshine state are now in the midst of funding transportation and educational improvements.

“People originally said it would eliminate the issuance of municipal bonds,” says John Cummings, who is head of muni-bond investments at money-management firm PIMCO. “Instead they have stabilized the market and helped to create jobs.

Predictable Gold Upleg Starts A Little Late

The exciting news from the CFTC gold and silver hearings seem to have coinincided with the predictable gold move. The past six months have had tremendous events and it appears black swans are flying in flocks. Now the gold price appears poised to reach my earlier predictions but this may not be easily played for profit.

EARLIER PREDICTIONS

With gold trading around $995 on 9 September 2009 in Gold Party Barely Started I wrote, “This puts $1,300 gold and $25 silver within range without greatly exceeding previous trading norms”.

Slightly later on 9 October 2009 with gold below $1,050 I was interviewed on BNN:

BNN HOST: You said the credit crisis has not been calmed but intensified. Why? … So as we get more and more concerned with the top of that pyramid, the derivatives play, you are talking about $1,300 bullion. How do you get to that figure?

TRACE: $1,300 bullion comes from looking at the 200 day moving averages and where gold has consolidated and where it goes based on the usual uplegs. It looks like we are following the same thing that happened in 2004 with the rise in 2005, the consolidation in 2006, which went to the rise in 2007, and the consolidation in 2008, and it looks that it will lead to a similar rise in 2009 and 2010 which will take gold to $1,300 which should be a little bit above its 200 day moving average. But in the same trading ranges as we saw in 2005 and 2007.

gold wheat oil commodities

SIX MONTHS OF BLACK SWANS

In the last six months many important events have transpired. The credit crisis intensified with CIT, Dubai and looming sovereign defaults. Commercial real estate is still frozen and about $600B needs to be refinanced during 2010. Massive fraud is being revealed on a grand scale such as with the 2,000+ page report on Lehman brothers. Greece is holding the Euro-zone hostage while Russia, as usual, most likely mass executed their political opposition. The spread between 2 and 10 year Treasuries has been getting omnious at highs not seen since the early 1980’s. Haiti and Chile rocked out. Civil unrest is increasing throughout the world from Bangkok to Paris. And to cap it off the CFTC gold and silver hearings led to some amazing convergence of opinions between Christian and GATA.

However, I did slightly jump the gun on timing as this late Jan 2010 chart shows.

The consolidation lasted longer than I anticipated. But that only leads to greater strength for the upleg. And given the past events in the last six months, any of which could lead to chaotic fingers of instability, I would rather be a little early than a little late.

I still think the probability of $1,300 gold in Q2 is very probable while $25 silver may not be so likely; although there will likely be good returns in the white metal. Of course, I still like platinum and the current gain is about $600/ounce from when I recommended buying platinum.

JEFFERY CHRISTIAN’S DANGEROUS IDIOICY

Zero Hedge did an excellent analysis of Jeffery Christian’s interview on Financial Sense Newshour. Because Whiskey and Gunpowder recently featured my article Survivialism In The Suburbs and it stirred up some good discussion I thought I would hone in on some of Christian’s comments that have been lost in the kerfuffle.

Mr. Christian said, “If you look at fishes and loaves of bread, the ratio of derivatives transactions to physical underlying it’s 5 to 1; if you look at aluminum or copper it is about 15 to 1.” During his CFTC testimony he downplayed the implications of shortages, “Another thing is that there are any number of mechanisms allowing for cash settlements”.

CASH SETTLEMENTS AND EMPTY BELLIES

Using Mr. Christian’s logic about always being able to use cash settlements instead of delivery is ludicrous. How helpful is cash settlement of commodities for the people in Haiti and Chile? But then again, Mr. Christian is from Goldman Sachs and their CEO thinks they are ‘doing God’s work’. But last I checked while one can eat cash, like they can eat gold, neither are very nutritious.

Government deficits are generally funded by inflation. Inflation is used as a weak excuse for ineffective price controls. Price controls lead to shortages. These artificial, yet real, shortages lead to rationing. If shortages are too acute and in this case if the Federal Reserve is unable to turn their colored coupons or derivatives into actual physical loaves and fishes, like Jesus did, then the shortages can and will lead to starvation and death.

The attempt by government to disable the chief numeraire to mask the effects of inflation indirectly acts as a price control on all goods and services; particularly raw materials such as commodities which should be viewed as competing currencies. This treasonous policy is fraught with tremendous societal risk. While no one knows precisely how it will play out; my gold chips are on the outcome that it will not end well.

GATA warned about this in the WSJ advertisement:

The objective of this manipulation is to conceal the mismanagement of the U.S. dollar so that it might retain its function as the world’s reserve currency. But to suppress the price of gold is to disable the barometer of the international financial system so that all markets may be more easily manipulated. This manipulation has been a primary cause of the catastrophic excesses in the markets that now threaten the whole world.

A LIFE HEDGE

As a basic life hedge I recommend a three month supply of food and a 72 hour kit. These will provide protection against the vast majority of probable scenarios. Just to be clear, for the extremely dense ones, I recommend taking physical possession of the food and not relying on another institution who engages in fractional reserve food storage at a 100:1 or even 5:1 ratio. When I am hungry I do not appreciate a waiter’s promise of cash settlement instead of my giant steak.

For the truly risk averse who want to ensure the safety of their family then what is the 72 hour kit for? To get somewhere else; like a cabin or for the lazy and social: La Estancia De Cafayate. As with everything just weigh the risk and probability, perform your value calculation and implement your decision. We all have different risk preferences; for example some people want meteorite insurance but I do not.

CONCLUSION

The entire worldwide financial and economic system is a Ponzi scam and will evaporate. No one knows how this will play out but those who are farsighted and understand the Austrian school of economics know this is extremely serious. I was in Chile a few weeks before the massive earthquake. Upon small hinges the wide arc of our lives turn.

The massive imbalances in the gold and silver markets and the entire worldwide economy will not be quickly corrected nor easily played for profit. Too many adhere to the cult of government for that to happen quickly and without too much disruption. But Daybreakers is a good primer so simply be prepared with every needful thing. Tell me, what do you think?

DISCLOSURES: Long physical gold, silver and platinum with no interest in the problematic SLV, Streettracks Gold ETF Trust Shares or the platinum ETFs.

Economic Events on April 13, 2010

At 7:45 AM EDT, the weekly ICSC-Goldman Store Sales report will be released, giving an update on the health of the consumer through this analysis of retail sales.

At 8:30 AM EDT, the International Trade report for February will be released.  The consensus is a deficit of $39 billion, which would be a increase of $1.7 billion over January.  Weaker oil prices in that month are expected to be offset by increases in consumer spending and corporate investments.

At 8:55 AM EDT, the weekly Redbook report will be released, giving us more information about consumer spending.

Also at 8:30 AM EDT, the monthly Import and Export Prices index for March will be released, providing some data that can be used to monitor the threat of inflation.

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