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For all the gnashing of teeth in the Democratic primaries about NAFTA, you’d think that were our number one trade issue. Just “fix” NAFTA, and our record trade imbalance will disappear, right? Wrong!

In fact, the most important impediment to American producers in the global market is our antique tax system. Unlike more than 140 of our trading partners, the United States stubbornly sticks to a system that primarily taxes personal and corporate income. Virtually every major American trading partner large and small (all but the oil exporters) has as a major component if its tax regime some sort of consumption tax. The most common form is a value added tax as in the EU, China and Mexico. Other countries, notably Canada, rely on sales taxes.

Whatever the form, these consumption taxes have one thing in common. Under international trade rules, they are “border adjustable.” That is, they are applied to imports at the same rate as to domestically produced goods, and they may be and usually are rebated on exports. Typically, the border adjustment runs in the range of 15 – 25 percent. Ten percent here, five percent there; pretty soon, you’re talking about real money, as a former senator from Illinois might have put it.

Since the US declines to adjust its tax system, it is by choice a loser in international trade. We have decided not to join ‘em, so they beat us. We seem to insist on doing poorly as a trading nation.

By comparison, most international trade negotiations and most trade disputes involve factors a lot less significant than the disparity in taxes. In fact, our “free trade” agreements are silent on border tax adjustments, leaving our trading partners free to increase their advantage not just while negotiating but even after the agreement is in place.

What’s wrong with Americans? Why is there no sense of outrage at this huge self-inflicted wound? Part of the answer can be found in our “silo” concept of economic policy-making. We have no sense of national purpose or strategy when it comes to economics and trade. Tax people do taxes; trade people do trade. Never the twain shall meet, apparently.

If you think we’ve paid too high a price for too long for silo government, feel free to join in a discussion this Thursday May 8^th with Yale Law Prof. Michael Graetz. He has a plan for a “competitive tax” system that I like a lot. He’ll be addressing the Coalition for a Prosperous America Issues Forum (which I chair) from 10:30 until noon EDT. Contact IAS at iasg@erols.com or 202-393-8600 if you want to be there in person or join or Webinar. You trade people will be glad you did!

Charles Blum

Labels: Tax, Trade

The most powerful tool that most societies have for shaping economic behavior is its tax system. America’s complex, convoluted and cumbersome system, overwhelmingly focused on income, is at the root of much of the economic behavior that accounts for our failure as a producing nation. At the heart of any viable tax system for the future will be a border-adjustable consumption tax. That may take the form of: a value-added tax as used in Europe, Mexico, China and the CAFTA countries; a national sales tax such as the Canadian tax on goods and services; or perhaps a business transfer tax that might rely on current financial statements but might tax the “value added” rather than “profit.”

Why should the US think of such a radical change in its tax system? Here are the top ten reasons:

1. We consume too much. If we collect more tax when dollars are spent than when they are earned, people will adjust. The more you spend, the more you tax pay, whether you are a lunch-pail factory worker, a high-flying stock broker or Paris Hilton.

2. We save too little. The solution: don’t tax savings by any American without any limitation or qualification. The more you save, the less tax you pay.

3. We invest too little. Solution: don’t tax invested funds; expense investment without any limitation or qualification. The more you invest, the less tax you pay.

4. We export too little. Increasing our net exports is the only way for the US to avoid a prolonged period of dollar weakness, high interest rates and steep inflation. Solution: rebate consumption taxes paid or due on all exports, just as more than 140 US trading partners do in a practice that is perfectly legal under international rules. The more you export, the less tax you pay.

5. Imports don’t pay their fair share of taxes in the US. Solution: impose the same consumption tax on imported goods as domestic goods must pay, also a perfectly legal practice under international rules. Outsourcers will be free to continue their supply chain practice, but they will no longer avoid contributing their full, fair share to the US economy.

6. The US is dangerously dependent on imported oil and gas. Solution: tax energy from renewable sources (overwhelmingly domestic in origin) at a lower rate than energy from non-renewable sources, whether domestic or imported. Instead of having an on-again, off-again policy of favoritism for specific technologies that are blessed with periodic subsidies, all technologies would benefit from the same tax advantage. The most competitive will win the biggest share of the market.

7. The underground economy, including many illegal immigrants, largely escapes taxation. Solution: tax people when they spend rather than when they earn.

8. Small businesses are unfairly burdened with bookkeeping, accounting and other administrative costs. The solution: substantially raise the minimum level for filing corporate and personal income tax returns, greatly simplify them (e.g. eliminate the alternative minimum tax), and do away with a host of smaller excise taxes now collected by the private sector.

9. Too much time and money are devoted to tax avoidance and evasion, leaving honest taxpayers to resent taxes as inherently unfair. Many taxpayers (and even their paid tax advisors) are often bewildered by the complexity of a tax code designed more to advance special interests rather than those of the nation as a whole. Solution: Rely on sellers to collect taxes from buyers; rely on the paper trail of purchases (taxes paid) and sales (taxes due); and devote the resources of the national tax agency to detecting and punishing

10. Lower-income families bear a heavy tax burden, taking into account the regressive effects of payroll taxes and those taxes imbedded in the cost of goods they buy. Solution: restore real progressivity to the tax system by eliminating payroll taxes on lower-income workers and refunding consumption taxes paid by lower-income consumers.

As a country we have become dependent on foreign borrowing to maintain our standard of living, ensuring that future generations will have to accept a reduced chance to live the American Dream. Every day we borrow more than two billion additional dollars to finance our trade deficit. The problem of America’s trade imbalance stems largely from systematic disadvantages stemming from our own tax system; the solution can be found largely in the same place. If America went from being a badly taxed country to be an excellently taxed one, we would start to benefit within a short period. By shifting towards a consumption-based tax system with progressive income taxation, we would also enable our government to immediately lower rates in response to a looming recession. No tax system is perfect, but ours is a perfect abomination to the national interest. Let’s change it – quickly, profoundly and with a steady eye on our performance as an international competitor. Good things will start happening once we do.

Labels: Tax

In the face of a looming recession some policymakers, pundits and presidential candidates advocate making the Bush tax cuts permanent. What they fail to explain is how avoiding a massive tax increase on selected Americans in 2011 will help avoid a recession in 2008.

Meanwhile, the press is reporting today that President Bush and Congressional Democrats have reached a deal on tax rebates for households and businesses. What they have failed to explain is how mailing checks in the summer – the IRS is saying that it could not process checks until June at the earliest – will help avoid a recession in the winter and the spring.

Of course if the U.S., like 142 other countries, had a consumption tax the government could simply reduce the tax rate for a period, providing an immediate cost deduction to every household and every business. Unfortunately we don’t yet have such a feature in our tax system.

So, the better way forward at this moment would be to suspend temporarily the collection of both the employer and employee FICA contribution. This would provide an instant 6.5% increase in the purchasing power for every working family. At the same time, this would ease the pressure on businesses big and small. New hiring would also be temporarily less expensive. The Social Security “trust fund” would be temporarily affected, but withholding a few months worth of FICA contributions is a drop in the bucket compared with the much larger issue of long-term adequate Social Security funding.

It is easy to accept that we live in a world of second best choices, but there is no reason to settle for third or fourth best.

Charles Blum

Labels: Tax