Peter Orszag, Obama’s recently departed Office of Management and Budget director, wrote earlier this week about how to handle the public deficit. It’s a good read because it is very specific on describing where we actually spend money, and where cuts would have to occur in his view as former budget chief. The rhetoric we generally hear on spending confuses more than it reveals.  For example, eliminating foreign aid, the most popular program to cut according to polls, would have basically zero effect on the deficit.

He also addresses the revenue side, proposing a VAT of five to six percent.  Also extending the Bush tax cuts for the wealthiest (those making over $250K annually) for two years, with an automatic expiration at that time.

Here are his VAT comments:

One possibility would be to establish a new source of revenue, perhaps through revenue-increasing tax reform, and possibly including a modest value-added tax (that is, a V.A.T. of 5 percent to 6 percent). This approach has many potential benefits, including the opportunity to improve our tax code by cutting back on loopholes and shifting toward a consumption-based tax system. It is also politically impossible, at least in the era of the 60-vote Senate. Those who fear a V.A.T. have little reason to worry — the votes aren’t there.

Orszag does not discuss the trade implications of a U.S. VAT, i.e. that it would neutralize the export subsidy foreign producers receive in other countries with a VAT.  This would be a very good benefit.  Every Chinese container ship would pay for our roads, bridges and defense… just as our exports pay foreign VATs to finance other countries’ roads, bridges and defense.  And we could rebate our VAT for exports, thus helping the President’s plan to “double exports” with progress towards balanced trade.

The U.S. debate is locked in a high vs. low tax framework.  A better debate is smart vs. dumb taxation.  Our consumption is too high in relation to production, so we consume from overseas with drastic GDP consequences.

A VAT is a consumption tax, which would marginally reduce consumption (if you tax something, you usually get less of the thing taxed).  If you reduce the tax on income and payroll, this lessens the burden on income and jobs taxes to get more production.  The argument is that employees are less expensive (because of reduced payroll tax) and they keep more of their income.

Brian O’Shaughnessy, CPA’s Chief Co-Chair and Chairman of Revere Copper, also argues that a VAT should pay for single-payer U.S. health care because all other countries have it, foreign companies don’t have to pay for health care, and that is a major competitive disadvantage for us.  His company pays the health care for Revere’s employees, and pays for the health care of foreign competitor’s employees when exporting and paying a foreign VAT.  Taking the health care burden from employers through a single payer financed VAT would be a huge U.S. competitive benefit.  (This is not the CPA position, but an intriguing argument).

There really needs to be a breakthrough to get a smarter tax system including a VAT, maintaining progressivity, and with relatively equivalent government revenue after the change.

This graph below, compiled in 2007 by Charles Blum of IAS Group, shows that the U.S. is not a high tax nation among developed countries.  His point is that we are poorly taxed (i.e. a dumb tax mix for competitiveness purposes).  The graph shows that those claiming the U.S. is a high overall tax country is incorrect.

Taxation methods (not just levels) are key to competitiveness.  China alters its VAT tax structure – both on the taxation and export rebate sides – every month on different sectors in pursuit of its economic strategy.  If the apparatchiks want to export more of a product, they increase the VAT rebates.  If they want to keep more of a product in the country, like a commodity so they can add value to export it in a different form, then they decrease the VAT rebate on that product.  China uses tax as a nimble competitiveness weapon.

Our country can hardly even contemplate a debate that integrates taxation and trade.  We just talk high or low taxes.  It is a neanderthal debate.  People get emotional with knee jerk reactions before you finish the first sentence.  The logic portion of the brain simply never engages.

Let the debate on smart taxes begin.