Given a choice between cutting spending and reforming our tax system, the President and Congress have taken the easy road of spending cuts. Yet poll after poll reveals that the American people want programs targeted for cuts such as Head Start, Medicare and aid to the elderly. The real problem is our tax system is antiquated and unfair - allowing giant corporations such as GE and Google to make enormous profits and pay few if any taxes - and thus overall revenues fall short of what they should be.
The U.S. needs a major tax reform that can simultaneously lower taxes overall, produce more revenues and enable fewer if any program cuts - as happened in 1986 during the Reagan administration.
If that is to happen, Congress and the Obama administration need first to agree on the principles that should guide such reform.
In testimony before the Senate Committee on Finance in 2006, David Walker, then comptroller general of the United States, identified five basic principles that should guide any business tax reform. They are equally applicable to any broader change in America's tax system. The first principle is that "any new system should raise sufficient revenue to fund America's current and future expected expenditures." Simply put, we need to return to a pay-as-we-go system, which the U.S. traditionally used for more than 200 years.
Walker's second principle is that "the tax base should be as broad as possible, which helps to minimize overall tax rates."
The third principle is that the proposed system "should improve compliance rates by reducing tax preferences and complexity and increasing transparency." In other words, no loopholes and more enforcement of the tax laws.
The fourth principle is a bit more complex, "To the extent that other goals, such as equity and simplicity, allow, the tax system should aim for neutrality by not favoring some business activities over others." The present tax code favors the rich over the middle-class, which widens the disparity in wealth and income and reduces the overall standard of living.
Wisely, Walker imposed a non-traditional fifth principle, that "transition rules must be an integral part of any reform proposal." Transition rules that establish interim steps, instead of one giant leap, will ease that shift and help educate the public about whatever approach is used.
There should be a sixth principle that "any new tax system be trade compatible."
The idea behind the sixth principle is little understood in the United States because this nation does not use a value-added tax (VAT), even though 153 other nations do. Because the United States is the only industrial country that does not have a VAT, other countries "game" global tax treaties by employing their VAT to subsidize their exports into the United States, simultaneously (and purposely) pricing U.S. imports out of the other countries' markets. They rebate VAT taxes on exports and impose an equivalent tax on all imports from the United States.
A VAT is a very simple consumption tax system. It greatly encourages savings by not taxing money saved or the interest generated. At each stage in the production and sale of a good or service, the business pays a tax on the value it adds, no more.
In practice, firms in most countries either pay the tax instantly or accrue the amounts owed and pay the government monthly or quarterly. The system is simple, perfect for modern computerized accounting, and allows taxpayers to know their tax liability and the government to better anticipate revenues. Cheating is difficult with a VAT, easily spotted, and thus limited. Best of all, taxpayers have no compliance burdens. None. There are no IRS penalties. The VAT is paid automatically when someone buys something. Business does the paperwork. There is no April 15 tax day.
Today, the federal tax on business is set at a 35 percent rate, the highest of any other nation. If a five percent VAT were created and the U.S. corporate business tax totally eliminated, the U.S. would get the same amount of revenues. Such a change, moreover, would meet all of Walker's five principles, plus be trade compatible.
Changing the U.S. tax system presents an historic opportunity to eliminate this discriminatory foreign VAT treatment, thereby helping reduce the huge U.S. trade deficit, recapturing millions of American jobs, increasing revenues, cutting taxes for most Americans and ensuring that corporations pay their fair share.
This may seem almost too good to be true. But it is. Ronald Reagan did it. So, too, can this President and Congress.