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Can the United States Curb Its Debt?

Posted on Apr. 15, 2024
Reuven S. Avi-Yonah
Reuven S. Avi-Yonah

Reuven S. Avi-Yonah (aviyonah@umich.edu) is the Irwin I. Cohn Professor of Law at the University of Michigan Law School. He thanks Kenneth Austin, Rita de la Feria, Dennis B. Drapkin, William G. Gale, Christopher Hanna, Kathryn James, Calvin H. Johnson, Ajitesh Kir, Ajay K. Mehrotra, and Martin A. Sullivan for helpful comments.

In this installment of Reflections With Reuven Avi-Yonah, Avi-Yonah examines whether a VAT could save the United States from its looming debt crisis and how it could be framed to appeal to politicians on both sides of the aisle.

After the upcoming presidential election, the United States is almost certainly going to have a president who is barred from running for reelection, regardless of the outcome in November. This situation has never happened before1 and it presents an important opportunity for fundamental tax reform.

The most important tax reform in recent memory happened in 1986, in the middle of President Reagan’s second term. This was not an accident: The reform raised some taxes significantly and would have been much less likely to happen in a first term with the president facing reelection. (Reagan won reelection by a landslide because his opponent promised to raise taxes.) The 2017 tax changes were in President Trump’s first term and consequently only involved tax rate cuts. (A more thorough reform proposal was put forward in 2014 by Republican Dave Camp, former House Ways and Means Committee Chair. It went nowhere because, like the 1986 reform, it was revenue neutral.) The next Congress will have to deal with the expiration of some of the 2017 changes and so some tax legislation is almost certain in 2025.

The Debt Elephant in the Room

But without presidential leadership, such legislation is unlikely to address one of the fundamental problems facing the country: the overall size of the U.S. debt burden. At the beginning of the next presidential term, debt held by the public is likely to total about $28.5 trillion. It is projected to grow2 by an additional $7 trillion over the next presidential term and by $22.5 trillion through the end of fiscal 2035.3

In the longer term, those debt levels will not be sustainable. According to the government, if current policy continues, the debt level, which is now almost 100 percent of GDP, will exceed 200 percent of GDP by 2047.4 At that level, lenders will require very high interest rates that will grow the debt even more, and this can happen much earlier than 2047 because Treasury currently sells bonds that mature in 2054. High interest payments will crowd out other federal expenditures, including essential ones. Moreover, much of the debt is held in foreign hands, including China, and international tensions could reduce the likelihood of foreign lenders agreeing to lend more. The way the United Kingdom lost its role as a superpower was through its impossibly high debt burden after the two world wars. The immediate impact was demonstrated when the United States, which held a lot of British debt, forced the United Kingdom to withdraw from the Suez Canal in 1956.5

Nor can the debt be reduced through spending cuts alone. As the Committee for a Responsible Federal Budget (CRFB) explains in a February 28 blog post:

It would be literally impossible to pay off the debt by the end of the next presidential term without large accompanying tax increases, and likely impossible with them. While the needed savings would equal $35.5 trillion, total spending is projected to be $29 trillion over that four-year period — of which $4 trillion is interest and cannot be cut directly. We estimate it would require the equivalent of cutting all non-interest spending by about 130 percent, which is of course impossible. (Even under a rosy scenario that assumes much faster economic growth and substantial new tariff revenue, cuts would be nearly as large). . . .

Although it would require less in annual savings to pay off the national debt over ten years relative to four years, it would still be nearly impossible as a practical matter.

We estimate that paying off the debt over the ten-year budget window between FY 2026 and FY 2035 would require cutting spending by about 60 percent — which would lead to $44 trillion of primary spending cuts and an additional $7 trillion of resulting interest savings. This would be the equivalent of eliminating Social Security, Medicare, Medicaid, and food stamps or eliminating all spending besides defense and Social Security.6 [Emphasis in original; internal citation omitted.]

Of course, such drastic cuts in the entitlements are politically impossible. Seniors vote. That is why no recent presidential candidate has run on reducing the entitlements for voters over age 55, and both President Biden and former President Trump have committed to not touching the entitlements in any way.

A similarly dire outlook is included in the most recent “Financial Report of the United States Government,” which summarizes the U.S. fiscal situation as follows:

A sustainable fiscal policy is defined as one where the debt-to-GDP ratio is stable or declining over the long term. The projections based on the assumptions in this Financial Report indicate that current policy is not sustainable. This Financial Report presents data, including debt, as a percent of GDP to help readers assess whether current fiscal policy is sustainable. The debt-to-GDP ratio was approximately 97 percent at the end of FY 2023, which is similar to (but slightly above) the debt-to-GDP ratio at the end of FY 2022. The long-term fiscal projections in this Financial Report are based on the same economic and demographic assumptions that underlie the 2023 [statement of social insurance], which is as of January 1, 2023. As discussed below, if current policy is left unchanged and based on this Financial Report’s assumptions, the debt-to-GDP ratio is projected to exceed 200 percent by 2047 and reach 531 percent in 2098. By comparison, under the 2022 projections, the debt-to-GDP ratio exceeded 200 percent one year earlier in 2046 and reached 566 percent in 2097. Preventing the debt-to-GDP ratio from rising over the next 75 years is estimated to require some combination of spending reductions and revenue increases that amount to 4.5 percent [present value] of GDP over the period. While this estimate of the “75-year fiscal gap” is highly uncertain, it is nevertheless nearly certain that current fiscal policies cannot be sustained indefinitely.7 [Emphasis added.]

Because entitlement cuts are off the table, the only politically feasible way to reduce the debt is through a large tax increase. But for reasons I have explored in an earlier column, this is impossible to accomplish through the income tax alone.8 A federal VAT is the only feasible solution.9

VAT to the Rescue

A VAT can solve the debt problem. The CRFB states in its February blog post that:

It is also likely impossible to achieve these savings on the tax side. With total revenue expected to come in at $22 trillion over the next presidential term, revenue collection would have to be nearly 250 percent of current projections to pay off the national debt. It’s not clear that this level of revenue collection is even possible without being above revenue-maximizing tax rates.10 [Emphasis in original.]

This means that an additional $55 trillion in revenue would be needed to pay off the debt over four years. This is completely unrealistic, but the debt does not need to be completely eliminated in four years to become sustainable without additional foreign borrowing. Let us say the goal is to achieve sustainability over 10 years, and that to do this the United States needs to raise $22.5 trillion (that is, the amount the debt is projected to grow until 2035, so that it will stay below 100 percent of GDP and decline as GDP grows), or $2.25 trillion annually. Because every percentage point in a broad-based VAT raises almost $100 billion annually, that translates into a VAT rate of 22.5 percent, which is quite feasible (the EU rates range from 15 to 25 percent).11

A second-term president could propose a VAT without having to risk political defeat. But would members of Congress agree?

VAT Tales

One of the myths of U.S. politics is that proposing a VAT is a recipe for political disaster. The cautionary tale is of Al Ullman, House Ways and Means Committee chair from 1975 to 1981, who lost his seat in the 1980 election after proposing a VAT. But 1980 was the year of the Reagan landslide, in which 34 other House Democrats not associated with the VAT also lost their seats, and the VAT proposal was not the reason Ullman lost.

Another frequently cited example is former Canadian Prime Minister Brian Mulroney, who died February 29. Mulroney introduced the Canadian goods and services tax in 1991 and his Conservatives were almost wiped out in the 1993 election. But as his New York Times obituary stated:

Haunted by a faltering economy and high unemployment, and saying that he had lost enthusiasm for the job, [Mulroney] stepped down in 1993 with the worst Canadian poll ratings of the 20th century. He handed power over to Kim Campbell, who became Canada’s first female prime minister but lost a disastrous election months later.12

The GST is not mentioned here, and the Conservative defeat had other causes. Moreover, the Conservatives rebounded and were in power from 2006 to 2015 and are likely to win the next election in 2025.13

Two more recent examples are relevant to rebutting the myth that introducing a VAT spells inevitable political defeat. John Howard was a conservative prime minister of Australia from 1996 to 2007, the second-longest tenure in Australian history. During the 1996 election campaign, he pledged to “never, ever” introduce a GST, but he proposed it anyway in 1997.14 He proceeded to win reelection in 1998 on a platform that included the GST, and the tax was duly adopted in 1999. Thereafter, Howard won elections in 2001 and 2004, before losing in 2007 for unrelated reasons.15

Another recent example of a politician successfully introducing the GST is Narendra Modi in India. Modi became prime minister in 2014 and introduced the GST in 2017 at a special televised midnight parliament session to signify its importance for India’s economic development.16 He then won reelection with an increased majority in 2019 and is expected to handily win again in 2024. Modi persuaded the Indian electorate that the GST would create a unified national market and bring an end to tax wars and economic distortions; the tax reform’s chief slogan was “GST — One Nation, One Tax, One Market.”17 Modi also negotiated and bargained with opposition parties — at the national and state levels — to generate bipartisan support for the GST (note that the Indian GST required a constitutional amendment, which is an onerous requirement).18 Interestingly, when Modi was chief minister of the Indian state of Gujarat, he was vehemently opposed to the GST; he explained his change of heart on the grounds that the flaws in the earlier proposal had been overcome and that the GST was indeed a beneficial reform for the whole country.19

Would It Work in the U.S.?

But even if Biden or Trump wanted to enact a VAT, could this work in the United States, with its bicameralism and partisanship, as well as historical opposition to tax increases?20

Republicans would almost certainly oppose a VAT as a money machine, despite its regressivity. Thus, even if a second-term president proposes a VAT, it can only be enacted if the Democrats control both houses of Congress and use reconciliation to overcome the filibuster, as has been done for most tax legislation enacted since 1986.

But even in that case, Democrats would not support a VAT either, because of the regressivity. Can this problem be solved?

There are several ways of alleviating VAT regressivity, but they are all problematic.

The most common way is to exempt certain essential goods from VAT, such as food and medicine. That is what most countries do. But this means giving an unjustified windfall to the rich when they consume the exempt items. In addition, it leads to endless fights about what constitutes food (candy?) and medicine (vitamins?).

Another, better way is to grant rebates to taxpayers below a certain income threshold (for example, by sending low-income individuals a preloaded debit card or adopting universal basic income). The problem with this solution is that it is expensive and takes away much of the revenue benefit of having a VAT, which means that the VAT is less useful in addressing the fiscal problems outlined above.21

The best way is to direct the added funds to spending that is inherently progressive. That includes the entitlements, because it can be shown that the entitlements contribute more to reducing inequality in the United States than taxes.22 Social Security, Medicare, and Medicaid are all very progressive, and so would be any expansion of the social safety net (such as Medicare for All and increasing Social Security benefits), free education (which can be means-tested), and anti-climate-change investments (because low-income individuals suffer from climate change more than the rich). But this may not be enough for the progressive Democrats to vote for a VAT.

Instead, the solution may be to combine the VAT with significantly increasing taxes on the super-rich. Taxing billionaires does not raise enough revenue, but it does help symbolically and can contribute to reducing inequality.

The key problem to taxing the rich is that most of their wealth consists of unrealized appreciation. Jeff Bezos, Elon Musk, and Mark Zuckerberg have most of their wealth in stock in the publicly traded corporations they founded. They cannot sell the stock without paying tax (albeit at the reduced capital gains rate), but they can borrow against it (as Musk showed when he bought Twitter). And they may also escape an eventual estate tax by donating to a foundation before they die or using other estate tax avoidance techniques (for the slightly less rich, the estate tax does not apply, and heirs can sell without paying income tax because of the step-up in basis upon death).

As both Senate Finance Committee Chair Ron Wyden, D-Ore., and Lily L. Batchelder, former assistant secretary for tax policy at Treasury have written, the solution is to tax wealth like wages, that is, to tax the rich on an accrual (mark-to-market) basis on publicly traded assets (like Amazon, Meta, or Tesla stock) and with an interest charge upon realization for non-publicly traded assets.23 Once the realization requirement is eliminated, there is no policy reason not to raise the marginal tax rate on dividends and capital gains to equal the top ordinary income rate because all the usual reasons for a lower capital gains rate (lock-in, inflation, and bunching) depend on realization.24

Combining a VAT with a significant increase in tax on the mega-rich satisfies both the need for more revenue to fund Democratic priorities and the need to increase the progressivity of the income tax system. In addition, the revenue from taxing the rich on an accrual basis could be used to offset the regressivity of the payroll tax by exempting the first $100,000 of wages while eliminating the payroll tax cap (currently $147,000).

The combination of a regressive revenue-raising measure (VAT) with a progressive income tax reform (mark-to-market) could be the key to enacting fundamental tax reform in 2025 and thereafter. The alternative is to wait until disaster strikes in the form of a financial crisis resulting from lenders refusing to buy U.S. treasuries, and it would be much better to avoid that.25

FOOTNOTES

1 In 1892 Grover Cleveland ran against Benjamin Harrison, and for the winner, the result would be a second term, but until the 22nd Amendment, in 1951, there was no constitutional bar to running for a third or fourth term.

2 Committee for a Responsible Federal Budget (CRFB), “CBO’s February 2024 Budget and Economic Outlook” (Feb. 7, 2024).

3 See CRFB, “Can Donald Trump Eliminate the Debt?” US Budget Watch blog (Feb. 28, 2024).

4 Department of the Treasury, “Financial Report of the United States Government: Fiscal Year 2023,” at 27 (2023).

5 G.C. Peden, “Suez and Britain’s Decline as a World Power,” 55(4) The Historical Journal 1073 (2012).

6 CRFB blog, supra note 3.

7 Treasury, supra note 4, at 27. The current rise in interest rates significantly worsens the situation. See Martin A. Sullivan, “Takeaways From the 2024 CBO Forecast,” Tax Notes Federal, Feb. 12, 2024, p. 1173; and Sullivan, “New Graetz Book Chronicles and Critiques the Antitax Movement,” Tax Notes Federal, Mar. 4, 2024, p. 1715.

8 Reuven S. Avi-Yonah, “Back to the Future? What to Do About the TCJA in 2025,” Tax Notes Int’l, Feb. 19, 2024, p. 1015. But see Calvin H. Johnson, “How to Raise $3.5 Trillion, Without a Rate Increase,” Tax Notes Federal, Mar. 18, 2024, p. 2155; Johnson, “We Don’t Need No Stinkin’ VAT,” Tax Notes, Apr. 29, 2013, p. 527.

9 This has been proposed many times before. See Ajay K. Mehrotra, “The Missing U.S. VAT: Economic Inequality, American Fiscal Exceptionalism, and the Historical U.S. Resistance to National Consumption Taxes,” 117(1) Nw. U. L. Rev. 151 (2022). For a proposal of how to design a U.S. VAT, see Avi-Yonah, “Designing a Federal VAT: Summary and Recommendations,” 63 Tax L. Rev. 285 (2010). William G. Gale follows Michael J. Graetz in proposing a 10 percent federal VAT while exempting the first $100,000 of income from the income tax; Gale’s proposal would use that 10 percent VAT to fund universal basic income while eliminating many deductions. Gale, “Four Proposals to Radically Simplify the Income Tax,” Tax Notes Federal, Mar. 18, 2024, p. 2173. See also Gale, “Raising Revenue With a Progressive Value-Added Tax” in Tackling the Tax Code: Efficient and Equitable Ways to Raise Revenue 191-236 (2020). Because these proposals are revenue neutral, they do not reduce the federal debt. But see Gale and Benjamin H. Harris, “A Value-Added Tax for the United States: Part of the Solution” in The VAT Reader 64-82 (2011) (proposing a VAT for deficit reduction); Charles E. McLure, The Value-Added Tax: Key to Deficit Reduction? (1987).

10 CRFB blog, supra note 3, citing Peter Diamond and Emmanuel Saez, “The Case for a Progressive Tax: From Basic Research to Policy Recommendations,” 25(4) J. Econ. Perspectives 165 (2011).

11 For the revenue projection from a broad-based U.S. VAT, see Eric Toder, Jim Nunns, and Joseph Rosenberg, “Using a VAT to Reform the Income Tax,” Urban-Brookings Tax Policy Center (Jan. 2012) (a 12.3 percent VAT would raise net federal revenues by $1,162 billion after income and payroll tax offsets — or a little less than $100 billion per percentage point of tax). This calculation assumes a broad VAT base. See Toder, Nunns, and Rosenberg, “Implications of Different Bases for a VAT,” Urban-Brookings Tax Policy Center (Feb. 2012).

12 Alan Cowell, “Brian Mulroney, Prime Minister Who Led Canada Into NAFTA, Dies at 84,” The New York Times, Feb. 29, 2024.

13 On the Canadian experience with the GST, see Sullivan, “Economic Analysis: VAT Lessons From Canada,” Tax Notes, May 3, 2010, p. 493.

14 See Kathryn James, “We of the ‘Never Ever’: The History of the Introduction of a Goods and Services Tax in Australia,” 2007(3) Brit. Tax Rev. 320 (2007).

15 Id.

17 See Ajitesh Kir, “India’s Goods and Services Tax: A Unique Experiment in Cooperative Federalism and a Constitutional Crisis in Waiting,” 69(2) Canadian Tax J. 391 (2021).

18 Id.

20 For an analysis of U.S. exceptionalism in this regard, see James, “Exploring the Origins and Global Rise of VAT” in The VAT Reader 15-22.

21 But see Artur Swistak and Rita de la Feria, “Designing a Progressive VAT,” IMF Working Paper No. 2024/078 (Apr. 5, 2024).

22 Avi-Yonah, “What Matters in Moore,” Tax Notes Int’l, Feb. 12, 2024, p. 883.

23 Batchelder and David Kamin, “Taxing the Rich: Issues and Options,” Aspen Institution (Sept. 11, 2019). Wyden released a proposal in 2019. SeeTreat Wealth Like Wages: A Plan to Fix Our Broken Tax Code, Ensure the Wealthy Pay Their Fair Share, and Protect Social Security.” Enacting this proposal depends on the outcome in Moore.

24 Avi-Yonah and Dmitri Zelik, “The United States” in Capital Gains Taxation: A Comparative Analysis of Key Issues 363 (2017).

25 See Avi-Yonah, “The Political Pathway: When Will the U.S. Adopt a VAT?” in The VAT Reader 334.

END FOOTNOTES

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