The Daily Capitalist: Will We See a National Sales Tax?

The Obama budget is based on false revenue assumptions. It is unlikely that tax revenues will recover as quickly as they project. Also, there are costs not currently budgeted that will add substantially to the deficit. Add to that increased interest costs on the national debt. It will not be feasible to raise tax revenues on the upper 2 percent sufficiently to reduce the deficit as they project. It is likely that they will look to new revenue sources to reduce the deficit. A national sales tax may be the most politically feasible alternative for the administration. A 4.5 percent tax could cover expenditures after rebating these tax costs to lower-income taxpayers. Such a tax would be regressive.

President Obama released his budget for the 2010 fiscal year. The projected budget deficit is estimated to be $1.7 trillion. He plans to cut that in half by the end of his first term (2012). That’s $850 billion extra he’ll need to come up with. As we know, he’s excluded 98 percent of taxpayers from any tax hikes. That means the lucky 2 percent will be squeezed for more. But can they make up the difference?

George Mason University economics professor Russ Roberts ran some quick numbers to see if this could work and made the astute observation that it would be rather difficult to impose that big of a tax increase on the upper 2 percent.

The Wall Street Journal saw the same problem. “A tax policy that confiscated 100 percent of the taxable income of everyone in America earning over $500,000 in 2006 would only have given Congress an extra $1.3 trillion in revenue. That’s less than half the 2006 federal budget of $2.7 trillion …”

I ran the numbers from the IRS. Here are my calculations:

There are 3,853,000 taxpayers in the $200,000-and-up income bracket. (The IRS doesn’t break it down at $250,000-2 percent). Their total adjusted gross income-AGI (taxable income, before deductions and credits) was about $2.4 trillion, which averages out to be about $623,000 of AGI per taxpayer. They paid $522 billion in taxes, about $135,500 per taxpayer (22 percent of their AGI), or 62 percent of all federal personal income taxes paid. The top 2+ percent would have to come up with another $169,000 on average to pay the $650 billion difference, or 49 percent of their AGI.

That big of a tax increase might be hard to get through Congress, but you never know. According to Obama economics adviser Robert Reich, “It’s about time a presidential budget uneqivocally (sic) redistributed income from the very rich to the middle class and poor.” According to Vice President Joe Biden, it’s patriotic to pay more taxes. I don’t think it will fly.

But the Obama administration faces a bigger problem: the deficits for the foreseeable future will be much larger than it has projected. Has any administration been very good at budgeting?

The Concord Coalition’s … estimates show that if all expiring tax cuts are extended, revenues as a share of GDP will fall to 17½ percent over the next 10 years, while spending as a share of GDP will grow to 24 percent, producing a deficit of 6½ percent — before any new spending or tax cuts considered as part of “economic recovery” policy.

Add to that the likelihood that the stimulus bill won’t work. Revenue will likely be much less than projected. I also think that when they realize the stimulus package doesn’t work they will try more stimulus, which means more spending and higher deficits.

Also, not all spending is included in their budget. For example, the budget doesn’t include the $250 billion in additional TARP funds. The budget books the cost of TARP at one-third of the cost of acquiring assets from bailed-out banks. Thus, they hold toxic assets on their books equal to two-thirds of their TARP costs. If the toxic assets can’t be sold for two-thirds of what they paid, the deficit will increase proportionately.

Another additional and unanticipated cost will be increased interest costs on the national debt. The debt is now $10.8 trillion, with interest costs of about $550 billion, or about 5 percent, per annum. Add another $1.75 trillion this fiscal year (2009-2010) for $12.55 trillion of total debt and there would be another $78 billion in interest costs, for an annual cost of about $627 billion.

But what if interest rates go up? First, for the Treasury to place that much new debt into the market without putting upward pressure on interest rates would be unlikely. If we have $12.55 trillion of national debt, for each ½ percentage-point increase in interest (50 basis points), the interest cost would increase another $63 billion. It is possible that the impact of this additional debt on the market will be somewhat offset by additional savings by Americans. As we have predicted, consumers won’t consume as hoped; instead they’ll save to prepare for the worst.

It is also likely that when the skyrocketing money supply hits the economy, prices of everything, including interest rates, will go up. History has shown that high inflation is caused by a rapid increase in the money supply by the Fed. Money supply is exploding right now. At some point this money will hit the economy, and when it does, prices will climb. History also tells us that inflation means higher interest rates.

Our foreign creditors may not be so accommodating in buying our debt this time. The problem is that our foreign creditors are having problems of their own. The largest foreign creditors as of December are: China, $727.4 billion; Japan, $626 billion; Caribbean banking centers, $197.5 billion; oil exporters*, $186.2 billion; United Kingdom, $130.9 billion; Brazil, $127 billion; and Russia, $116.4 billion. In tough economic times we can be assured these creditors will look to their own national interests before the well being of the United States. We may be required to increase the coupon on our debt in order to place that much new Treasury paper with willing foreign buyers.

All of the foregoing suggests that (1) revenues will be less than expected, and (2) the deficit will be greater than projected. Obama can cut spending but this runs counter to his political goals. He can partially raise taxes on the upper 2 percent and add the difference to the deficit. Or, if he is true to his word, he will find a new tax to cover the spending.

Based on his budget and promises, Obama doesn’t have much room to maneuver. My guess is he will try to impose a “temporary” national sales tax to finance the deficit. Of course, it will never be repealed, but the idea of being “temporary” will get it through Congress. He will structure it so that low-income people will get a refund of taxes paid. The refund will be phased out as income increases.

My guess is it will include nonfood retail sales and they will add services (information, professional, technical and scientific, administrative and support, waste management and remediation, but excluding medical services). The services aspect is important because this will skew the tax more to corporations and upper-income taxpayers.

In 2008 retail sales (excluding food) were about $4 trillion. Services in 2007 were another $2 trillion. Let’s say they need to raise $1 trillion over the next four fiscal years, or $250 billion a year. That would require a 4.5 percent national sales tax. In Europe they call this a value-added tax (VAT) and the rate in the European Union is about 15 percent.

Unfortunately, this will be added to the existing income-tax structure, which makes it a regressive tax, further hampering recovery.

So lay down your bets and let’s see what happens. Some time during Obama’s administration I think we’ll see a VAT, What’s your bet? I hope I lose this bet.

* Algeria, Bahrain, Ecuador, Gabon, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Oman, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela.

— Jeff Harding is a principal of Montecito Realty Investors LLC. A student of economics, he has a strong affinity for free-market economics. This commentary originally appeared on his blog, The Daily Capitalist.