President kick-starts stalled economic growth

Fulfilling election promises regularly made by losing presidential candidates, newly-installed US President Hillary Clinton today announced that the US would be one of the first countries to move away from taxing income and start taxing personal consumption.

Announcing a selective Value Added Tax of up to 25% to be implemented within six months, Clinton claimed this proposed new form of personal taxation was not all that new.

“It’s really just a change of focus to restore economic growth and investment”, she said. “We also have to encourage environmental awareness, and remove the incentive to hide earnings – it’s about creating a more responsible, open, honest and positive marketplace. Let’s face it, our excessive consumption in the past decades has left us with huge deficits and zero economic growth.”

The USA has become the second country in the world, after South Africa, to put its weight behind this system. SA president, Nkosazana Dlamini Zuma, is flushed that the US has followed South Africa’s lead. “Innovation always happens at the edge of the empire”, she said.

The surprising announcement has left many small service firms in a quandary. Individuals will need much less tax advice and small service firms will have to re-tool around the new proposed legislation.

ANALYSIS >> SYNTHESIS: How this scenario came to be

Two principles have governed taxation (in US et al): The rich pay more than the poor, and no form of income is immune from taxation. There is a silent revolution bubbling up as governments look for innovative new ways to spur economic growth – many are now seriously re-looking at the ideas around taxing consumption rather than income. Could it become a future norm?

The idea was first outlined in the White House’s annual economic report to Congress in February 2003. The report, prepared by the White House Council of Economic Advisers and signed by Mr. Bush, offers a scathing critique of the current system and an exuberant description of radical alternatives. Bush was then distracted from such fundamental reforms by the Iraq war, itself a massive black hole for tax funds.

But many administration officials have made no secret of their fondness for fundamental tax overhaul, and the report described a detailed rationale for a system that taxes spending rather than income.

By eliminating the complexity and the thousands of arcane preferences in today’s tax code, the report says, a consumption tax would not only increase efficiency but promote investment and growth.

“Most estimates suggest that a shift to a consumption tax base would generally increase the size of the capital stock in the long run,” the report said. Economic output could increase as much as 6 percent, it added.

Michael Graetz, a professor of tax policy at Yale Law School and a longtime advocate of a tax on consumption, said the report was a clear signal about the administration’s long-term thinking.

“It’s unusual for something like that to be in the economic report of the president,” Mr. Graetz said. “I don’t believe the president has made a decision about what he would like to do. On the other hand, this shows they are serious about fundamental tax reform.”

Republican lawmakers have periodically campaigned for a consumption tax in recent years. R. Glenn Hubbard, chairman of the Council of Economic Advisers, wrote numerous papers while at Columbia University about the merits of a consumption tax.

At its simplest, a consumption tax would eliminate traditional income taxes for most if not all taxpayers and replace those taxes with some kind of tax on spending. Corporations might still pay taxes, but they would abandon most of the rules for depreciating investment in new equipment or buildings and simply write off those costs as expenses in the year they occur.

The allure of such systems is their simplicity. Fans of the consumption tax said it would save ordinary taxpayers billions of dollars, eliminate the wasteful gaming of current rules and ultimately be more fair.

Since the poor tend to spend all of their earnings, their entire income will therefore be subject to the tax. Higher income individuals, on the other hand, will only pay taxes for that portion of their income that they spend. Income that are saved or invested will not be affected. This valid argument against consumption taxes can be countered by the implementation of a progressive consumption tax approach rather than by a flat rate system. Under this approach, progressive rates will be imposed and a standard deduction may even be allowed so that tax obligations will be proportionate to the taxpayers’ ability to pay. Critics continue to argue that a consumption ‘stealth’ tax moves the tax burden from the rich to the poor – and that it is unfair as such.

The recent announcements in South Africa and the US have made it clear that it does not have to be that way. South Africa’s practical experience in the past year has been overwhelmingly positive, even in a country where the vast majority is classified as ‘poor’.

For South Africa’s leadership, a consumption tax was a way of creating an open growing economy – a stark contrast to many years of apartheid’s economic introspection.

Now, for the USA, it represents a bold economic experiment that is hoped will rescue the US economy from the doldrums and kick-start personal innovation and entrepreneurship.

“The best scheme of [public] finance is, to spend as little as possible; and the best tax is always the lightest.” J. B. Say

Warning: Hazardous thinking at work

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