Review of 1989-1990 consumption tax activity.

• Author: DeLuca, Michael A.

Review of 1989-1990 Consumption Tax Activity

Consumption taxes received increased congressional and Administration attention in 1989, due largely to concerns over the government's ability to meet future Gramm-Rudman-Hollings deficit reduction targets. This article reviews that activity.

January 1989: Darman "Ducks"

The first major 1989 discussions regarding a consumption or value-added tax (VAT) surfaced early in January, when Office of Management and Budget Director-designate Richard G. Darman addressed the extent to which President-elect Bush would hold the line on taxes. In written statements submitted to the Senate, Mr. Darman stated that certain types of revenue increases must not necessarily be labeled as "tax hikes." Revenue raisers referred to included higher federal excise taxes on gasoline, alcohol, and tobacco; an oil import fee; elimination of the deductibility for interest on certain types of borrowing; taxation of employer-provided fringe benefits; and fees charged to visit national parks and for other government services. In response to these statements, some critics concluded that President Bush's stated opposition to higher taxes was merely a matter of semantics and that the President's pledge to hold the line on taxes essentially referred to income tax rates and other tax increases with which the public could identify.

Mr. Darman said that, in light of the President's "read my lips" pledge against new taxes, the Administration was unwilling to accept any major changes in the tax code. He stated that although consumption taxes would be preferable to income taxes in an economic sense, they did not represent a panacea. Mr. Darman also stated that, from an economic efficiency point of view, a VAT imposed at each stage of production would offer advantages over a general excise tax at a retail or wholesale level. He also stated that a VAT would have advantages in international trade in that (i) it can be imposed on imports to prevent foreign products from gaining an advantage over U.S. goods, and (ii) it can be rebated to exporters without violating international trade agreements. Mr. Darman nevertheless concluded that a VAT would be difficult to administer, as well as enforce, and would also likely lead to a higher level of taxation and spending than an income-based tax:

A broad-based consumption tax would have definitional

and measurement problems which could be as

difficult to handle as the income tax. Moreover,

implementing a brand new tax could be administratively

difficult.

Holling's VAT

Buoyed by the pressure to find new revenue to reduce the federal deficit, Senator Ernest F. Hollings (D-South Carolina) introduced S. 442 on January 26, 1989. Senator Hollings, a member of the Senate Budget Committee, estimated that this proposal would raise $80 billion in fiscal year 1990.

S. 442 would impose a VAT on the sale of property and the performance of services in the United States with respect to commercial transactions. The VAT would also be imposed on the sale or lease of real property and on the importation of property without regard to whether it is with respect to a commercial transaction. Under the Hollings Bill, a five-percent tax would be imposed on the value added to the property sold or the services performed at each stage of production and distribution, including the retail stage. To ensure that the revenues raised by the VAT would go to reduce the federal deficit, S. 442 would require that all revenues net of administrative expenses be placed in a trust fund dedicated to deficit reduction and prohibit their use to finance current expenditures.

S. 442 has four important characteristics:

* It is a consumption-type VAT.

* It uses the credit-invoice method to calculate

tax liability.

* It uses the destination principle for border tax

adjustments.

* It exempts or zero rates certain commodities

such as food, housing, health care and interest.

In addition to the VAT, Senator Hollings also proposed a freeze on spending at the fiscal year 1989 level, except for Social Security and federal retirement cost-of-living adjustments. The proposed freeze was estimated to raise $36 billion.

Center for National Policy Study

January activity concluded with the release of a study performed by the Center for National Policy (CNP). The study concluded that the Bush Administration and Congress would need to raise at least $15-$20 billion in new revenues, and achieve an equal amount in spending cuts in order to meet the federal deficit reduction targets for fiscal year 1990. Although the easiest way to raise the needed funds would be through a general increase of existing taxes, President Bush's "no new taxes" campaign pledge would make it necessary for the government to resort to "loophole closers" to generate new revenue. The CNP study stated that, in the long term, the best option...