For conservative tax wonks, X marks the spot

November 16, 2012

As if we were lacking in plans for cutting the federal deficit going forward, as of Friday, we have five more. The Pete G. Peterson Foundation, the namesake of the notoriously anti-debt private equity billionaire, has launched round two of its "solutions initiative."

As in round one, conducted last year, think tanks on both sides of the aisle were asked to put together a plan to reduce the deficit to a level the foundation considers "sustainable." Four of the five participants this year — the Center for American Progress, the Economic Policy Institute and the Bipartisan Policy Center — all submitted plans during the first initiative, and their latest plans are not much different from the first go-around. Earlier Friday Suzy ran through what each of them would mean for the debt going forward; be sure to check out her rundown.

The new kid on the block this time is the American Action Forum, the conservative group run by former McCain campaign economic guru Douglas Holtz-Eakin. The spending side of AAF's plan is fairly predictable, including a Ryan budget-like "premium support" reform to Medicare and repeal of the Affordable Care Act. But the revenue side sticks out.

AAF endorses replacing the income tax with an "X tax." As I've explained before, the X tax is a special form of value-added tax (VAT), a kind of sales tax popular in Europe. Normally, VATs require companies to pay taxes on all their expenses. As with U.S.-style sales taxes, this ends up being regressive, as ultimately consumers bear the price, and poor people tend to spend more — and thus pay more sales tax — than the rich.

The X tax fixes this problem by having businesses pay a VAT on all of their expenses except wages paid to their workers. Then, those workers pay a progressive payroll tax on their wages. So the X tax ends up taxing the same thing as a VAT, but doing it in a progressive manner.

Economists generally agree that consumption taxes, like the X tax and the VAT, are much better for economic growth than income taxes. One simulation found that an X tax would permanently increase the size of the economy by 6.4 percent in the long-run. That's a huge boon.

And an X tax would be just as progressive as the current tax code. The presidential tax reform commission report issued in 2005 considered an X tax as a potential reform, and found that each income group's share of the tax burden would not differ much from the pre-Bush tax cuts code (update - I assumed "current law" meant the same thing here as it means in CBO reports. It doesn't; this reflects the post-Bush tax code. My apologies):


Source: The President's Advisory Panel on Tax Reform

As if that weren't enough, the X tax would also mean that no individuals would ever have to file a tax return again. Taxes would be paid the way Social Security and Medicare taxes are currently, without any need for individuals to submit forms.

While some, like Michigan's Joel Slemrod, see the X tax as conceptually elegant but politically quixotic, the Peterson initiatives suggest it has real legs in the conservative think tank world. It was included in both the AAF plan and the American Enterprise Institute's plan from round one. Alan Viard, one of the authors of the AEI plan, co-authored a whole book with Robert Carroll this year touting the X tax and explaining its potential benefits for investment and growth.

But there's no reason why it should be a specifically conservative idea. In fact, there's a lot in the X tax to recommend it to liberals. It's highly progressive, for one thing, and while the payroll tax component doesn't apply to investment income, that income would be subject to the VAT component, which is set at 35 percent in most versions of the X tax. So investment income would not only not get a preference, it'd be taxed at a higher rate than wage income, which most X tax plans tax in brackets of 15, 25, and 35 percent.

That's not to say there aren't hiccups. While investment income is taxed, its taxation is much less visible, and liberals incensed by the current preference given to investment income could find that troublesome. And it doesn't necessarily entail a lot of base-broadening. You could, for instance, leave major deductions like that for mortgage interest untouched, which, while politically useful, means that those distortions remain the tax code.

That being said, AAF and AEI have hit on a plan that's just as progressive as the Clinton code, boosts growth significantly, and satisfies conservatives' goal of not raising the top marginal tax rate. It may not be part of any congressional discussions yet, but it sure satisfies a lot of the goals of both sides.

Correction: The original version of this post claimed Carroll and Viard's X tax includes a mortgage deduction. It does so initially but then phases it out. We apologize for the error.

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Suzy Khimm · November 16, 2012