DAVID B. TIMMINS American Embassy - Bucharest APO AE 09213-1315 March 10, 1995 The Editor Business Week 1221 Avenue of the Americas Mew York City, NY 10020 Dear Sir: Can you believe in the light of current criticism of White House policies (the possibly illegal use of the Treasury's dollar defense fund to rescue the Mexican peso, which has set off a run on the dollar -- as well as Wall Street), that just four years ago the Washington Post and others in the media were taking John Sununu to task for his insufficiencies in advising the President what to do about a lagging economy. The White House Counselor for Domestic and Economic Affairs at the time was Roger Porter, on loan from Harvard University, leaving me wondering why all the darts were aimed at Sununu. Perhaps Professor Porter got off so easily because he wisely chose to adopt a lower profile than Governor Sununu. Anyway, here we are, approaching the end of the Clinton Administration, and White House advisors are no nearer coming up with solutions to the Budget and Foreign Trade deficits, nor our current problem, the run on the dollar, than Sununu or Porter. Clearly, the Democrats want to avoid a further Fed rise in the interest rate, in order to keep the Economy moving, because a lagging economy would only intensify the President's negatives as we approach next year's election -- a repeat of Mr. Bush's problem. But today's White House appears as bereft of ideas as that of Mr. Bush. Republicans are making political hay over social welfare expenditures, wanting to show themselves the Party of fiscal responsibility and reform. But all the GOP can think of is slashing spending programs. regardless of their social benefits, and amending the Constitution, as if words on paper can substitute for legislative will. And while one can agree philosophically with Business Week 's attitude (The Wrong Way to Balance the Budget , BW March 6, p.33), one looks in vain for BW' s prescription for how Congress is to gain control of the Budget, now that Mr. Hatfield has been heard regarding the Balanced Budget Amendment, .in the face of the exceptionally low U.S. savings rate, the NAFTA crisis, and the resultant dollar crisis Illogical as this may at first sight appear in the light of contemporary political exigencies, and to those reared on Keynesian economic theory, the time may, in fact, be opportune for well-thought-out tax reforms. This needn't mean current new (added) taxes, since this would run the risk of precipitating a recession (and in any event would be contrary to political promises of both Parties). But the psychology is unprecedented for permitting reforms drafted to permit judicious implementation as the economy progresses through the next cycle. Informed and experienced people know that the President lacks the policy instruments to do much about the current situation. And it's becoming widely, and correctly, recognized that the effect of the US's unparalleled capital gains tax is to act as a drag on the economy (and continuation of the current expansion) because capital gains are a powerful disincentive to business and investors, the cost of shifting capital into new businesses being a confiscatory penalty on past success. Along with the Line Item Veto, let's give the present (and future) Presidents some tools while the problem is recognized. Neither of our most successful competitors, the Japs and Germans, have a capital gains tax. Let's give Mr. Bush credit where credit's due: While opposing the crazily timed Democratic tax hike as long as he could, he argued as vociferously as any man could for a capital gains cut from the time he took office. Now with a Republican controlled Congress, let's get on with it. We should be seizing this moment of maximum concern to undertake some long-term reforms so that the next time we experience a lagging recovery (or an overheated or excessively protracted recovery) whoever is President will have some tools in the kit to do something about it. All the talk shows have been asking the experts for their 1, 2, 3s of what to do. I've heard no answers. So here are mine: 1. As a professional economist with thirty years experience in government and university teaching, much of it abroad, I'm persuaded that the time has come when the U.S. must give serious consideration to adopting a European-style Value Added Tax as a partial replacement for our near-total reliance on personal and corporate income taxes. I won't take time here to review all the reasons -- this letter addresses other proposals. But it's already widely recognized that if we enacted a VAT, it would help the U.S. economy out of its current doldrums in several ways: 1) it would, through its GATT-authorized rebate on exports, stimulate U.S. sales abroad; 2) through the offsetting shift from pay-as-you-go payroll tax deductions, it would leave important money in the pockets of American consumers and industry; 3) through taxing sales, not income, it would stimulate savings, currently near our all-time low, and a matter of major concern to those worried about America's long-term future; and 4) if, as I've argued in another paper, a VAT were initially set at the European average level of sixteen per cent, and split with the States, this sugar-coating would help overcome state reluctance to yield their monopoly on sales taxes which has been the chief basis of opposition to a VAT. Not least importantly, in adopting a VAT we could follow the example of our Canadian cousins, concentrating all tax collection at Federal level (where the reputation of the IRS for hard-nosed efficiency would result in more effective collection than in many states), enabling states to disband their fifty tax agencies at considerable savings -- releasing money to improve education, build bridges, and otherwise catch up infrastructure needs -- or even reduce state tax levies, which would constitute just as important a stimulation of consumer spending as a reduction in federal taxation. I hope that you'll use your columns to do some "consciousness raising" about early consideration of a VAT as a substitute for at least part of the income tax burden. 2. I have elsewhere argued for consideration of a Stamp Tax -- a form of taxation considered beyond the pale by most Americans simply because a stamp tax was instrumental in fomenting our Revolution. Actually, revenue stamps are used to validate legal documents -- wills, deeds, car titles, stock market transfers, and even personal checks -- in many countries. Of course, this is not the time to impose new taxes. But as part of a thoroughgoing tax reform to better equip the nation to confront our next disequilibrium, we should strike while the iron is hot, because the only time Congress is willing to act on taxes is while the shoe is pinching. Stamp taxes are highly effective and almost infinitely flexible revenue raisers; by making all stamped papers, in effect, government documents, fraud is greatly reduced. In Britain few rubber checks are written because fraudulent check writing is a Crown Offense as a consequence of the stamp printed on each cheque. Most small businessmen I've discussed this have told me they'd gladly assume a ten cent per check charge if this meant that they could depend on the police, FBI, or Secret Service to involve themselves in rigorous prosecution of bad check writers. At present, local law enforcement agencies tell small businessmen that they're too busy fighting "real" crime to be bothered with pursuing rubber check artists. And this is, in itself, a substantial burden on small businesses. And stamp taxes are almost infinitely flexible. Not only can the level of taxation be varied, but it is possible to require a validation stamp merely on the signature page of a red-taped document, or on each and every page. If combined with the "Regulator" approach outlined in the paragraph below, a stamp tax would be a powerful instrument in the hands of the President (or the Fed) if used to narrow (or broaden) the documents subjected to taxation. Perhaps you can use you columns to get the Congressional group on tax revision to consider this suggestion. 3. The major new proposal I'm raising in this letter, however, relates to a British tax notion which the Brits call "The Regulator" . Parliament has legislated a pre-approved list of excise taxes, which it has authorized the Cabinet to vary without further reference to Parliament for purposes of "fine tuning" the economy. The list includes taxes on beer and wines, cigarettes, radio and television fees, and many, many more items. Forty years ago such a proposal would have been a non-starter in the United States because of Supreme Court decisions barring delegation of Congressional authority. More recent decisions make it possible that the Court would approve tightly drafted legislation permitting the President to raise or lower specified excises within defined limits, enabling him to react to economic needs without the "recognition delay" and "legislation delay" involved in going to Congress. We live in a climate of accelerating economic change. Because of programmed buying and selling which computer technology has made possible, even the stockmarket has had to adopt policies to enable it to react more quickly to stampeding events. Seems to me that given the independence of the Federal Reserve Board from White House or Treasury guidance -- unlike the Bank of England which is subject to British Treasury guidance regarding reserve requirements, discount policy, and Open Market operations -- such legislation is even more important in the United States than in Britain if the President is realistically to be expected to avoid high unemployment. If a President (or the Treasury -- or even the Fed) could raise or lower the luxury tax on specified items by ten or twenty per cent, similarly increase or decrease the child deduction of the income tax, permitted IRA deductions, vary the level of federal gasoline taxes, or broaden or narrow the imposition of a stamp tax on legal documents, we could avoid the recognition delay and the protracted legislation delays in resolving problems like the current stalled economy. Experience has shown that when we have to go to Congress every time we enter a recession or face heated overemployment, action is so protracted that, as noted, we often end up worsening the succeeding cyclical upturn or downturn. American "Regulator" legislation could importantly contribute to solving this problem . I'm sure your editorial writers can come up with a dozen other items which could reasonably be included in Regulator legislation to give the President tools to cool the next excessively accelerated upturn or downturn or to help jump-start the next sluggish recovery. 5. An additional suggestion relates to a Swedish device used to stimulate industrial investment during downturns -- just what we've been unsuccessfully trying to get banks and businesses to do to give the economy a boost. The Swedish Treasury imposes a surtax on profits during normal times . These moneys belong to the company, not the Treasury, but are impounded until the next downturn . Once a recession has been identified, the Treasury releases these funds. They must be used solely for plant investment and are free to be so used only until the Treasury withdraws investment permission once the next upturn occurs. As you can imagine, this has been a powerful tool in shortening and reducing the depth of Swedish recessions by giving recovery a needed boost just when investment would normally be tailing off the worst in other economies. Again, this isn't the moment to actually impose such a tax, but it is the appropriate moment to get it on the books for use as the economy starts overheating again, or when we next experience a sluggish recovery. A further important contribution which could be expected from the adoption of a Swedish-style Surtax on Retained Earnings might be as a realistic quasi-substitute for the failed Balanced Budget Amendment in redressing the unwillingness of Congress properly to employ Keynesian mechanisms. Keynes himself assumed that the public debt created by budget deficits incurred during periodic economic downturns to offset Private Sector shortfalls in demand, would be repaid during the following expansion, with taxes raised to cool down the overheating which customarily occurs as the economy approaches full employment. That governments have proved unwilling, if not incapable, of reducing such recession-incurred public debt, is a fact of recent history -- U.S. debt having risen to near three trillion dollars, causing an enormous debt service burden on the national budget and in early March 1995 causing a near-panic run on the U.S. dollar as the proposed Balanced Budget Amendment was defeated in the Senate by a single vote. The availability of a Swedish-style Impound mechanism would enable the Treasury to exercise this policy tool to stimulate investment in plant and equipment during periods of economic decline, and by reintroducing the "impound" of a portion of retained earnings as the cycle approached its peak, serve much the same purpose as increased taxes to repay the public debt, i.e. removing immediate purchasing power from the economy in a manner to cool overheating. 6. Another notion relates to a mechanism used in Germany with regard to job training . Like the Swedish investment tax, it imposes a one per cent levy on gross profits but, in this case, for purposes of apprenticeship training . If the company reacts to this incentive by setting up an apprenticeship program, the money is available for funding. If a company chooses not to run such a program itself, the funds go into a national kitty for financing apprenticeship training through the federal school system. I think such a program in the U.S. would at least constitute a start at the type of meaningful educational reform (and job promotion) the Administration is looking for. And it could, perhaps, even be included in "Regulator" legislation. enabling the President to raise or lower the levy by a quarter of a point to boost the economy moderately during periods of recession, or cool it during periods of full expansion. Sincerely, David B. Timmins, PhD (Harvard) Professor of Finance & Economics (ret.)