Monday, January 31, 2005

The Fiscal Mess and the Housing Bubble

So, how does the US fix its fiscal mess (supposing that it wants to fix the fiscal mess)? Here is what the OECD recommended in a survey last year.
Restraining both discretionary and mandatory spending, while necessary, is unlikely to be sufficient to restore the budget to balance over the longer term. To the extent that revenues have to be raised, this should be done primarily by broadening the tax base rather than by reversing recent reductions in marginal tax rates. Considering the low aggregate tax burden compared to other member countries, statutory and marginal effective tax rates remain rather high, reflecting the heavy reliance on income taxes, in particular at the federal level.

To broaden the tax base of the personal income tax, the deductibility of mortgage interest (regardless of the use of the loan) and of charitable donations should be phased out, as should the unlimited exclusion of employer health insurance plan premia. As to the corporate income tax, base-broadening efforts should focus on exemptions that reduce revenues and create inefficiencies, such as sectoral tax shelters. In any case, there is significant scope to improve revenue yield by better enforcement.

If the yield from broadening existing income tax bases is ultimately insufficient, a further move to a consumption based tax system through the introduction of a nationwide value added tax (VAT) should be considered. While introducing a VAT would be complicated in the US context, in which most states rely heavily on sales taxes for their revenues, such a step would be an efficient approach to raising revenues and might also help to boost household and national saving. Restraining both discretionary and mandatory spending, while necessary, is unlikely to be sufficient to restore the budget to balance over the longer term. To the extent that revenues have to be raised, this should be done primarily by broadening the tax base rather than by reversing recent reductions in marginal tax rates. Considering the low aggregate tax burden compared to other member countries, statutory and marginal effective tax rates remain rather high, reflecting the heavy reliance on income taxes, in particular at the federal level.
Pretty dramatic... When I first read this, I simply discarded the possibilities as politically impossible, but now I see that the Wall Street Journal is advocating the elimination of mortgage deductibility (thanks to Jane Halt).

Now, I wonder what would happen to government revenues if interest payments suddenly became less affordable, and the housing bubble burst... Looks like plan B would have to be enacted. Hello VAT.


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