June 2010

Tax and Spending Reform is Key for Recovery and Future Economic Growth

By John Hendrickson

“The New Deal order will face future crises that may yet bring a revival of limited government,” wrote John Samples of the CATO Institute.[1] Samples, who is director of the CATO Center of Representative Government, has recently published The Struggle to Limit Government: A Modern Political History, which focuses on the difficulty of returning toward constitutional limited government in the post-New Deal political world. Although the national economy is improving in certain aspects, the issues of unemployment, rising debt, deficits, and the looming entitlement crisis may force an abandonment of New Deal style programs in favor of a return toward traditional limited government. Policymakers in confronting economic recovery and solving the fiscal crisis must reform taxes along with reducing government spending to bring economic recovery, job creation, and prevent national bankruptcy.

The recent passage of health-care-reform legislation complicates the fiscal and economic problem the nation now faces. The health-care-reform legislation is not only unconstitutional, based on the Commerce Clause and Tenth Amendment, but it also creates a new entitlement that will require businesses and taxpayers to pay enormous amounts of money to comply with the government-mandated reforms. The health-care-reform law, unless repealed, will not only cost trillions of dollars, but also “cost taxpayers $503 billion between 2010 and 2019.”[2]

In order to address the $12 trillion national debt, $1.6 trillion deficit, and the projection of continual deficits and the escalating costs ($107 trillion) of Social Security, Medicare, and Medicaid, President Barack Obama and some policymakers are considering a value-added tax or VAT to address needed revenue and to pay for costly government programs.[3]

A VAT is a consumption (sales) based tax on all stages of a products’ development. This is a hidden tax that would hit consumers multiple times. The VAT would be an additional tax to the income tax, which is sanctioned by the Sixteenth Amendment to the Constitution. Income-tax rates are already expected to rise when President George W. Bush’s tax cuts expire because of the failure of Congress to renew those tax reductions. To make matters worse the United States has a high corporate tax rate which hinders economic growth and competiveness for our nation’s businesses trying to compete in a global market place. This scenario does not provide much confidence for job growth or addressing the national fiscal crisis.

A VAT is an entirely bad idea if it is in addition to the income tax, but is less destructive if it were to be a replacement. “The VAT has its virtues: as a single-rate, consumption-based system, much like the flat tax or national sales tax, it would introduce far fewer economic distortions than today’s income tax…,” noted CATO Institute Senior Fellow Daniel Mitchell.[4] Although Congress should seriously consider eliminating the current tax code and replacing it with a flat tax or a national sales tax, it is unlikely that a Democrat-controlled Congress would consider such a major, but necessary reform. Creating a VAT would only bring economic ruin and increase the tax base to pay for largess of the welfare and regulatory state. “A VAT is the political class’s recourse when the resources of the minority that is targeted by the envious are insufficient to finance ravenous government,” wrote columnist George F. Will.[5] And as Will noted: “Because the 16th Amendment will not be repealed, adoption of a VAT would proclaim the impossibility of serious spending reductions and hence would be the obituary for the Founders’ vision of limited government.”[6]

The federal government continues to grow at an enormous pace and it appears it will continue to grow and consume more of the Gross Domestic Product especially if many of President Barack Obama’s policies are initiated. The federal budget continues to grow and as Brian Riedl of The Heritage Foundation recently wrote:

Washington will spend $31,406 per household in 2010 — the highest level in American history (adjusted for inflation). It will collect $18,276 per household in taxes. The remaining $13,130 represents this year’s staggering budget deficit per household, which, along with all prior government debt, will be dumped in the laps of our children. Government spending has increased by $5,000 per household since 2008, and nearly $10,000 per household over the past decade. Yet there is no free lunch: If spending is not reined in, then eventually taxes must also rise by $10,000 per household.[7]

The solution to the economic and fiscal problems as well as reversing the welfare and dependency state is to follow a constitutional free-market blueprint. One solution is to follow the economic policies of Presidents Warren G. Harding and Calvin Coolidge who not only slashed government spending and debt, but also pushed for substantial tax reform that encouraged entrepreneurship, restored employment, and created the prosperous economy of the Roaring 1920s.[8] Policymakers should also reconsider the Balanced-Budget Amendment, and as stated above, consider an overhaul of the current tax code and replacing it with a flat tax or national sales tax — and spending reductions must be taken seriously.

The Tea Party movement is leading a grass-roots drive to lower taxes and spending, but more importantly to return to constitutional limited government. As economist Larry Kudlow wrote:

Harking back to the Founders’ principles of constitutional limits to government is a very powerful message. It’s a message of freedom, especially economic freedom. The tea partiers have delivered an extremely accurate diagnostic of what ails America right now: Government is growing too fast, too much, too expensively and in too many places — and in the process it is crowding out our cherished economic freedom.[9]

The New Deal philosophy of government has certainly created a crisis that only can be solved by returning to constitutional principles of limited government, federalism, and supporting economic programs that encourage, defend, and promote economic liberty.

John Hendrickson is a Research Analyst at Public Interest Institute.

The views expressed herein are those of the author and not necessarily those of Public Interest Institute or Tax Education Foundation.  They are brought to you in the interest of a better-informed citizenry.

[1] John Samples, “Limiting Government, 1980-2010,” Cato Policy Report, Vol. 32, No. 2, March/April, 2010, p. 1.

[2] Curtis S. Dubay, “Obamacare: Impact on Taxpayers”, Backgrounder, No. 2402, The Heritage Foundation, April 14, 2010.

[3] George F. Will, “The perils of the value-added tax,” The Washington Post, <http://www.washingtonpost.com> (April 18, 2010).

[4] Daniel J. Mitchell, “Beware: ‘Value-added tax’ is an economy killer,” CATO Institute, <http://www.cato.org/pub_display.php?pub_id=11668> (April 8, 2010).

[5] Will.

[6] Ibid.

[7] Brian Riedl, “How Washington is Spending Your Taxes in 2010,” The Heritage Foundation,    <http://www.heritage.org/Research/Commentary/2010/How-Washington-Is-Spending-Your-Taxes-In-2010/.org> (April 9, 2010).

[8] Burton W. Folsom, Jr., “Can we get out of this economic mess,” BurtFolsom.com, <http://www.burtfolsom.com> (April 19, 2010).

[9] Larry Kudlow, “America’s Constitutionalist Revolt,” Real Clear Politics, <http://www.realclearpolitics.com> (April 16, 2010).