The Guest Blog

Busch: VAT Is Where It's At 

In the business section of the NYT on Sunday, they ran a piece written by an economist from Cornell University that should concern everyone in the United States.  Entitled "How to Run Up a Deficit, Without Fear" should strike fear into those reading it as it advocates the Krugman (or is it Cheney?) point of view that deficits don't matter and the government should be running a larger one to stimulate demand.  Of all things, he uses California as an example to justify why cutting government spending is not an appropriate approach.

This leap in logic isn't as bad as what he next advocates: taxing any activity to bring in receipts to reduce the deficit.  Mr. Frank states, "Anti-tax zealots denounce all taxation as theft, as depriving citizens of their right to spend their hard-earned incomes as they see fit. Yet nowhere does the Constitution grant us the right not to be taxed." If we take this position's logic to the extreme, we would have the government tax all behavior and then spend it on whatever "winners" a technocrat/bureaucrat would deem "socially necessary or important."

I bring this up because I foresee a path developing for the United States based on this logic.  From this camp, every government spending program is justified to increase demand and can be paid for by simply taxing activities to pay for it.  Getting back to our Cornell economist, he makes no mention of dynamic logic such as taxpayers changing behavior when they get taxed.  As I wrote last week, our US Treasury Secretary from the 1920s knew that higher taxes bring changes to behavior.  Taxpayers attempt to avoid the tax either by using their capital for non-productive purposes or they simply lose the incentive to work.  Or worse, both.

I mention all of this because I believe there is one last radical concept to be introduced soon to the US economy:  a national sales tax.  A value added tax would be the final extension of a "tax activities" receipt raising concept.  This is not as far fetched as it may appear as Speaker of the US House of Representatives Nancy Pelosi has alreadycome out in favor of it.  "Somewhere along the way, a value-added tax plays into this," she said. "Of course, we want to take down the health-care cost, that's one part of it. But in the scheme of things, I think it's fair to look at a value-added tax as well."

Given the projected cost curve of health care and social security, it is likely to be brought up as a "temporary" cure for these programs.  Given that the current health care reform is predicated on the fiscally competing dual mandates of reducing costs while simultaneously adding beneficiaries, I would say a VAT is much closer to reality than the markets are giving it. 

This is the path of Japan with low/zero growth and deflation as the country can't grow it's way out of its deficits.  What would be the first indications of this in the United States?  After the end of QE at the end of Q1 2010 if we do not see interest rates begin to go higher, it would tell us that the market is pricing in this slow growth scenario.   

Andrew B. Busch is Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and

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