The Commission, the Deficit, and the VAT
By Arnold Kling
let’s suppose that you are a conservative and you want the fiscal commission to succeed. You will have to agree to higher taxes as part of the bargain. But what should you aim to get in return?
He would ask for an increase in the age of eligibility for both Social Security and Medicare. He would also ask for tax reform, including the introduction of a value-added tax (VAT), elimination of the estate tax, and lower tax rates on personal and corporate income.
Tyler Cowen also makes the case for a VAT.
My position is that we redistribute far too much income from the young to the old. This requires taxes that reduce total output, which makes the redistribution bucket very leaky–a lot of wealth is lost in doing all this redistribution. If I were a conservative on a Budget commission, I would hold out until the liberals agree that redistribution should be limited to a safety net, not a program of transfers to the affluent.
Social Security’s age of eligibility should be in the early 70’s. More importantly, Social Security benefits should be very much means-tested, based on lifetime wage income prior to age 70. Benefits should gradually be phased out with lifetime income, so that someone not in the bottom 25% of lifetime income should receive no benefits.
Medicare as currently structured–reimbursement for services–should be scrapped. Instead, I would have the government provide supplemental extreme catastrophic insurance along with fixed-sum vouchers. The catastrophic insurance would not really kick in until you incur $50,000 of health costs in one year. The idea is not to protect the typical individual, but to provide enough of a supplement so that private health insurance companies would be willing to insure those who are not in perfect health. Think of my proposal as a variation on catastrophic reinsurance, an idea that was floated by Democratic wonks during the 2004 election, applied to the elderly.
Honestly, I do not see any alternative that looks feasible. Given all of our other taxes, I doubt that a VAT would raise enough money at the margin to make a difference. Already, marginal tax rates are very high for several classes of people, particularly those with low enough incomes to qualify for various means-tested government programs. Introduce a significant VAT on top of the current tax system, and lots of people are going to decide that housework and the underground economy are more lucrative than working in the market.
Tax reform, along the lines that Mankiw suggests, might produce more net revenue, but not nearly enough to rescue Social Security and Medicare.