Home > Economics, Fiscal Policy, Greg Mankiw, Tax Policy, The New York Times, VAT > Mankiw on Fiscal Responsibility and the VAT

Mankiw on Fiscal Responsibility and the VAT

Greg Mankiw has a new column in the New York Times on Obama’s budget which will increase the budget deficit above historical levels even in the long term. Mankiw, sensibly allows for large deficits during wartime and recession.

The troubling feature of Mr. Obama’s budget is that it fails to return the federal government to manageable budget deficits, even as the wars wind down and the economy recovers from the recession. According to the administration’s own numbers, the budget deficit under the president’s proposed policies will never fall below 3.6 percent of G.D.P. By 2020, the end of the planning horizon, it will be 4.2 percent and rising.

He points out that Obama has called for a commission to deal with this problem. In news to me, Nancy Pelosi “gave a hint in an interview last October when she said a value-added tax was “on the table.”” In contrast to Bartlett, Crook, Emanuel, and myself, Mankiw is less enthusiastic about that prospect.

YET despite its efficiency compared with other taxes, a VAT does not offer a free lunch. It would raise consumer prices, lower real wages, discourage work and depress economic growth. It would also break President Obama’s pledge not to raises taxes on the middle class.

Professor Mankiw would rather spending be sharply cut (that is on the table too, of course) – I imagine both has to occur. I certainly don’t think VAT is an anagram for TINSTAAFL. But if a taxes must rise (I believe they do) eventually, a VAT is probably the best option. Does Mankiw have a preferred tax? He suggests that he also thinks a VAT is the least bad option. The President’s budget deserves the type of rebuke that Mankiw offers and every tax system’s faults should be highlighted. But for Obama’s potential willingness to raise such a tax, Mankiw unfairly criticizes the President for not being “ready to face up to the long-term fiscal challenge.” Keeping all options on the table is the most responsible option.

[update: 02/17/10]: On his blog, Mankiw now recommends conservatives support a VAT if coupled with spending and other tax cuts (which is exactly what I’ve advocated).
3. Use of consumption taxes rather than income taxes. A VAT is, as I have said, the best of a bunch of bad alternatives. Conservatives hate the VAT, more for political than economic reasons. They should be willing to swallow a VAT as long as they get enough other things from the deal.
4. Cuts in the top personal income and corporate tax rates. Make sure the VAT is big enough to fund reductions in the most distortionary taxes around. Put the top individual and corporate tax rate at, say, 25 percent.
5. Permanent elimination of the estate tax. It is gone right now, but most people I know are not quite ready to die. Conservatives hate the estate tax even more than they hate the idea of the VAT. If the elimination of the estate tax was coupled with the addition of the VAT, the entire deal might be more palatable to them.
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