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Archive for the ‘Fiscal Policy’ Category

Whenever there’s a fight over raising the debt limit, the political establishment gets hysterical and makes apocalyptic claims about default and economic crisis.

For years, I’ve been arguing that this Chicken-Little rhetoric is absurd. And earlier this week I testified about this issue before the Oversight and Investigations Subcommittee of the House Financial Services Committee.

By the way, when I first showed up, my placard identified me as Ms. Mitchell.

Since I work at a libertarian think tank, I reckon nobody would object if I wanted to change my identity. But since I’m the boring rather than adventurous kind of libertarian, I guess it’s good that I wound up being Dr. Mitchell.

More important, here’s some elaboration and background links to some of the information from my testimony.

America’s long-run fiscal problem isn’t debt. That’s just a symptom. The real challenge is a rising burden of government spending, largely because of demographic change and poorly designed entitlement programs.

Measured as a share of economic output, the tax burden already is above historical levels. Moreover, taxes are projected to rise even further, so there is zero plausible evidence for the notion that America’s future fiscal crisis is the result of inadequate tax revenue.

International bureaucracies such as the IMF, BIS, and OECD show America in worse long-run shape than Europe, but the U.S. is actually in a better position since a spending cap easily would prevent the compounding levels of debt that are driving the terrible long-run outlook in the United States.

It’s good to have debt limit fights today if such battles enhance the possibility of averting a future Greek-style economic calamity.

Arguments against using the debt limit as an action-forcing event usually are based on the bizarre claim that an inability to borrow more money would cause a default and wreck the “full faith and credit” of the United States. Nonsense. Treasury would be able to avoid default in the absence of a higher debt limit for the simple reason that tax receipts are far greater than what’s needed to pay interest on the debt.

This last point is worth some extra attention. I’ve been arguing for years that debt limit fights are harmless since there’s no risk of default. I even explained to the Senate Budget Committee a few years ago that it would be easy for the Treasury Department to “prioritize” payments to ensure that bondholders would never be adversely impacted.

The Obama Administration routinely denied that it was sufficiently competent to engage in “prioritization” and even enlisted the then-Fed Chairman Ben Bernanke to dishonestly fan the flames of economic uncertainty.

Well, thanks to the good work of the Subcommittee on Oversight and Investigations, we now have a report outlining how the White House was prevaricating. Simply stated, of course there were and are contingency plans to prioritize in the event of a standoff on the debt limit.

By the way, I didn’t get the chance to mention it in my oral testimony, but my full written testimony addressed the silly assertion that any delay in a government payment is somehow a “default.”

I will close by noting the utterly disingenuous Administration tactic of trying to…make it seem as if delaying payments of things like crop subsidies and Medicaid reimbursements is somehow equivalent to default on interest payments.

One final point. Let’s imagine that we’re four years in the future and political events somehow have given us a Republican president and a Democratic Congress. Don’t be surprised if the political parties then reverse their positions and the GOPers argue for “clean” debt limits and make silly claims about default and Democrats argue the opposite.

That’s why I’m glad I’m at the Cato Institute. I can simply tell the truth without worrying about partisanship.

P.S. Here are some jokes about the debt limit, and you can find some additional humor on the topic here and here.

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The left is very clever about accepting “compromise,” so long as the result is a larger burden of government.

This is one of the reasons why I’m so concerned about Senator Cruz’s proposal for a value-added tax. Even though he wants a VAT for good reasons (to finance lower tax rates and also to reduce the tax bias against saving and investment), my fear is that the statists will say yes, then quickly use the VAT to finance a big expansion of the welfare state.

Which is exactly what happened in Europe.

Some folks think I’m being paranoid, to which there are two responses. First, there’s the old joke that even paranoid people have enemies.

But the second and more serious response is to point out that lots of statists openly say they want a VAT to make government bigger.

Indeed, some of these folks already are semi-embracing Cruz’s VAT because of their desire to have a new source of revenue for Washington. Consider, for instance, these excerpts from an editorial in USA Today.

The VAT is a kind of national sales tax used by virtually every other nation in the world because it can raise lots of money …partly because deficits are set to explode again as Baby Boomers retire, the VAT is back. Texas Republican Ted Cruz, winner of the Iowa GOP caucuses, is proposing a VAT… The concept has a lot going for it. …Cruz’s plan is flawed, but he’s on to something. A more progressive, phased-in VAT deserves to be part of any future conversation

You don’t have to read between the lines to understand that the editors at USA Today want a VAT to expand the public sector. The editorial even favorably cites Senator Cardin and former Treasury official Michael Graetz.

Do they want a VAT for the same reasons as Senator Cruz?

Not exactly. Senator Cardin acknowledges that the VAT could lead to a spigot of new tax revenue (“enacting a consumption tax could mean enacting a new and easy-to-adjust lever to raise taxes irresponsibly”), but he claims to have a mechanism that supposedly will guard against ever-higher tax burdens.

The Progressive Consumption Tax Act addresses this concern with a circuit breaker that returns overages from the PCT to taxpayers when revenues exceed predetermined levels.

This is a joke. The politicians in Washington get to set the “predetermined levels,” so it goes without saying that those levels will go from predetermined to redetermined in a blink of an eye, just as we’ve seen in other nations.

And what about Michael Graetz’s plan? Well, here are a few excerpts from an article he wrote.

…tax increases will be necessary to…address the nation’s unsustainable fiscal condition fairly… With this plan in place, our ability to raise additional revenue would be increased…

To be fair, Graetz is not a leftist. He basically wants a VAT because it’s a less-destructive way of financing bigger government.

I agree. It’s highly likely that a $100 billion VAT hike would do less damage than a $100 billion increase in income taxes, but why on earth would anyone want higher taxes to fund bigger government, particularly when we know sensible entitlement reforms could fix the nation’s long-run fiscal problem?

No wonder Avik Roy, writing for Forbes, is so worried about a VAT.

Sen. Ted Cruz…favors replacing the corporate income tax with what Cruz calls a “business flat tax,” and what Canadians and Europeans call a “value-added tax.” But the real debate isn’t about terminology; it’s about whether or not Cruz’s approach would drive an explosion of government taxes—and spending—over the mid- to long-term.

One reason it’s a money machine is that it’s actually a hidden tax on wages and salaries.

…businesses would no longer be able to deduct the cost of labor. As my colleague Ryan Ellis has detailed, that amounts to a “16 percent wage tax withheld at the employer level under the Cruz plan.”

And that creates a very large tax base, so any increase in the tax rate transfers a lot of money from the private sector to Washington.

…the most important problem with the Cruz plan is how Democrats would take advantage of it. Cruz envisions a VAT tax rate of 16 percent. But his plan would hand progressives a simple tool to raise taxes to far higher rates in the future. …the vast majority of federal revenue will hit voters indirectly, because it will come from businesses. From a political standpoint, Cruz’s plan would pave the way to higher tax rates in the future. …every one percent increase in the VAT would yield $1.6 trillion in new revenue over a decade. The temptation for a Democratic president and Congress to raise VAT rates to higher levels will be enormous.

And Avik echoes one of my concerns, warning that a VAT will greatly undermine and perhaps even kill any opportunity for genuine entitlement reform.

Under Cruz’s tax system, there would be absolutely no pressure on Washington to reform Medicare and Medicaid. Why reform entitlements when you can simply increase the “business flat tax” rate from 16 percent to 17 percent to 18 percent to 19 percent? This is exactly what has happened in Canada and Europe, where VAT rates started out low, and have gone up and up over time.

I should point out (as he does in his column) that Avik supports Marco Rubio, so he has a political motive to trash the VAT.

Indeed, he even makes some anti-VAT arguments that strike me as unfair, so I’ve omitted them from this analysis.

But the parts I have shared are completely accurate and they are more than adequate to make a very powerful case against giving Washington a new source of revenue.

Let’s close with some wisdom from the 1980s. I wrote that one of America’s worst presidents wanted a VAT to expand the welfare state. And I also mentioned that one of the best presidents in American history was on the right side of the issue. And it’s worth listening to the Gipper’s wisdom on this issue.

P.S. Here’s a short update to my recent post about the craziness of Keynesian economics. You may recall that the economic illiterates at the International Monetary Fund said diverting money from the private sector to finance government outlays on refugees would be good for growth.

Well, we now have estimates of how much will be spent on this so-called stimulus.

Shelter, medical care and integration policies for refugees will cost the German state €22 billion in 2016, and €27.6 billion in 2017.

Gee, according to the perpetual motion machine of Keynesianism, maybe the German government should put the entire population on welfare and the economy will really boom.

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If pessimism was an Olympic event, I used to think I might be favored to win a medal. After all, growing levels of dependency outside of Washington and rampant corruption inside of Washington sometimes lead me to conclude that America is doomed to a Greek fiscal future.

But compared to some people, maybe I’m just an amateur Cassandra. Or even a Pollyanna.

Holman Jenkins of the Wall Street Journal has an ultra-pessimistic column today arguing that “many of us believe the entitlement programs need to be reformed” but worrying about “Republicans who pose as ‘conservative’ defenders of Social Security and Medicare.”

And part of his column is rather convincing since he points out that Donald Trump has criticized Republicans who favor reform.

…the meaning of Trumpism…goes like this: “…Every Republican wants to do a big number on Social Security, they want to do it on Medicare, they want to do it on Medicaid. And we can’t do that. And it’s not fair to the people that have been paying in for years and now all of the sudden they want [it] to be cut.” Mr. Trump is a political harbinger here of a new strand of populist Republicanism.

To be fair, Trump’s comments aren’t necessarily anti-reform. One could argue that he’s simply saying that benefits for existing retirees and older workers shouldn’t be adversely impacted.

But since “The Donald” hasn’t expressed any support for reforms that would create better and more viable options for younger workers, Jenkins is probably right to be pessimistic.

But he also argues that Tea Party-type Republicans are opposed to reform.

The tea party animus toward ObamaCare is…means-tested new entitlements…are viewed as a threat to the traditional, universal, “earned,” middle-class retirement programs of Social Security and Medicare. …The unspoken tea party stance of defending the good old-fashioned entitlements of “real” Americans is increasingly, in dog-whistle terms, what differentiates one Republican from another.

While it’s almost certainly true that there’s more animosity to redistribution-oriented programs such as Obamacare than there is to so-called earned entitlements, I think Holman misreads the Tea Party crowd.

Based on my speeches to – and other interactions with – these activists, I have never detected any measurable hostility to Social Security reform and Medicare reform. Fixing those programs may not be at the top of their agenda, but they’re not on the wrong side.

Moreover, I work closely with folks on Capitol Hill and I almost never hear about any meaningful opposition from Tea Partiers. And since House GOPers have approved budgets with genuine entitlement reform for five consecutive years, there’s been plenty of time for opposition to materialize.

Jenkins also is glum because Governor Christie, who has openly expressed support for reform, hasn’t fared well. And he notes that Senator Rubio has rejected reforms that would harm current seniors.

Chris Christie, who went nowhere in Iowa, did himself no favor by dragging Social Security and Medicare into every debate, however much those programs need to be addressed. Marco Rubio was just as quick to modify any implication that Republicans therefore are entitlement reformers: “We are talking about reforms for future generations. Nothing has to change for current beneficiaries. My mother is on Medicare and Social Security. I’m against anything that’s bad for my mother.”

I’m not a political expert, so I won’t pretend to know why Chris Christie didn’t get many votes in Iowa, but I don’t think it’s right to label Marco Rubio as an opponent. He’s been very upfront about supporting much-needed structural reform of Medicare and Medicaid. He simply doesn’t want to change the rules for existing retirees and older workers.

You can argue that such a condition makes it harder to save money in the short run, but I’m more concerned about dealing with the long-run fiscal challenge (as seen in these IMF, BIS, and OECD numbers). So Rubio’s position doesn’t strike me as a problem. Indeed, I think he’s pushed the envelope in the right direction, particularly since he comes from a state with so many seniors.

And since Ted Cruz also has said similar things about entitlement reform, that means both top-tier GOP candidates (other than Trump) are willing to do the right thing to restore fiscal sanity.

To be sure, maybe I am being naively optimistic. Perhaps Rubio or Cruz will win and will decide to kick the can down the road, even with a GOP Congress that might be primed for reform.

If that happens and we miss what may be a once-in-a-lifetime opportunity for genuine entitlement reform, I’ll be very unhappy and Holman Jenkins will have demonstrated that pessimism is a much smarter assumption when contemplating the actions of politicians.

In which case my already-low opinion of politicians would drop to a record depth. And it also might be time to escape to a country that still has some sensible people and is less likely to suffer fiscal collapse.

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There is some very good news to share. The income tax will disappear in April.

But there’s also some bad news. The income tax is only being abolished in the Caribbean nation of Antigua and Barbuda, and there’s little reason to think that America’s awful internal revenue code will disappear anytime soon.

Nonetheless, we should celebrate this development because it shows that fiscal mistakes can be reversed.

A report from Caribbean News Now has some of the highlights.

The people of Antigua and Barbuda will from April receive tax relief when the government plans to abolish personal income tax (PIT).  PIT, introduced by the now opposition United Progressive Party upon coming into office in 2004, imposes a tax of 8% on residents earning an income above $3,500 and 15% on those earning an income above $25,000. …Prime Minister Gaston Browne…noted that previous Antigua and Barbuda Labour Party administrations governed Antigua and Barbuda successfully for 27 years without personal income tax. He said that the cost of collecting PIT, the difficulty of enforcement, and its unfairness, make it sensible to remove the PIT from the books.

Wow, the Antigua and Barbuda version of the Labour Party obviously is much better than the crazed British version.

But let’s not get sidetracked. Here are some additional details from a story in the Jamaica Observer.

Prime Minister Gaston Browne yesterday announced that, effective April, personal income tax will be abolished in its entirety. …”Abolishing personal income tax is an important reform. Not only will it put more money in the pockets of the people, so that they can save or spend more for the benefit of the economy as whole, it will help to re-establish our country as one of the most competitive in the Caribbean and beyond.” …He noted that with this move, Antigua and Barbuda will be a location that is competitive and also the choice of retirees.  “Antigua and Barbuda will become a competitive location to attract the headquarters of companies and for professionals to relocate, thereby creating more jobs. Retirees will choose Antigua and Barbuda as their retirement home; Citizenship by Investment Programme (CIP) investors will invest and choose Antigua and Barbuda over our competitors,” said the prime minister. …”taxing income is destructive to investment, savings and consumption. Also, it penalises entrepreneurship.”

For a politician, Mr. Browne has a good understanding of economics. I don’t like the “money in the pockets” rhetoric because it implies a bit of Keynesianism, but everything else he said is based on solid, microeconomic observations about incentives. Very reminiscent of JFK.

And I also like his point about wanting to be a “competitive location.” Yet another example of why tax competition is such a wonderful force for good policy. It encourages governments to do the right thing even when they don’t want to.

I bet, for instance, that the good reform in Antigua and Barbuda will put an end to the suicidal talk of an income tax in the Cayman Islands.

But what about the United States? Is there any chance that good policy in the Caribbean will encourage tax reform in the United States?

Unfortunately, most politicians couldn’t find Antigua and Barbuda on a map, much less care about that nation’s fiscal policy. So I’m not holding my breath that we’ll reverse the horrid mistake that was made in 1913.

But maybe, just maybe, we can at least figure out a less corrupt and less destructive way for the politicians to grab our money.

P.S. Antigua and Barbuda is a beautiful place, but I’ve noted before that government always has the ability to turn Heaven into Hell.

P.P.S. By the way, because of our awful worldwide tax system, American citizens can’t move to Antigua and Barbuda and benefit from that nation’s good tax policy. But there is a Caribbean island where you can legally slash your tax burden.

P.P.P.S. For those who follow Caribbean tax policy, we also enjoyed a fiscal victory a few years ago when a value-added tax was rejected in the Turks and Caicos Islands.

P.P.P.P.S. On an unrelated topic, I want to augment my observations on the water crisis in Flint, Michigan, by citing some very important analysis by Reason‘s Shikha Dalmia. While a wasteful and incompetent local government caused the mess, she explains that state officials deserve some blame because they wanted to “create jobs” with an infrastructure project instead of accepting a good water deal from Detroit.

…the debacle is the result of Snyder’s efforts to stimulate the local economy—the exact opposite of the liberal line. …the then DWSD Director Susan McCormick presented two alternatives to Emergency Manager Ed Kurtz that slashed rates for Flint by nearly 50 percent, something that made Detroit far more competitive compared to the KWA deal. …Genesee County and Flint authorities saw the new water treatment as a public infrastructure project to create jobs… And neither Snyder nor his Emergency Manager Ed Kurtz nor the state treasurer Andy Dillon had the heart to say “no,” especially since to hand Flint to DWSD would have made the whole project less viable. …the Flint water crisis is the result of a Keynesian stimulus project gone wrong.

Hmmm…, statists make silly claims about terrorism being caused by climate change or inequality. Maybe I can be equally silly and now argue that stimulus schemes cause poisonous water!

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The Congressional Budget Office has just released its new 10-year fiscal forecast and the numbers are getting worse.

Most people are focusing on the fact that the deficit is rising rather than falling and that annual government borrowing will again climb above $1 trillion by 2022.

This isn’t good news, of course, but it’s a mistake to focus on the symptom of red ink rather than the underlying disease of excessive spending.

So here’s the really bad news in the report.

  • The burden of government spending has jumped from 20.3 percent of GDP in 2014 to 21.2 percent this year.
  • By the end of the 10-year forecast, the federal government will consume 23.1 percent of the economy’s output.

In other words, the progress that was achieved between 2010 and 2014 is evaporating and America is on the path to becoming a Greek-style welfare state.

There are two obvious reasons for this dismal trend.

Here’s a chart that shows what’s been happening. It shows the rolling average of annual changes in revenue and spending. With responsible fiscal policy, the red line (spending) will be close to 0% and have no upward trend.

Unfortunately, federal outlays have been moving in the wrong direction since 2014 and government spending is now growing twice as fast as inflation.

By the way, don’t forget that we’re at the very start of the looming tsunami of retiring baby boomers, so this should be the time when spending restraint is relatively easy.

Yet if you’ll allow me to mix metaphors, bipartisan profligacy is digging a deeper hole as we get closer to an entitlement cliff.

Now let’s shift to the good news. It’s actually relatively simple to solve the problem.

Here’s a chart that shows projected revenues (blue line) and various measures of how quickly the budget can be balanced with a modest bit of spending restraint.

Regular readers know I don’t fixate on fiscal balance. I’m far more concerned with reducing the burden of government spending relative to the private sector.

That being said, when you impose some restraint on the spending side of the fiscal ledger, you automatically solve the symptom of deficits.

With a spending freeze, the budget is balanced in 2020. If spending is allowed to climb 1 percent annually, the deficit disappears in 2022. And if outlays climb 2 percent annually (about the rate of inflation), the budget is balanced in 2024. And if you want to give the politicians a 10-year window, you get to balance by 2026 if spending is “only” allowed to grow 2.5 percent per year.

In other words, the solution is a spending cap.

Here’s my video on spending restraint and fiscal balance from 2010. The numbers obviously have changed, but the message is still the same because good policy never goes out of style.

Needless to say, a simple solution isn’t the same as an easy solution. The various interest groups in Washington will team up with bureaucrats, politicians, and lobbyists to resist spending restraint.

P.S. A final snow update. Since my neighbors were kind enough to help me finish my driveway yesterday, I was inspired to “pay it forward” by helping to clear an older couple’s driveway this morning (not that I was much help since another neighbor brought a tractor with a plow).

It’s amazing that these good things happen without some government authority directing things!

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This isn’t intentional, but there’s been a European theme to this week’s posts. I wrote yesterday about economic chaos in France, and the previous day I wrote about the grim consequences of Italian statism.

Today, we’re going to look at Greece. In the past, I’ve explained that Greece is special, albeit in a bad way. But I’ve also asserted that Greece could be rejuvenated and could deal with its debt with the right reforms.

Heck, Greece could even renege on its debt and still enjoy an economic renaissance if it adopted the right policies. That’s the message of this short video narrated by Garett Jones of George Mason University

So the $64 question (actually, the $231,199,453,552 question according to the latest projection of Greek debt) is whether Greece will do the right kind of reform.

Unfortunately, it appears that all the bailouts have subsidized bad policy. Writing for National review, a journalist from Greece explains that his government is adding more and more taxes onto an overburdened private sector.

…the new austerity measures, which are often amusingly termed reforms, are for the most part tax increases — which may not be popular, but which conform to SYRIZA’s ideological creed. The new package agreed to by SYRIZA and Greece’s creditors is about 90 percent new taxes or tax increases and 10 percent reforms. The tax increases have the benefit of protecting SYRIZA’s core constituency, which is the public-sector employees. Despite the collapse of public revenue and the overall dismal economic outlook, the SYRIZA government plans to increase the salaries of public-sector employees (by as much as 8 percent) and carry on with 45,000 new hires in 2016. Meanwhile, in the private sector, SYRIZA has increased taxes on all sorts of things and is planning to double the taxation of farmers. It has increased business taxes and also demanded the pre-payment of business taxes. It has increased the VAT on almost all goods, and it is defining affluence down so as to increase income taxes for a greater number of taxpayers. And although Greece has probably the highest social-security contributions in Europe, SYRIZA is planning to increase these contributions even more, despite the fact that pensioners now outnumber those who are still employed in the private sector.

More pensioners that private-sector employees?!?

Wow, even I’m shocked by that factoid. There definitely are far more people riding in the wagon than pulling the wagon when you add up pensioners, bureaucrats, and welfare recipients.

So you can understand why Greece is almost surely doomed.

Especially when you consider that many of the people leaving Greece are the productive ones (i.e., those who normally would be pulling the wagon). Here are some passages from a story in the New York Times from last year.

From 2010 to 2013, about 218,000 Greeks emigrated, according to an estimate from the Greek statistics agency. Nearly half of them went to Germany. …Resentments against Germany — Greece’s most powerful creditor — quickly fade when it comes to the prospect of a regular paycheck. Many of those leaving Greece are highly educated professionals and scientists seeking greater opportunity and better pay. An estimated 135,000 Greeks with post-secondary degrees have left since 2010 and are working abroad, according to Lois Labrianidis, an economic geographer and official in Greece’s Economy Ministry. “We think this is human capital that is crucial for the development of the country,” Mr. Labrianidis told me recently, calling the departures a “major blow.” …While much of the attention on recent Greek emigration has focused on the highly educated, I’ve been surprised by the number of working-class Greeks I’ve met who left due to financial desperation.

But there’s one group of people who aren’t leaving.

You probably won’t be surprised to learn that they are the bureaucrats. As noted in this report from the U.K.-based Telegraph, their privileged position is zealously protected by vote-buying politicians.

The other thing most people in the area seem to agree on is that the biggest impediment to progress is the size of Greece’s public sector. The country has a population of 10 million, of which 2.5 million are pensioners, one million are government employees and two million work in the private sector. A further 1.7 million are unemployed. The rest are children or students. “So you can see why the current situation is unsustainable,” says Tryfon. “The only solution is for the public sector to be cut back. But every government since the crisis has chosen to raise taxes, while doing little to stimulate the private sector because they only want to protect votes.” “…Public sector employees and pensioners are the first to get paid and the only ones to get paid on time. We need investment into the private sector, but there is no motivation for companies to come to Greece…” a company would be nuts to invest in a politically unstable country, creaking under debt and crippled by an incredibly punitive tax regime. “What business will invest in a Greece when it takes six months to set up a company compared to Cyprus where it takes 15 minutes?” asks Dimitris Karkavitsas, an investment banker-turned-strawberry farmer. …the young engineer, says everyone who tries to make it in the private sector gets strangled. “The tax is killing us,” he says. …In the meantime, the public sector remains a massive beast.

Moreover, when you set up a company in Cyprus, there’s never a risk that you’ll be required to provide disgusting forms of DNA  as part of bureaucratic requirements.

Yet rather than be outraged by overpaid and meddlesome bureaucrats, I suspect most Greeks probably think how they can get on that gravy train. Which explains why, in an interview, I said the Greeks shouldn’t be allowed to “loot and mooch their way through life.”

Until and unless they learn that lesson, the nation is doomed to societal collapse.

P.S. Another sign of Greece’s moral and fiscal bankruptcy is that pedophiles can get disability payments.

P.P.S. To offset the grim message of today’s column, let’s also enjoy some Greek-related humor.

This cartoon is quite  good, but this this one is my favorite. And the final cartoon in this post also has a Greek theme.

We also have a couple of videos. The first one features a video about…well, I’m not sure, but we’ll call it a European romantic comedy and the second one features a Greek comic pontificating about Germany.

Last but not least, here are some very un-PC maps of how various peoples – including the Greeks – view different European nations.

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My views on the value-added tax are very simple and straightforward.

If we completely eliminated all income-based taxes, I would be willing to accept a VAT (or even a national sales tax) as a revenue source for government.

But unless that happens, I’m unalterably opposed because it’s far too risky to give politicians two major sources of tax revenue. Just look at what happened in Europe (and Japan). Before the VAT, the burden of government spending wasn’t that much higher in Europe than it was in the United States. Once VATs were adopted, however, that enabled a vast expansion of the welfare state.

This is why I’m worried about the Rand Paul and Ted Cruz tax plans. On paper, both plans are very good, dramatically lowering income tax rates, significantly curtailing double taxation, and also abolishing the corporate income tax. But I don’t like that they both propose a VAT to help make up the difference. It’s not that I think they have bad intentions, but I worry about what happens in the future when a bad President takes office and has the ability to increase both the income tax and the value-added tax. When the dust settles, we’re France or Greece!

By contrast, if we do some type of tax reform that doesn’t include a VAT, the worst thing that could happen when that bad president takes office is that we degenerate back to the awful tax code we have today. Which would be unfortunate, but not nearly as bad as today’s income tax with a VAT on top.

Bad since I’ve already addressed this issue, let’s focus on a part of the Paul and Cruz tax plans that has received very little attention.

Both of them propose to get rid of the payroll tax, which is the part of your paycheck that goes to “FICA” and is used to help fund Social Security and Medicare.

Alan Viard of the American Enterprise Institute has a column in U.S. News & World Report that explores the implications of this repeal.

Would you like to see the FICA item on your pay stub go away and be able to keep the 7.65 percent that the payroll tax takes out of your paycheck? If so, Republican presidential candidates Rand Paul and Ted Cruz have a deal for you – each of them has proposed getting rid of the tax. The senators’ plans would also eliminate the other 7.65 percent that the government collects from your employer, which you ultimately pay in the form of lower wages.

That sounds good, right? After all, who wouldn’t like to keep 15.3 percent of their income that is now being siphoned off for entitlement programs.

But here’s the catch. As Alan explains, other revenue sources would be needed to finance those programs, particularly Social Security.

The payroll tax finances two large benefit programs – 6.2 percent goes to Social Security and 1.45 percent goes to Medicare Part A. If the payroll tax went away, we would have to find another way to pay for those benefits. Paul and Cruz would turn to a value added tax, known as a VAT. …using it to pay for Social Security would have repercussions for the program that the candidates haven’t thought through. …once the payroll tax was gone, Social Security would no longer be a self-financed program with its own funding source. Instead, it would draw on the same general revenues as other government programs.

Viard thinks there are two problems with using VAT revenue to finance Social Security.

First, it means that there’s no longer a limit on how much money can be spent on the program.

…having a separate funding source for Social Security has been good budgetary policy. It’s kept the program out of annual budget fights while controlling its long-run growth – Social Security spending is limited to what current and past payroll taxes can support.

Second, replacing the payroll tax with a VAT eliminated the existing rationale for how benefits are determined.

And that will open a potential can of worms.

…what would happen to the benefit formula if the payroll tax disappeared and Social Security was financed by general revenue from the VAT? Paul and Cruz haven’t said. …One option would be to switch to a completely different formula, maybe a flat monthly benefit for all retirees. …that would be a big step, cutting benefits for high-wage workers and posing tricky transition issues.

I imagine there are probably ways to address these issues, though they might wind up generating varying degrees of controversy.

But I’m more concerned with an issue that isn’t addressed in Viard’s article.

I worry that eliminating the payroll tax would make it far harder to modernize Social Security by creating a system of personal retirement accounts.

With the current system, it would be relatively easy to give workers an option to shift their payroll taxes into a retirement account.

If the payroll tax is replaced by a VAT, by contrast, that option no longer exists and I fear reform would be more difficult.

By the way, this is also the reason why I was less than enthused about a tax reform plan proposed by the Heritage Foundation that would have merged the payroll tax into the income tax.

Yes, I realize that genuine Social Security reform may be a long shot, but I don’t want to make that uphill climb even more difficult.

The bottom line is that I don’t want changes to payroll taxes as part of tax reform, particularly when it would only be happening to offset the adverse distributional impact of the VAT, which is a tax that shouldn’t be adopted in the first place!

Instead, let’s do the right kind of tax reform and leave the payroll tax unscathed so we’ll have the ability to do the right kind of Social Security reform.

P.S. Some of you may be wondering why Senators Paul and Cruz included payroll tax repeal in their plans when that leads to some tricky issues. The answer is simple. As I briefly noted above, it’s a distribution issue. The VAT unquestionably would impose a burden on low-income households. That would not be nice (and it also would be politically toxic), so they needed some offsetting tax cut. And since low-income households generally don’t pay any income tax because of deductions, exemptions, and credits, repealing the payroll tax was the only way to address this concern about fairness for the less fortunate.

P.P.S. Since we have a “pay-as-you-go” Social Security system, with benefits for current retirees being financed by current workers, some people inevitably ask how those benefits will be financed if younger workers get to shift their payroll taxes into personal retirement accounts. That’s what’s known as the “transition” issue, and it’s a multi-trillion-dollar challenge. But the good news (relatively speaking) is that coming up with trillions of dollars over several decades as part of a switch to personal accounts will be less of a challenge than coming up with $40 trillion (in today’s dollars) to bail out a Social Security system that is actuarially bankrupt.

P.P.P.S. It goes without saying (but I’ll say it anyhow) that class-warfare taxation is Obama’s (and Hillary’s) ostensible solution to Social Security’s shortfall.

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