Friday, August 31, 2012

Is there any other option?

From $1.4 trillion in 2009, the US fiscal deficit is projected to hit an alarming $1.6 trillion this year. One alternative that perhaps can save US from collapsing is the implementation of a nationwide VAT. by Manish k. Pandey

Though it has been almost a year since the so-called ‘green shoots’ of recovery started showing up on the US soil (GDP grew at 1.6% in Q3 2009 for the first time since 2008), they still don’t seem to holding onto the ground firmly. Not only have they started turning pale (US Q2 2010 growth is to be revised sharply, lower to 1.2%, from 2.4% originally), but nurturing them for long is also now deteriorating the nation’s long-term fiscal health. In fact, the US fiscal deficit that has ballooned with the recession is now slowly turning out to be a major threat to its long-term economic sustainability. From a colossal $1.4 trillion (9.9% of GDP) in 2009, the fiscal deficit is projected to hit an alarming $1.6 trillion (10.6% of GDP) this year, the largest since World War II. What’s more? The gross federal debt too is poised to stand at $13.8 trillion by the end of 2010 (US Office of Management and Budget) making the situation critical.

The simple reasoning – that the nation has just come out of the worst economic downturn since the Great Depression, and the bailout programmes including the Troubled Asset Relief Program (TARP; As of April 2010, estimates of its cost to the government had come down to $89 billion from original $356 billion) and the American Recovery and Reinvestment Act (ARRA) have made this dent – also does not come to the rescue of the policy makers. A Moody’s Economy.com analysis of US Budget data reveals that the deficit in 2009 still would have been $1.2 trillion, even without the TARP and ARRA.

To put it simply, the US economy faces a biting budget deficit, and fixing it will not be easy for Obama administration. Raison d’être: Most of the government spending is dictated by several laws and entitlement programmes whose cost grows automatically, without annual authorisation from Congress. Other major portions of the budget too go in paying for defence and interest on the national debt, both of which are also largely beyond government’s control (see chart).

Well, one option is to tax the rich. But here the numbers backfire. Top tax rates in US are already at around 40% and an increase above that would prove counterproductive. Even if that happens, the revenue generated will not be enough to repay the $13.8 trillion debt. Similar is the case when it comes to taxing big business. The US corporate tax rate (at 35%) is already among the highest in the world and raising it further would reduce the competitiveness of US firms. Another option is to cut spending. But that too isn’t happening anytime soon. A major portion of federal spending is on social security programmes, medicare, et al, which are all set to rise sharply as baby boomers retire. So if not these, what’s the alternative?

One that perhaps can solve the problem is the implementation of a nationwide value-added tax (VAT). As VAT has a broad base, it could generate enough revenue to deflate the ballooning deficit while simplifying the tax code. And since VATs are already in use in most of the countries across globe (about 150 countries have a VAT, with tax rate ranging from 5% in Japan to 25% in Sweden), implementing it in US too would further harmonise global business rules and reduce trade frictions. 


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