The 15% (of GDP) Solution

The 15% (of GDP) Solution
July 8, 2016

(This item originally appeared on July 8, 2016 at Forbes.com)

http://www.forbes.com/sites/nathanlewis/2016/07/08/the-15-of-gdp-solution/#443e289051c6

“The problem with the supply-siders,” I have had several people tell me recently, “is that they claim that, after a tax reform, tax revenue/GDP will be stable, and revenue will actually go up.” This used to be a good thing. Now it is a bad thing.

I am amazed to find this new consensus forming: that the Federal government is simply much too big, and that the last thing we want to do is actually give it more money – the increased revenue that comes from something like a flat-tax reform and ample growth. More money just means more waste and more corruption.

I actually agree with this. In the last chapter of Gold: the Monetary Polaris, I suggested a plan for “21st century capitalism” in which the total U.S. government (Federal, state and local) amounts to 18% of GDP, from about 28% today. This model has already been demonstrated by several successful states, with Hong Kong perhaps my favorite example. Hong Kong has a revenue/GDP ratio of 13%, but also has universal healthcare, a small welfare system, state schooling, public libraries, parks, universities, and all the other government services that most people consider desirable today.

So, how would we get there? Lower taxes, obviously. But, the general pattern over history has been that revenue/GDP is actually quite stable. Twenty years of continuous tax-cutting in Japan, 1950-1970, did not reduce the revenue/GDP ratio. Giant tax cuts in Russia 2001-2008 — including a 13% flat tax, a cut in the VAT to 18% from 23%, a reduction in corporate taxes to 20% from 35%, a payroll tax cut to 24% from 35.6%, and the elimination of inheritance and gift taxes — did not reduce the revenue/GDP ratio. Nor did it go down in a dozen other flat tax-adopting countries I looked at. Revenue/GDP didn’t go down during the Reagan or Thatcher tax reforms, or after the Kennedy tax cut, or during the Harding/Coolidge reforms of the 1920s.

Between 1998 and 2008, Bulgaria reduced its top personal income tax rate to 10% from 50%. The corporate rate fell to 10% from 40%. The payroll tax rate fell to 31.7% from 43.6% (still high), and the VAT was unchanged at 20%. During those ten years, tax revenues more than tripled (+208%), and the tax revenue/GDP ratio rose to 38.3% from 34.8%.

You see? It’s not so easy to reduce revenue as you think. It’s hard even to make the revenue/GDP ratio go down.

So, if you really think you are going to reduce the total U.S. government tax revenue/GDP ratio to perhaps 15%, you better get real serious.

At a 15% revenue/GDP ratio (for the total U.S. government), something like a unified sales tax (“fair tax”) becomes a lot more feasible, in my opinion. No more income or payroll taxes. I personally would prefer a two-part indirect tax, perhaps a broad tax on fossil fuels combined with a sales tax with a lower rate. But, I am a bit of a greenie. Hong Kong goes the other way, with a “flat” income tax, but no sales taxes.

It seems a little silly to talk about such things, when it seems so politically difficult to enact even minor tax reforms in the U.S. But, the Republican presidential primaries turned into a game of “can you top this?” regarding tax reform. Major change is in the air.

So, I suggest that U.S. conservatives start to think about what they really want. Not just minor tweaks to the existing arrangement, but a total top-to-bottom reform. The “fair tax” idea was one half of this – a total rewrite of the taxation side, but maintaining the status quo in terms of spending.

I suggest a total government budget of 15% of GDP. How would this be split up? Would it be 5% local, 5% state, 5% Federal? Or something different? What programs would it support? Then: what kind of tax code would be the best way to pay for this?

Unfortunately, even reducing the revenue/GDP ratio to 15% probably wouldn’t make actual tax revenues go down. They would probably go up, within the span of only a few years, unless the economy was crushed by some kind of extraneous factor, like a Federal Reserve nominal GDP target of 3.65%.

Think about your own 15% Solution. What kind of tax system is needed, and where does the money go? As the existing arrangement gradually disintegrates, and new arrangements are made, you might actually get what you want.