I agree with IMF. Consumption must be more taxed.

Last year, the International Monetary Fund introduced a new regular report called the Fiscal Monitor. It provides a lot of useful data on fiscal conditions in various countries and how they are dealing with the massive run-up in debt we have seen over the last couple of years.

The latest report presents some new estimates on the impact of a rise on the debt/GDP ratio. Previously, the IMF staff had estimated that a 10 percentage point rise in the debt/GDP ratio would lead to an increase in long-term real interest rates of 50 basis points (one percentage point is 100 basis points). With the US debt level projected to rise from about 60 percent of GDP before the crisis to almost 110 percent of GDP in 2015, according to the IMF, this suggests that we can expect real interest rates to rise by 2.5 percentage points over the next five years. (Keep in mind that any rise in inflationary expectations will raise nominal rates by the amount of the expected inflation in addition to the rise in the real rate.)

The IMF’s new estimates look at the impact on economic growth of a rise in the debt/GDP ratio. The results show that a rise of 10 percentage points in the debt/GDP ratio reduces the growth of real per capita GDP by 0.15 percentage points per year in advanced economies. This suggests a decline in the growth rate of real per capita GDP of 0.75 percentage points over the next sever years. This results mainly from a decline in productivity growth due to a decline in investment and slower growth of the capital stock. The IMF estimates that a 10 percentage point rise in the debt/GDP ratio reduces investment by 0.4 percent of GDP per year.

For many years, economic debate in the US has focused almost exclusively on the impact of taxation on growth. This has tended to push other factors off the policy agenda. But in coming years we are going to have to confront the reality that the debt is also an important factor. Since the debt is the accumulation of past deficits, reducing future deficits will have only a modest effect on the debt/GDP ratio. Moreover, to the extent that rising debt reduces growth it will be harder for us to grow our way out of our debt problem.

At some point, we must confront the fact that higher revenues will be necessary to stabilize the debt and raise growth. Although right-wingers will insist that even the tiniest tax rise will devastate growth, it should be remembered that they made exactly this same argument in 1993, the last time there was a significant tax increase. They were 100 percent wrong; the economy boomed instead of crashing.

To be sure, the means by which revenues are raised is critical. Raising income tax rates more than already projected would be a bad idea, although new research by Anthony Atkinson and Andrew Leigh suggests that there is still a lot of potential revenue available from taxing the rich even accounting explicitly for Laffer Curve effects.

The IMF suggests—and I agree—that it would nevertheless be preferable to raise additional revenue by taxing consumption. The best way of doing so would be by imposing a value-added tax. The IMF estimates that 10 percent VAT could raise revenues equal to 4.5 percent of GDP. If we don’t raise the additional revenue that is inevitably going to be raised in this way, it is a certainty that it will be raised in ways that will be far more debilitating to growth.


Tagi