Pelosi Planning Huge Mistake

I love Ronald Reagan, as do you. But Reagan made two mistakes. One he’s admitted -- the illegal alien amnesty. The other took longer to become apparent. Now Pelosi seems intent on undoing that mistake by making her own version of that mistake. Hmmm. Read on my friends. . .

The second mistake Reagan made was the tax reform he enacted in 1986. From an economic perspective, this was a great reform. It eliminated some tax brackets, flattening the tax structure, and lowered the capital gains rate. That reduced some of the distortions of the tax code and spurred the economic growth that we’ve continued to enjoy until pretty much last year.

But within that success lay a political disaster. As a result of those reforms, millions of people came off the income tax rolls. Economically, that’s a good thing. But politically, it created a problem. People who don’t pay taxes have no incentive to keep the size of government under control. To the contrary, they have an incentive to increase the size of government because it doesn’t cost them anything. Thus, by taking millions of Americans off the tax rolls, Reagan accidentally created a class of people that had nothing to lose from an increase in the size of government!

And that class has been growing. Indeed, the number of Americans who pay no income tax has risen from 15% in 1985 to 40% today. Add in the fact that just over 52% of Americans now receive a check from the federal government, and you’ve got the makings of a “pro-government-growth” constituency.

But if Nancy Pelosi has her way, this problem may be about to correct itself. Over the past few weeks, the left, i.e. Pelosi and many within the MSM, have begun talking about “the need” for a value added tax.

A value added tax is like a sales tax, only the product is taxed at every stage of its production rather than at the point of sale. Said differently, whereas a sales tax is paid once -- by retail consumers, a value added tax is paid by each business that participates in the creation of the product or service. Each business is taxed on the “value it adds” to the product. Since businesses don’t pay taxes, they pass those along to consumers by rolling those taxes into the price of the product as it moves along the production chain.

Economically speaking, a value added tax is a good method for raising taxes. It doesn’t distort people’s incentives to work, like an income tax, nor does it distort their consumer behavior, like targeted deductions. It is also much less intrusive than an income tax. Thus, economically speaking, a value added tax is far superior to an income tax.

But the downside with a value added tax is that it is an easy tax to raise because consumers don’t see it. They only see the final price of the product, they don’t see where it was taxed at each stage of production. And while this could be countered with a requirement that all products identify the total tax paid, consumers still are a notoriously difficult group to organize against bad governmental decisions. A case in point is sugar subsidies, which harm all consumers and which everyone agrees should be eliminated. But because consumers are a diffuse group and the sugar industry is a determined lobby, no one has been able to gather the political muscle needed to eliminate those subsidies.

In any event, if I had a choice between an income tax and a value added tax, I would probably lean toward the value added tax, with certain safeguards. But Pelosi isn’t talking about replacing the income tax, she’s talking about adding a value added tax to the income tax. This, I cannot support.

Anyhoo, here’s the interesting bit about what Pelosi is trying to do. She wants a value added tax. But a value added tax hits all consumers. Thus, she’s working hard to pass a tax that will suddenly smack right in the face that 40% of Americans who currently pay no income taxes. What does this mean? It means, that if she passes this, she’s going to undo Reagan’s 1986 mistake by taking this “pro-government-growth” constituency and making them pay for the services they get. God bless her little black heart.

What’s even more interesting is that a value added tax smacks all consumers equally. That means that the tax is “regressive” in that it takes a larger share of poor people’s income than it takes from rich people. This is not going to make the “pro-government-growth” constituency happy at all. Indeed, even if they exempt food and medicine, for example, this constituency will suddenly find that cars, clothes, DVDs and consumer goods are 20% more expensive.

And here I thought liberals cared about poor people?

Interesting times ahead.