Tyler Cowen from Marginal Revolution wrote a much-discussed piece this week ("Is There a Case for a VAT?") about a value-added tax (VAT).  I would read that first before continuing to read this, which should be considered ATR's rebuttal.

• If there's a fiscal boogeyman, it's not taxes.  Federal taxes have averaged about 18 percent of GDP since 1960.  According to the Obama budget, they will equal 19.6 percent in the tenth year of his budget policy.  In other words, taxes are not too low.  A case can be made that taxes under the Obama budget (or current law) are already too high.  Even under a "full extension" tax plan (Bush tax cuts, AMT patch indexed, extenders) taxes only revert back to their historical average of 18 percent of GDP
• The fiscal boogeyman is spending.  Spending as a percent of GDP has averaged about 21 percent of GDP since 1960, creating a structural deficit average of 3 percent of GDP (21 minus 18).  Yet, the Obama budget calls for a year-10 spending level of 23.7 percent of GDP.  Spending is the source of the long-term budget imbalance, not taxes.  If spending was to end up at its historical levels, we'd be pretty close to a balanced budget by the end of this decade
• Cutting spending as a percent of the economy is very realistic.  Cowen points out that it is too politically-difficult to cut spending.  I agree.  Congress isn't set up to do that.  However, the 1992-2000 period shows us how limiting spending to less than the rate of nominal GDP growth can have profoundly free-market results.  When the first President Bush left office, federal spending was 22.1 percent of GDP.  Republicans stymied the Clinton agenda, took over Congress, and stopped the big-spending Clinton agenda in its tracks (Clinton's presence avoided the unchecked spending excesses of the Republican-only era of this decade).  Spending fell all the way to 18.2 percent of GDP in 2000 and 2001.  This was a monumental achievement for less government.  How did it happen?  Simple--the government grew at a slightly slower rate than the economy grew.  We can do that again, probably with a GOP House and a Democrat President.  This is not ancient history.  It's the 1990s.  This is the model to shrink Washington.  Boil the lobster slowly.
• There is no "credible bipartisan deal" for a VAT and spending restraint.  This is a fantasy of politically-disconnected policy wonks and the mainstream media.  Every time tax increases have been on the table with spending restraint (TEFRA 1982, the 1990 "Read My Lips" Andrews Air Force Base deal, etc.) the spending cuts didn't materialize.  The tax hikes sure did.  This "deal" would be no different.  We'd end up with phony spending cuts and a VAT.  And, as Dan Mitchell from Cato has amply pointed out, a VAT killed Europe's economy in the second half of the last century.

So, there's our rebuttal.  Higher taxes are not needed (in fact, scheduled tax hikes need to be scrapped, and pro-growth tax cuts put in place to make sure we get enough GDP growth).  On the spending side, don't spend the rest of the stimulus bill.  Don't re-spend TARP.  Back out some of the waste from the Bush-Obama-Pelosi-Reid spending spree.  But mostly rely on the 1990s divided government strategy.  Grow the government, but less than you grow the economy.  We can all take a deep breath and move on with our lives.

UPDATE: Tyler Cowen emailed me to clarify that his first preference is spending cuts, and he does not endorse a VAT.  This is made abundantly-clear in his post, which should be read prior to reading this rebuttal.

Posted by Ryan Ellis on Thursday, February 18, 2010 11:53 AM EST

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