Monday Smackdown: The Elementary Arithmetic of a Value-Added Tax (VAT)

It would be nice if I could start off October with another real DeLong smackdown: an incisive critique of a place where my argument has been wrong, or at least pathetically incomplete and one-sided.

But it is not to be: the environment is just too target-rich.

Somebody who wishes me ill sends me a link to Paul Gigot and Gerry Baker's execrable Wall Street Journal, and provokes me into clicking it. It is John Cochrane from Stanford's Hoover Institution: claiming a hypothetical tax rate is 20%, when five minutes' thought gets 42.9% as the true number:

John Cochrane: Tax Consumption Through a VAT, and Voilà "If the administration and Congress drop the income tax, it won’t be difficult to achieve 3% growth...

...It is easy to make a value-added tax progressive: In place of current exemptions, send everyone a 10,000 dollar check.... What about the tax rate? Well, if the federal government is going to spend 20 percent of gross domestic product, the VAT will sooner or later have to be about 20 percent...

Innumerate. Incompetent. I--------. I------. I-----. I-----. O------. O-------------. U---------. Unprofessional.

Sending each of our 330 million people a 10,000 dollar/year check to make the value-added tax progressive is 3.3 trillion/year. That is 16.5 percent of our 20 trillion/year GDP. Thus the gross share of GDP that Cochrane's value-added tax thus has to raise is not 20 percent but 36.5 percent of GDP.

And no value-added tax is levied on GDP. GDP is not the tax base. The value-added tax is, as Cochrane says, levied on consumption spending. Private consumption spending is 70 percent of GDP. Public consumption spending is another 15 percent of GDP.

What would the VAT rate have to be? If it were to be levied on a tax base of full private plus government consumption spending: 42.9 percent:

needed_net_revenue = 0.2               # as a share of GDP
progressive_offset = 10 * 330/1000     # in <span>$</span/year
progressive_offset_share = (
    progressive_offset/20)             # as a share of GDP)
personal_consumption_spending = 0.7    # as a share of GDP
government_consumption_spending = 0.15 # as a share of GDP

total_revenue_share = (needed_net_revenue 
    + progressive_offset_share)

tax_rate = (total_revenue_share
    + government_consumption_spending))

print(str(round(100* needed_revenue, 1)) + "% : needed revenue")
print(str(round(100 * (personal_consumption_spending + 
    government_consumption_spending), 1)) + 
    "% : personal plus government consumption spending")
print(str(round(100 * tax_rate, 1)) + "% : tax rate")


36.5% : needed revenue   
85.0% : personal plus government consumption spending   
42.9% : tax rate

Not a 20 percent tax rate. A 42.9 percent tax rate.

"Why is he doing this?" people ask—well, person asks—me.

Person goes on: "Wasn't John Cochrane, in his youth, both smart and careful? Didn't he make his reputation by conclusively demonstrating that an assumption that had been sold as a mere harmless technical assumption—that time series could we well-modeled by low-order ARIMA processes—in fact committed you to asserting that you had very precise estimates of important long-run properties of time series that were, in fact, unidentified?"

Well yes, I say. And, I go on, I remember a conversation I once had with the extremely smart and careful Jim Hines of UMich. We were both praising Cochrane's Asset Pricing "I read that", he said, "and I think: 'Maybe someday I will be able to write a book as good as that'. And then I think: 'Naah. I could not...'"

But that was long ago, and in another country, and besides, the Braineater has struck...

I find myself reminded of something the immensely knowledgeable Amitabh Chandra tweeted a couple of weeks ago:

GOP choked on health care reform because it lacked a bench of serious technocrats. Tax-reform is much harder...needs even more technocrats... There is a huge opportunity to rise to the very top in GOP policy making if one invests in learning economics and analytical public-policy... [But] one has to say whacky things in order to appease ones masters and stay relevant...

But "whacky" does not have to mean you descend all the way to "innumerate". It does not. Does it?

Do one's political masters really thank one if they read one's op-ed and get a "20 percent rate" into their skulls, and then the revenue estimators at JCT and TTP come back with: "No. Not 20 percent. 42.9 percent."?

The appeasement of one's political masters from this degree of innumeracy is short-term, isn't it? Leaving one's political masters high-and-dry is not a road to relevance, is it? They have memories of who has led them astray in the past, don't they?

And then there are the norms of academia.

Yes, academics are free to think and say wherever their brains lead them—that is what academic freedom is for.

But academic freedom does have limits.

In the late-1940s Berkeley Professor Ernst Kantorowicz claimed that academics are responsible only to "their conscience and their God" for what they teach. But one of principal tasks of a university is to teach the young that such a responsibility to one's conscience and one's good is an awesome one—not a get-out-of-jail-free license to play political dingbat kabuki. And one of the principal responsibilities of departments, deans, provosts, chancellors, and presidents is to hire only those of the old who have internalized that responsibility to their conscience and their God, and take it seriously.

And academics are also responsible to their peers, who need to provide moral suasion, take their colleagues out for coffee, and ask them if they really have consulted "their conscience and their God".

Where does the urge to divide 20 by 100 when even five minutes' thought would lead you to recognize that you should be dividing 36.5 by 85 come from?

What are we supposed to do with that?

And what do the Wall Street Journal and Stanford University's Hoover Institution think that they are doing? Yes, I know that as Irving Kristol laid down the party line forty years ago:

The task... [is] to create a new majority... a conservative majority... a Republican majority-so political effectiveness [is] the priority, not the accounting deficiencies of government...

But do the Wall Street Journal and the Hoover Institution really want to be in the business of rejecting not just reality but basic arithmetic as having a left-wing bias? And does Stanford University really want to be in the business of housing a Hoover Institution that chooses to be in that business?

And, no, a value-added tax would not automagically get us back to 3 percent per year growth in real national income and product.

I must, say, this whole mishegas is profoundly depressing.

One of the minor elements: At the level of this weblog: This "Monday Smackdown" feature can function properly only if balance is maintained—roughly one-third people smacking me down, one-third me watching somebody smack down somebody else, and one-third me smacking down somebody who eminently deserves it. The problem is that this is such a target rich environment.

Last week, however, I managed to restrain myself. The feature was a Noah Smith critique of my view of Milo and company's using the Berkeley Campus as a backdrop for their game of dingbat kabuki.

It wasn't really a smackdown, but it was close enough.

And when I couple it with Dean Baker's OPPOSITION TO TRADE DEALS: BRAD DELONG'S "SOCIALISM OF FOOLS" MIGHT LOOK LIKE COMMON SENSE TO THOSE OUTSIDE THE FRATERNITY, I can hold my head up and say that I managed to get one real DeLong Smackdown in each of August and September.

(Plus in June and July I managed:

So it would be nice if I could start off October with another real DeLong smackdown: an incisive critique of a place where my argument has been wrong, or at least pathetically incomplete and one-sided.

But it is not to be: the environment is just too target-rich.