Bottom Line: Sum of Debate Will Be New Kinds of Taxes

What’s the real bottom line amid all the confusion about taxes? Short term, it’s for more political hokum, and long-term for a significant new kind of tax that many experts argue will do the economy good. Hope springs eternal, as they say.

Income tax changes will be slight for most people but a number of weird and pesky taxes will be tried as financing of government--local and federal--moves from today’s impasse to a new and grander scale.

Tax questions reflect a time of profound change. The income tax system, which financed the postwar period, has reached the limits of its usefulness. In the next few years, Americans will be making fundamental decisions about how to pay for the government they want and the society they’ll pass on to future generations.

Right now, however, taxpayers are simply worried about what additional taxes will be needed to finance health care reform. And the Clinton Administration is not calming their fears by suggesting that “sin” taxes on tobacco and alcohol could pay for the health program. Because that’s not true.

A $1-a-pack cigarette tax, as was proposed in Congress last week, might bring in $8 billion--where $90 billion could be needed to provide health coverage for 37 million uninsured Americans. Indeed, sin taxes will yield diminishing returns--as more smokers give up cigarettes and more cigarettes are smuggled or sold with counterfeit tax stamps. Federal agents would have to be hired to combat illegal activity.

The years ahead could be quarrelsome. As Clinton’s program delays spending cuts but pumps out more than $100 billion in new spending for highways and Head Start, there will be a reaching out for revenue. The Treasury Department has already studied the idea of taxing the theoretical rental value of your home--a tax on wealth instead of income.

That theory may never become practice, but some change is likely in estate taxes--perhaps a lowering of the $600,000 exemption on what can be passed to heirs. The resulting revenue might be used to finance long-term care for the elderly, a growing need.

However, such tax moves, while they may arouse controversy, won’t bring in really big money. And Clinton’s tax hikes on high-income individuals, slated to bring in $34 billion, will also reopen the door to tax shelters and maneuvering. The contradictions are a sign that “we’ve gone as far as we can go with the income tax,” says a Washington expert.

So a new kind of tax is looked for. And the emerging favorite--mentioned by Clinton himself in offhand remarks last month--is a consumption tax.

As the name implies, the aim is to tax spending and not saving. For the consumption tax introduced by Sens. Sam Nunn (D-Ga.) and Pete Domenici (R-N.M.) you would add up your gross income, subtract all savings, investments and income on saving, and pay tax on the rest--after deductions for mortgage interest or school tuition or whatever is allowed. Details remain to be worked out.

More common and widespread is the value added tax, in which a tax is levied on the value added at every stage of production--iron ore to steel, a tax, steel to automobile part, a tax, auto part to finished auto, a tax and so forth. In service businesses, taxes are added onto legal fees, accountants’ charges, etc.

Ultimately, the value added tax reaches the consumer, who pays it. But there is no tax on savings or income from savings in the VAT system. The aim is to build up capital for society to invest and expand, explains Lawrence Stone, partner in the Los Angeles law firm Irell & Manella, and a tax expert who first advised the U.S. Treasury in the Kennedy and Johnson administrations.

One big reason we are not building capital today is the $300-billion budget deficit, which borrows from tomorrow to pay current needs. Investments in Treasury bonds are used to pay for Medicare and soldiers’ uniforms--and interest on the growing debt.

A VAT could pay down the deficit fast because the money would be huge. “A VAT would bring in $35 billion for every percentage point of tax,” says Charls Walker, an influential Washington consultant and deputy Treasury secretary in the Nixon Administration.

A 5% VAT would bring $175 billion to the federal government, and a slightly larger VAT would produce revenue for the cash-strapped states.

But raising a big new tax would not eliminate the need to cut expenditures. On the contrary, if we levied a VAT and went on spending as usual, the result would be highly inflationary.

There are other perils. The VAT, because it is built into the cost of production, can be like carbon monoxide, an unseen killer. It is an awesome tool for government because politicians can adjust to favor one product or business over another.

“The virtue of a VAT right now is that it’s a fresh approach,” says Stone, “but in 10 years it would become encrusted with exceptions, as our income tax did.” So we’re likely to hear debate about value added taxes this year, and get closer to actual tax laws in the next two years.

Another virtue is that at least a VAT--unlike “sin” taxes--would represent a real attempt to pay down the deficit and deal with the challenges facing America. Prominently, we need money to educate a work force, unite a diverse society and prepare for the truly aging American society that will be upon us in the next century.

The debates about taxes are really about priorities--and setting them is the bottom line.