Payback TimeMany See the VAT Option as a Cure for Deficits

The value added tax (VAT) has been around for decades in other countries. It is predicated on the  idea that ALL people should share in the cost of government. The way it works (see below) is that the government picks up 10% (for example) of each stepof the production and sales process. It is normally reserved for hard goods instead of services.

I think that is is the only good idea around topay down the deficit IF it is applied to Wall Street. In addition to raising money it would force all intermediaries to report every transaction and their profit on it. It would force them todeclare the profit (VAT) and pay the income taxes from the fees and profits.

Let’s look at the way this would work in the derivative market. Better yet let’s look at the derivative market over the last 10 years. Maybe you’ll fee outrage when you read this somewhat over simplified version of the way things REALLY work. 

  1. Mortgage Bonds are sold  to investors by a “seller.” Who gets the selling fee? How much was it? Where did it go? Even under current rules most of this money went untaxed for income tax because by playing the shell game cleverly you can create a question of tax jurisdiction and end up paying no tax and  not even reporting it.
  2. The Seller of the mortgage bonds (and a percentage interest in the underlying notes and mortgages) received a stack of certificates from the Special Purpose Vehicle (SPV/Trust)at a cost of  less than what the certificates were sold for. The great thing for the seller is that the Selling Agent is allowed to “sell forward” to investors, thus knowing exactly6 what his profit is going to be when he takes the stack of bond certificates. The VAT tax would apply here and perhaps result, heaven forbid, in a double tax of VAT and income taxes. Criminal law enforcement could beeefed up on the VAT so that the intermediary parties in the securitization chain have nowhere to hide — if the government does its job in enforcement which would mean training special VAT agents who can understand the workings of securities transfers on Wall Street and can enforce the jurisdicitional issue thaty has been the favorite tool of investment banks working both sides of the Atlantic and Pacific.
  3. The SPV has received an assignment (of dubious legality) from an aggregator pool. It is paying a huge premium over the true value fhe pool, and thus, so are the investors who buy the bonds. In the presence of a government doing its job to enforce tax liability —VAT and Income Tax — the fraud of the entire mortgage meltdown wouldhave been exposed, the government would have taken possession of the investment banks running these pools, and taxpayers would have received in their coffers huge amounts of money paid in taxes from this yield spread premium. But alas,Wall Street continues to get its way and this is considered no a profit or a fee but instead it is either not shown at all as this yield spread profit from sale of ggregator to SPV or it is actually shown as an expense. On an average basis the YSP on the sale from aggregator to SPV was about 80% of the mortgage funding amount. This is where the toxicity of the mortgages and notes was hidden.
  4. And then you continue down the line with the usual undisclosed YSP between mortgage broker and”lender” (actually a straw man through whom the transaction passes etc.

If you put pencil to paper you’ll see that Wall Street didn’t  just dodge responsibility for the mess they created, they dodged the taxes too. If the government was enforcing our existing tax laws through this process, the entire stimulus and other lines of credit from the Federal government would have been paid by the culprits who did this to us.

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December 11, 2009 Payback TimeMany See the VAT Option as a Cure for Deficits By CATHERINE RAMPELL Runaway federal deficits have thrust a politically unsavory savior into the spotlight: a nationwide tax on goods and services. Members of Congress, like their constituents, are squeamish about such ideas, instead suggesting spending cuts or higher taxes on the rich. But with a lack of political will to do the former, and a practical ceiling to how much revenue can be milked from the latter, economists across the political spectrum say a consumption tax may be inevitable once the economy fully recovers. “We have to start paying our bills eventually,” said Charles E. McLure, a tax economist who worked in the Reagan administration. “This strikes me as the best and most obvious way of doing it.” The favored route of economists is known as a value-added tax, which is a tax on goods and services that is collected at every step along the production chain, from raw material to a consumer’s shopping bag. Similar to a sales tax, it generally results in consumers paying more for the things they buy. The revenues could be used to pay for health care or other social programs, or just to pay down existing debt. Like universal health care, every other industrialized country in the world already has a value-added tax (as do about 100 emerging countries). And also like universal health care, this once-taboo policy option has recently been invoked, at times begrudgingly, by many prominent Washingtonians, including the House speaker, Nancy Pelosi; John Podesta, who was co-chairman of President Obama’s transition team; and two former Federal Reserve chairmen, Alan Greenspan and Paul A. Volcker Introducing such a tax would probably require an overhaul of the entire federal tax code, no small order, and something the government last did in 1986. At the time the goal was to simplify the tax system, to raise money more efficiently and with fewer headaches for taxpayers. Since then, federal spending has ballooned, while the government’s ability to raise taxes has become increasingly inefficient. Consider the page length of the tax code and tax regulations, which has expanded by more than 70 percent, according to Thomson Reuters Tax and Accounting. (There are more words crammed onto each page, too.) The tax system is now a compendium of lobbied-for ifs, ands and buts. As the tax code has been embellished and then Swiss-cheesed, the portion of Americans footing the nation’s income tax bill has shrunk. “There are many more deductions and credits, which can often encourage inefficient behavior such as tax shelters,” said Leonard E. Burman, a public affairs professor at Syracuse University, about the changes to the tax system since the 1986 reform. “The ideal tax system has a broad base — few deductions or exemptions — and low rates.” Most of the rest of the industrialized world — including, most recently, Australia — has already taken this lesson to heart by imposing value-added taxes. Unlike income taxes, which are often front-loaded on the rich, then subsequently diluted, a value-added tax is paid by almost everybody. That broad base is one of its major advantages, and why the International Monetary Fund frequently recommends it to countries that need to raise money quickly. What is good for economic purposes, however, can be bad politics, especially since Mr. Obama pledged not to raise taxes on the bottom 95 percent of Americans. (And many Republicans have pledged not to raise taxes on the bottom 100 percent of Americans.) The value-added tax is also the darling of many economists for its bounce-a-quarter-off-its-abs efficiency. Its administrative costs to the government are generally low. It is also considered less of a drag on the economy over the long run than raising income taxes, which discourage people from saving money and thereby making capital available to businesses. To understand why a value-added tax is considered so efficient, you have to understand how it usually works. Imagine the production of a new dress, in three steps: ¶A fabric store sells a tailor enough silk to make one dress, at a total price of $10 before taxes; ¶The tailor sews a dress and sells it to Macy’s for $30 before taxes; ¶Macy’s then sells the dress to a shopper for $50, before taxes. Let’s say the value-added tax is 10 percent. The government will collect some tax revenue in each step of the production process, from roll of fabric to cocktail-party scene-stealer, but each business in the chain gets credit for the tax already paid by other suppliers. When selling the cloth to the tailor, the fabric store adds a tax of 10 percent, or $1 on the $10 of supplies the tailor purchases. The tailor pays the fabric store $11, and the store remits $1 to the government. When the tailor sells his dress to Macy’s, he calculates the value-added tax as $3, or 10 percent of his $30 pretax price. Macy’s pays the tailor $33. But instead of sending the full $3 to the government, the tailor gets to subtract the $1 of taxes he had already paid to the fabric store. So he sends $2 to the government. When Macy’s sells the dress to a shopper, it adds another 10 percent, so the shopper pays $55, or $50 plus $5 in tax. That would be in addition to any state or local sales taxes consumers have to pay, depending on the locale. Macy’s checks to see how much the previous companies in the supply chain — the fabric store and the tailor — have already paid the government in value-added taxes, and subtracts that from the $5. Macy’s ends up remitting just $2 to the government. The government receives $5 total, or 10 percent of the final purchase price, but from three different businesses. Although more complicated, value-added taxes are considered better than equivalent sales taxes — where the tax is levied only when the consumer buys a product — for two main reasons. First, if a single business evades the value-added tax, the government does not lose a large portion of money, because it will collect taxes at other stages of production. Since companies usually get credit for taxes already paid by their suppliers, companies will pressure other businesses in the production chain to prove they paid their taxes. That means the system is somewhat self-policing. To some foes of big government, though, the efficiency of the tax is also its fatal flaw. Conservatives worry that it enables the government to raise money with such little effort that it will encourage Washington to spend even more. On the other hand, liberals are wary of value-added taxes because they are regressive. Poor people spend a higher portion of their income buying things than the rich, meaning lower-income people would be disproportionately hurt. That is why countries often make other major changes to their tax code at the same time. In Australia, the government imposed a value-added tax in the middle of an overhaul of the system in 2000, which included making the income tax system more progressive. “Many countries with VATs have income taxes that start out at higher income thresholds,” said James Poterba, an economics professor at M.I.T. Combining a broad-based VAT with a steeply progressive income tax, he said, avoids affecting the poor too much. But just as the income tax has been hollowed out by countless loopholes, so could a value-added tax. Many European countries, for example, have counteracted the regressive qualities of the tax by exempting broad categories of goods, like groceries and children’s clothing. This always creates problems, economists say. Companies are tempted to mislabel their products so they can avoid the tax. “What really is the difference between prepared food versus nonprepared food?” said Alan J. Auerbach, an economics professor at the University of California, Berkeley. “You start having to split hairs, and that can become quite complicated.” Besides cheating the government of revenue, this sort of behavior also distorts what people choose to buy, causing a drag on economic development, Mr. Auerbach said. Moreover, in some industries — like financial services — it is difficult to evaluate how much value is added because of the way they make their money. The solution in many places, like New Zealand, is to exempt the financial services industry. But that might not go over well in a country whose federal debt has recently swelled precisely because of a major banking crisis. Such political hurdles, along with a still-tentative economic recovery, make a consumption tax — or a tax increase of any kind — unlikely in the immediate future. But with economists like Kenneth Rogoff of Harvard predicting that federal tax revenues will need to rise by 20 to 30 percent in the next few years, politicians may hold their noses and decide this tax is the least worst option. “Of course, we want to take down the health care cost, that’s one part of it,” Ms. Pelosi told Charlie Rose of PBS. “But in the scheme of things, I think it’s fair to look at a value-added tax as well.” Kitty Bennett contributed reporting.

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